Understanding Entity Theory And Residual Equity Theory Is Crucial For This Essay.

Search the Swinburne Library databases (e.g. Business Source Complete) for quality* accounting journal articles (dated 2017) that adopt one or both of your chosen theories until you have four (4) such articles (at least two for each theory). 

Write your Report for the intended audience, explaining each theory and how it is relevant to the study described in the article and its findings, integrating your narrative where possible so that you do not just create a list of the studies. (Hint: skip the statistics [unless you are expert in statistics] and use the article’s narrative to understand what the research did and its findings.) *Refer Australian Business Deans Council (ABDC) journal rankings available.

Explanation of Theories

This study mainly focuses on the accounting theory along with its importance in different business organizations. Generally, companies are developing their financial background to provide quality products in the market. At the same time, appropriate finance or accounting is helping organizations to measure and control the cost, which assists in making a reasonable profit from the market. Through the study, two theories have been taken into consideration, which includes entity theory and residual equity theory.

Contextually, entity theory can be justified as a conjecture, which reflects potential economic activities of an organization within a specific market. However, the owners of the businesses are not related or responsible for the changes, thus accountability has been changing automatically due to economical along with market constraints. On the other hand, the residual equity theory is a process of assuming shareholders. Through this theory, shareholders of organizations have been treated as an owner and they have faced every organizational situation such as profitability and loss (Academic, 2017).

The main purpose of this study is providing information regarding the aforementioned theories. The study also focuses on highlighting the ways that the above-mentioned theories can develop its performance. At the same time, the process of the implication of these theories within the organization and its influence has also been elaborated within this study. Thus, an organization is facing various issues regarding, economy, market price, shareholders dividend, share price fluctuations, budget making, and others. Hence, these issues can affect the business of any organization. Simultaneously, organizational profitability and brand image can also be affected significantly by the aforementioned activities.

Hence, the implications of both the theories have also been the discussed in this study. Subsequently, the reasons behind the issues and ethical solution through the theory have also been discussed so the reader of this report can easily understand the factors of both theories. The importance of this particular study is that it can help in understanding both the entity theory and the residual equity theory along with its implications. These above-mentioned factors can be considered as the major purpose of this report. Through this report, a clear perspective of both entity theory and residual equity theory have been developed, which will assist in various organizations for developing their situations during the period of economic and market constraints.

Responses in Accordance with the Theories 

Explanation of Theories

As above discussed, two theories have been taken into consideration for this study. These theories are entity theory and residual equity theory. Hence, a brief explanation of these theories has been provided in the below sections of the study.

Findings of Selected Articles

Entity Theory

Entity theory can be defined as a market fluctuation or market evaluation of an organization, which cannot be controlled by the owner or the company. However, capital can be considered as a major aspect of any organization. Hence, the companies are more focused on deciding a capital volume every year for developing organizational performance (Zanoni, n. d.). Moreover, the value of the capital is depending entirely on the market fluctuations. Based on the market variations, the volume of capital can be increased or decreased. Hence, the entity theory is providing a path or way to the higher authorities of an organization for taking a reasonable decision during the period of economic changes.

In addition, the entity theory helps organizations to drive two major theories, which includes proprietorship theory and scientific accountancy (Dean, Clarke & Capalbo, 2016). Not only capital, there more accounting activities that have been, changing over the years such as the law of business, taxation volume, investment volume, financial management, economic condition, and scientific process of accounting. Apart from this, humans are also part of the changes, which includes stakeholders, managers in different sectors, debtors, organizational employees, and government of a country (Preißinger & Schoen, 2018). These aforementioned factors are changing automatically throughout the time being. Therefore, the entity theory is helping the owner of a business to take an appropriate decision during the changes in the economy and human resource.

Residual Equity Theory

Residual equity theory can be referred to as a process of shareholder consideration. As discussed above, each shareholder is perceived as the owner or proprietor of an organization through this theory (Crook, n. d.). In this context, an organization is preparing its financial statements such as budget, cash flow, and balance sheet among others with the help of these owners. Without the reasonable approval of these owners, an organization is not able to pass its financial statements due to unethical as well as unlawful work. In this theory, owners or the proprietors of an organization are following equation to measure the worth of their shares.

The equation is, ∑assets - ∑liabilities = ∑equity, proprietorship or net worth (Mourik, 2010). Based on the equation, it has been identified that the figure initiating after subtracting organizational assets from the organizational liabilities can help in obtaining equity or net worth. This figure can be considered organizational assets, as it helps in making a reasonable capital for an organization. The only a proper capital structure can lead an organization to achieve market success, which has been conducting precisely through the theory of residual equity. In order to calculate residual equity, the theory has reflected another equation, which has been used by the preference shareholders of a company, the equation is as follows (Mourik, 2010),

Implications of the Theories

 Assets – Specific Equities = (Liabilities + Preferred Stock)

 = Residual Equity

The relevance of the Selected Articles’ Findings in Respect of the Study

Based on the above discussion, it has been identified that both the entity theory and residual equity theory plays a major role in an organization (Bekaert, Ehrmann, Fratzscher & Mehl, 2014). In order to identify the implication of these theories, four articles have been taken into consideration. With respect to entity theory, the articles namely “The Separate Legal Entity and the Architecture of the Modern Corporation” and “Sustainable Enterprise Theory:

A Good Life for All” have taken into consideration. Simultaneously, “Valuation Based Test of Market Timing Theory” and “Residual Earnings and Book Value in Equity Valuation on China Stock Market” have been are associated with residual equity theory. Major findings along with its implications of aforementioned theories have been elaborated by taking support from these journals. At the same time, the importance of these theories has also been discussed in this particular section of the study.

The study findings of Veldman, (2018) have mainly focused on elaborating the overall legal entity along with its effect on the modern organization. This particular article highlights certain factors, which are related to a separate legal entity. In addition, a separate legal entity is being formed by organizations with the purpose of resolving an issue related to the liability as well as attribution. Fundamentally, an organization is maintaining several laws and legislation for conducting their business operation. It makes the business perfect and profitable. However, law, legislation, and the rule of business can be considered as changeable aspects.

Thus, it is included under the entity theory due to the fact that “legal fiction” has been resolving through Separate Legal Entities (SLEs). Apart from the above factors, three major duties of SLEs have been observed, which are maintained by the higher authorities of an organization. These duties are organs and fiduciary duties, directors’ duties, and social license (Veldman, 2018). The article further discussed that an SLE is a modern corporate architecture, which assists organizations to develop uncontrollable issues within the market. Thus, by maintaining the above-mentioned duties, SLEs are able to implement entity theory so that they can survive reasonably during the period of economic and market crisis (Ryazanov & Christenfeld, 2018).

Based on the study findings of Fagerström & Cunningham, (2017), sustainability can be defined as a process of business organization to survive in the market for a long period of time. Hence, survival over a long period within a market is not an easy process. Thus, it is a difficult task for the business to survive in the market, as economic change has been observed over the years. Thus, this theory has reflected a reasonable effect and its mitigation process called “green economy”.

 The above Figure 1 reflects the green economy, as it can be considered as a part of entity theory, whereas the organization can develop its performance during the period of economic constraints within the market (Jack, 2017). At the same time, certain resources also have also been identified, however, have been changing over the years. This include changes in these are human recourses, social resources, environmental resources, technological resources, and stakeholders or internal resources. These resources can thus be justified, as major resources of any company are changeable as well as uncontrollable. Hence, sustainability enterprises theory assist organizations with the process of “green economy” and it is operating as well as developing reasonably by using entity theory within respective organizations.

In accordance with Yun, (2017), it can be stated that the journal has focused on the Chinese stock market. The residual value of equity has been examined along with analyzed in the article. In the first section of the article, the different stock market of China and its co-relation with the others has been reflected. These co-relations have shown below Table 1.

From the above Table 1, it has been identified that the correlation of each market has been developed over the years. From the year of 1996 to 2008, Stock Holding Corporation of India (SHCI) had a correlation of 0.0609 with S&P 500 from the year 2002 to 2008 at the volume of 0.103. Similarly, other markets of China such as Shenzhen Component Index (SZCI) and Hang Seng Index (HIS) were also developed. Based on this observation, it can be stated that the value of residual equity has increased over the period of time (Adachi, Asano, & Okuda, 2016). In order to prove the effect of shareholder investment within the Chinese market, four models have been prepared through the research, these are

• P_{i t} = β₀ + β₁BPS_{i t−1} + β₂ ^RI_{i t−1}/ ^k_t∗^S_{i t} + ε_{i t}                         Model 1
• P_{i t} = β₁BPS_{i t−1} + β₂ ^RI_{i t−1} /^k_t∗^S_{i t} + ε_{i t}                           Model 2
• Cap_{i t} = β₀ + β₁E_{i t−1} + β₂ ^RI_{i t−1}/ ^k_t + ε_{i t}                         Model 3
• Cap_{i t} = β₁E_{i t−1} + β₂ ^RI_{i t−1}/ ^k_t + ε_{i t}                                 Model 4

After analyzing the above four models, it has been observed that the effect of each model has been reflected. The results are as follows,

Based on the above results, it has been recognized that both mainland China and Hong Kong market was performed well within the market. Each of the models along with its significance is reasonable for the S&P 500. Thus, it can be stated that the proper residual equity of an organization can develop organizational profitability within the operating market. At the same time, it also provides profitability to the owners of the business.

According to the Asif, Abbas, & Hassan, (2018), it has been observed that the author has focused on four major aspects of the share market, in addition to its activities. These aspects are market timing, Capital structure, change in equity, and deficit (Warusawitharana & Whited, 2015). Additionally, residual equity of an organization largely depends on the aforementioned aspects. At the same time, these aspects also changed and fluctuated as per the performance of residual equity within the market. Through this article, the researcher has established a model to prove the effect of the above-mentioned aspects on the residual equity of the market. The model is

ΔE = α + β1 DEF + β2 (DEFit * VPit) + to,

Through the analysis of this model, the researcher has identified that 61% of shareholders depends on the residual value of shares. At the same time, it has also been determined that the variables of this research can change the value of residual equity at the percentage of 55%. Hence, it can further be stated that only appropriate residual equity of an organization can lead to the organization towards the market success. Thus, it has been possible to implement it properly if the residual equity theory has well maintained within an organization (Osborne, 2018).

Conclusion

Based on the study value, it can be inferred that the theory of entity and residual equity plays a major role in an organization along with the stock market. Thus, by implementing these theories, an organization can develop its situation during the period of economic as well as stock market constraints. An organization can survive reasonably in a long-term period with expected profitability and brand image by implementing the abovementioned theories of accounting.

References

Academic, 2017, Residual equity theory, Interpretations, viewed 22 September 2018, 

Adachi, T., Asano, T. & Okuda, T., 2016, ‘Simultaneous estimation of cost of equity and expected earnings of individual firms with the residual income model’, Monetary and Economic Studies, vol. 34, pp.1-38.

Asif, J, Abbas, S. K.., & Hassan, H. A., 2018. ‘Valuation Based test of market timing theory’, International Journal of Academic Multidisciplinary Research (IJAMR), vol. 2, Iss. 4, pp. 28-30.

Bekaert, G., Ehrmann, M., Fratzscher, M. & Mehl, A., 2014, ‘The global crisis and equity market contagion’, The Journal of Finance, vol. 69, no. 6, pp.2597-2649.

Crook K., No Date, ‘The conceptual djstinction between liabilities and equity: A new approach required’, University of Canterbury, pp. 1-115.

Dean, G., Clarke, F. & Capalbo, F., 2016, ‘Pacioli's double entry–part of an intellectual and social movement’, Accounting History Review, vol. 26, no. 1, pp.5-24.

Fagerström, A. & Cunningham, G. M., No Date, ‘Sustainable enterprise theory: A good life for all’, Essays on Sustainability Celebrating 60 years of making Life Better, pp. 123-138

Jack, L., 2017, ‘Strong structuration theory and management accounting research. Advances in Scientific and Applied Accounting,’ vol. 10, no. 22, pp.211-223.

Mourik C. V., 2010, ‘Equity theories and financial reporting: past, present and future’, Conference on Accounting, Business & Financial History, pp. 1-19.

Osborne, K.C., 2018, ‘Flipping the field: Using Football to Explain corporate personality theory and the ability to opt out of the shareholder wealth maximization norm’, Transactions: The Tennessee Journal of Business Law, vol. 19, no. 11, p.25.

Preißinger, M. & Schoen H., 2018, ‘Entity and incremental theory of personality: Revisiting the validity of indicators’, Personality and Individual Differences, pp. 1-15.

Ryazanov, A.A. & Christenfeld, N.J., 2018, ‘ Incremental mindsets and the reduced forgiveness of chronic failures’. Journal of Experimental Social Psychology, vol. 76, pp.33-41.

Veldman, J., 2018, ‘The separate legal entity and the architecture of the modern corporation’, City, University of London, pp. 61-75.

Warusawitharana, M. & Whited, T.M., 2015, ‘Equity market misvaluation, financing, and investment’. The Review of Financial Studies, vol. 29, no. 3, pp.603-654.

Yun, L., 2017. ‘Residual earnings and book value in equity valuation on China stock market’, St. Petersburg University Graduate School of Management, pp. 7-38.

Zanoni, A. B., No Date, ‘Genesis of the entity theory: An Analysis of the scientific context in the United States of America at the beginning of the XX century’, From the Proprietorship Theory to the Entity Theory, pp. 1-20.