Behavioural Finance and its Influence on Accounting Decisions

Introduction: Understanding Behavioural Finance

Behavioural finance is a fascinating area of study that merges psychology with traditional financial theory. It’s interesting because this is like the fight between emotion and logic. People tend to be logical. But everyone has emotions that occasionally cause them to react illogically.

It examines how individual investors, professionals, and even entire markets might make decisions based on emotion and cognitive biases rather than logical or rational reasoning. But how does this connect to accounting, a field that thrives on precision and order? Let’s dive in.

The Human Element: Why Emotions Matter

At its core, accounting is about providing a clear picture of a company’s financial health. However, humans are behind every number recorded and every report generated. This means emotions and biases can sneak in, influencing decisions.

For instance, an accountant might cling to an outdated asset valuation because they’re emotionally attached to past successes, even if recent data suggests a different value. This type of attachment is an example of the “endowment effect,” a common behavioural bias.

Common Behavioural Biases in Accounting

  1. Overconfidence: Some accountants might overestimate their expertise or the precision of their predictions. This can lead to financial statements that are overly optimistic or lack the necessary conservatism. Note that overconfidence in a company has led to accounting fraud like the infamous Enron Scandal.
  2. Confirmation Bias: This occurs when individuals give more weight to information that aligns with their existing beliefs. In accounting, it could mean favouring financial models that produce desired results while ignoring alternative models.
  3. Anchoring: When making decisions, accountants might rely too heavily on one piece of information (often the first piece of data encountered). For example, they might undervalue an asset because they’re anchored to its initial purchase price.

Real-World Impacts of Behavioural Biases

When these biases creep into accounting decisions, the consequences can be significant:

  • Inaccurate Financial Statements: This can mislead investors, leading to poor investment decisions and potential financial losses.
  • Regulatory Scrutiny: Biased decisions can draw the attention of regulatory bodies, resulting in penalties and damaged reputations.
  • Operational Challenges: Biased accounting can mask operational inefficiencies, leading to missed opportunities for improvement.

Overcoming Biases: Strategies for Accountants

Awareness is the first step. By understanding the potential for bias, accountants can take active measures to counteract it:

  1. Regular Training: By revisiting the fundamentals of behavioural finance, accountants can stay alert to their biases. It doesn’t have to be a behavioural finance course. It could be any course like Xero training, where you are using logic to make decisions. Learning through logic will help you practice that muscle and gather more information to avoid using emotions to react to new situations.
  2. Peer Reviews: Having colleagues review decisions and financial statements can help identify and rectify biased reasoning.
  3. Use of Technology: Modern accounting software often includes checks and balances to flag potential issues that might arise from biases. For example, many people use Xero. (Enterprise SG’s PSG Grant has encouraged many businesses in Singapore to use accounting softwares like Xero and Quickbooks.) You can set up Xero and use Xero to help you with financial reporting and predictions to improve your decision making. There are Xero accounting courses that can help you do this.

Embracing Rationality in Accounting

While the human element ensures that accounting will never be entirely devoid of emotion, recognising the influence of behavioural finance is crucial. By understanding our biases and actively working to counteract them, accountants can make better, more rational decisions, ensuring the accuracy and reliability of financial information.

In the end, a blend of self-awareness, continuous learning, and collaboration holds the key to minimising the impact of behavioural biases in the accounting world.

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