Accounting Theory
Michelle_Michy
L4-WhatisTheory.pptxWhat is Theory?
Unit 4
ACC3135: Accounting Theory
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Lecture outcomes:
Evaluation of theory in accounting
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What have we learnt so far?
Various authors have tried to come up with suggestions in the form of theories or imagery as to how accounting SHOULD function in society.
However, there has been disagreement between authors i.e. Solomons and Tinker as to how these are appropriate and worthwhile for accounting.
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Today’s lecture will attempt to explore what is ‘theory’ and how theories can be used and furthermore what is their role in accounting.
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Oxford English dictionary:
‘A scheme or system of ideas or statements held as an explanation or account of a group of facts or phenomena’
What is a theory?
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On the other hand, Hendriksen 1970, p.1 defines a theory as:
‘A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of enquiry’.
Can be suggested to be a normative theory of accounting
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Why do we need these in accounting?
According to Deegan & Unerman (2006, page 4):
‘How the various elements of accounting should be measured’
What motivates organisations to provide certain types of accounting information.
What motivates individuals to support and perhaps lobby regulators for some accounting methods in preference to others.
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What are the implications for particular types of organisations and their stakeholders are if one method of accounting is chosen or mandated in preference to other methods?
How and why the capital markets react to particular accounting information?
Whether there is a ‘true measure’ of income.
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We all know now that accounting plays a very important role within society (see Unit 1).
Furthermore, at a broader level according to Unerman & O’Dwyer (2004), the recent rise in high profile accounting failures has raised the level of awareness among non-accountants of some of the significant impacts which accounting has on their lives.
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1920-1960’s development of accounting theory relied on the Process of Induction
(Observations-Laws/theories-Prediction) – (more in Unit 5)
Based upon what accountants did in practice (i.e. stock valuation).
Further careful consideration of what accountants did in practice revealed patterns of ‘consistent’ and ‘prudent’ behaviour (Deegan & Unerman (p.6)
Some history surrounding accounting theories
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However, such an approach is problematic:
If we generate theories based upon what accountants do, then it is assumed that what the majority do is the most appropriate practice.
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Another two approaches became popular in the 1960’s and 1970’s.
Positive theories (normative theories):
Emphasis on prediction and explanation (based upon empirical observation).
Prescriptive (normative) accounting theories:
Based upon what the researchers believe SHOULD occur in particular circumstances.
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According to Deegan & Unerman (p.10) the conceptual framework of accounting is an example of a normative theory of accounting. It relies upon various assumptions about the type or attributes of information useful for decision making. Also provides guidance on how assets etc should be recognised.
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Must be noted that no one theory is the best.
Karl Popper (a falsificationist) suggests that knowledge develops as a result of continual refinement of a theory.
Ex. ‘All Ravens are Black’
If one raven was found to be red then this theory is thrown out.
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New theory: ‘Some ravens are black’.
More precise theories can be proved false through empirical observation.
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The Scientific Method
World of facts -> Recognition of a problem ->
Collection & organisation of data ->
Formulation of propositions & definitions ->
Development of hypotheses ->
Testing hypotheses - > Theory verification,
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Modification or rejection ->
Theory acceptance
In accounting however, practice maybe changed to accommodate theory. The accounting profession, government and policy bodies need to respond and change their practice in the light of new research findings or new discoveries.
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If policy makers and the profession fail to incorporate research findings in the policies they devise it may reduce the potential usefulness of accounting information.
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1. Descriptive
2. Decision usefulness
3. Welfare
1. Theories developed using this approach are usually concerned with what accountants do. Such an approach also enables predictions to be made about behaviour, for example how a particular matter will be treated.
Approaches to the development of accounting theory
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Underlying this approach is the belief that the objective of financial statements is associated with the stewardship concept of the management role (See week 4 Reading List).
Also, the standard setting bodies have been concerned with discussing the varied practices used by accountants and reaching a consensus on the most feasible basis on which to reduce the diversity of these practices.
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2. Derived from the expansion of behavioural research into accounting in the 1970’s.
The American Accounting Association in 1971:
‘The principal purpose of accounting reports is to influence action that is behaviour. Additionally it can be hypothesized that the very process of accumulating information , as well as the behaviour of those who do the accounting, will affect the behaviour of others.
Decision Usefulness Approaches
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In short, by its very nature accounting is a behavioural process’.
3. Welfare approach:
Considers the effects of decision-making on social welfare. Focus on the external social effects of decisions.
i.e. allocation of resources in society, the possession of insider information and its effects on the markets.
3. Welfare approach
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All of these approaches are useful in accounting.
More theories are better than one!
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