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ATPB 313 Accounting Theory & Practice

Sem 2 2013/2014(updated October 2013)

Topic 2: OVERVIEW OF ACCOUNTING THEORY

REF: 1 & 2 (Godfrey et al 2010)

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Learning Outcomes

At the end of this lecture, students should be able to:

Discuss an overview of what

accounting theory is

Describe the

development of

accounting theory

Describe how

accounting theories

are formulated and tested

Describe how

accounting theories

are constructe

d and measured

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1.0 What is Accounting Theory?

Accounting theory - logical reasoning in the form of a set of broad principles

that:

provide a general framework of

reference by which accounting practice can be evaluated

guide the development of new

practices and procedures

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1.0 What is Accounting Theory?

How well it explains and predicts reality

How well it is constructed

How acceptable are the implications of the theory

The acceptance of a theory will depend on:

Explain why & how current accounting practice evolved

Suggest improvements

Provide the basis for development of such practice

Main objectives of accounting

theory

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2.0 Development of Accounting Theory

1400-1800Pre-theory

period• No theory of

accounting was devised

1800-1955General

Scientific Period

• Observe what actually happened

• Based on empirical analysis i.e. relying on real-world observations not simply on logic

1956-1970Normative

Period• Prescribe

what should happen

• 2 group dominated

• Limitation of the theory• Do not involve

hypothesis testing

• Based on value judgment

1970-present

Specific Scientific

theory• Describe,

explain and predict accounting practice

• i.e.: bonus plan hypothesis

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2 3 4

Pragmatic

accounting

Positive accounting

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2.0 Development of Accounting Theory

5. Behavioural Research

6. Current development

Result from the narrow approach of positive theorists

Concerned the broader sociological

implications of accounting numbers and the associated

actions of ‘key players’

Emerged in 1950s

Corporate collapses e.g. Enron & WorldCom has triggered question on whether a

comprehensive theory of the impact of accounting on behaviour had been developed

increase in legislative reporting requirements. convergence

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3.0 Approach to formulation of accounting theory

 

FORMULATING ACCOUNTING

THEORY

Deductive Inductive

General to specific

Specific to general

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Approach to formulation of accounting theory

 

Deductive Drawing specific conclusion from detailed observations and

measurements A "top-down" approach.

DeductionP1 all asset accounts have debit balance.P2 The plant & machinery account is an asset account.Conclusion the plant & machinery account has a debit balance

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Approach to formulation of accounting theory

 

Inductive • From specific observations to a general

conclusion• A "bottom-up" approach

InductionP1 the plant and machinery account is an asset account and has a debit balance.P2 the motor vehicle account is an asset account and has a debit balance.P3 the land is an asset account and has a debit balance.Conclusion all asset accounts have debit balance.

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4.0 Parts of a Theory

 

Theory development eventually must relate to the real world.

Theoretical structure

Syntactic

Semantic

Pragmatic

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5.0 Testing a TheoryIn developing theory using scientific approach, we need to test a theory using criteria of truth. 

Theory testing

Dogmatic self-evidence

Syntactic

Feyeraband

Scientific

Kuhnian

Research program /Lakatos

Falsification/Popper

Induction

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Testing a Theory

 

Dogmatic basis

Accept the statements made by people who has the authority

Self-evident

The justification of self-evidence as a way to determine truth is the reasonableness, sensibility, or obviousness of a statement based on our general knowledge, experience, or observation

SCIENTIFICSyntactic Statements ascertained as valid or invalid by logic or reasoning alone

Induction Statements whose truth or falseness can be known only by reference to empirical evidence or its correspondence with observations of real-world phenomena

Falsification (Popper)

• the trial and error testing of speculative hypothesis • can never be proven absolutely true, but can be rejected when

shown to be false

Research Programs (Lakatos)

• hard core of the research program which stipulate the basic assumptions of science

• forms a protective belt of hypothesis

Kuhnian paradigms

Revolutionary i.e. involves the abandonment of one theory and replace by another incompatible theory.

Feyerabend’s approach

There is no single scientific way of getting ideas.

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6.0 Accounting Theory Construction

A useful way to study & assess accounting theories is to classify them according to the assumptions they rely on, how they are formulated and their approach to explaining & predicting actual events.

Accounting theory classification:

 

Pragmatic Syntactic Semantic

Normative Positive Naturalis

tic

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Accounting Theory Construction

THEORIES EXPLANATION

Pragmatic Theories

Descriptive pragmatic approach

Observe behavior of accountants

Psychological pragmatic approach

Observe users’ responses to the accountants outputs i.e. financial reports

THEORIES EXPLANATION

Normative Theories (1950s and 1960s)

• How to derive the ‘true income’ for an accounting period

• Type of information useful for economic decisions.

Positive Theories (1970s)

• Testing theories back to the experiences or facts of the real world (to find the reasons)• i.e. questionnaires/survey

Alternative Naturalistic approaches

• Tries to explain complex & unique situations using an unstructured approach.• Use case studies & individual experiences • Try not to generalize.

Syntactic • rely on logical argument based on a set of premise.

Semantic • how theories correspond to real-world events.

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Accounting Theory Construction

Syntactic and Semantic Theories A theory that has both syntactic and semantic element E.g. historical cost: Proponents:

Syntactic: Logic in the sense it is the value recorded on the day transaction is made

Semantic: The cost recorded based on real vouchers Opponents:

Syntactic: Poor as different monetary measures are added

Semantic: Do not consider inflation and no independent empirically observable correspondent to concepts such as profit or assets.

 

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Accounting Theory ConstructionIssues for auditing theory construction

 

Development of a theory of

accounting

Development of a theory of auditing

(lag in 1960s)Early writers attempted to document the

process of auditing and the duties of

expected of auditors.

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Summary: Topic 2

Accounting theory Definition: Logical reasoning in the form of a set of broad principles to provide a general framework of reference by which accounting practice can be evaluated & guide the development of new practices and procedures.Objective: Explain current accounting practice evolved, suggest improvements & provide the basis for development of such practice.

Development of Accounting Theory

1.Pre-theory period (1400-1800)2.General Scientific Period (1800 –

1955) 3.Normative Period (1956 – 1970)4.Specific scientific

theory/Positive Era (1970 –present)

Theory Construction:1.Pragmatic – behavior of

accountants & users of accounting information

2.Syntactic – rely on logical argument based on a set of premise.

3.Semantic – how theories correspond to real-world events.

4.Normative – rely both on semantic & syntactic approach.

5.Positive – test hypothesis against actual events.

6.Naturalistic – consider individual cases & try not to generalize.

Formulate:• Deductive: general to specific• Inductive: specific to general

Parts of Theory:1.Syntactic

.2.Semantic 3.Pragmati

c

Testing:1.Dogmatic .2.Self-evident 3.Scientific:• Syntactic• Induction• Falsification/Popper• Research program /Lakatos

• Kuhnian•Feyeraband

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TUTORIAL 2 (40 MARKS)Q1 Useful theories must eventually relate to the real world.

Using examples, please discuss THREE distinct relationships of theories which are: syntactic, semantic and pragmatic.

[6 marks]

Q2. Accounting theorist attempted to established norms for best practice during the normative period. While, specific scientific theory is to explain and predict accounting practice.

i. Explain two groups dominated during the normative period. [4 marks]

ii. Explain the reasons why the specific scientific theory arises. [6 marks]

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TUTORIAL 2Q3 Explain TWO (2) limitations of self evidence. Discuss with example.

[4 marks]

Q4 In your opinion, can accounting theory be constructed as a purely syntactical exercise without involvement by other approaches? Provide your reasoning.

[4 marks]

Q5 Is it important to account for the effects of inflation on deriving the ‘true income’ in normative theory? Provide your reasoning. [4 marks]

Q6 What role(s) can theory play in relation to accounting? Give an example. [4 marks]

Q7 Explain FOUR (4) main differences between normative and positive theories. [8 marks]