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CHAPTER 2
ACCOUNTING THEORY CONSTRUCTION
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1.2 Introduction to Accounting Theory
1.2.1 Overview of Accounting Theory
1.2.2 Nature and Purpose of Theory
1.2.3 Theory and Method
1.2.4 Accounting Theory Construction and Formulation Approaches to the Development of Accounting Theory: Paradigms in
Accounting Research
Pragmatic theories
Syntactic & semantic theories
Normative theories Positive theories
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Belkaoui (2004); Accounting is the art of recording, classifying, & summarizing in asignificant manner & in terms of money, transactions, & events whichare, in part at least, of a financial character, & interpreting the resultthereof. (AICPA)
From broader perspective;The process of identifying, measuring, & communicating economic
information to permit information judgments & decisions by user ofinformation
Quantitative information;Accounting is a service activity. Its function is to provide quantitative
information, primarily financial in nature about economic entities thatis intended, to be useful in economic decisions, in making resolvechoices among alternative course of action.
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Accounting deals with enterprise, which are certainly socialgroups;
It is concerned with transactions & other economic eventswhich have social consequence & influence societal
relationship;
It produces knowledge that is useful & meaningful to humanbeings being engaged in the activities having socialimplications;
It is primarily mental in nature;
On the basis of the guidelines available, accounting is a socialscience.
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Accounting as;
1. Ideology
2. Language
3. Historical record
4. Current economic reality5. an information system
6. Commodity
7. Mythology
8. Rationale9. Imagery
10. Experimentation
11. distortion
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As a means of sustaining & legitimizing the current
social, economic & political arrangement.
Perceptions of accounting as an instrument of economic
rationality.
Capitalist practice turns the unit of money in a tool of
rational cost-profit calculations, of which towering
monument is double-entry bookkeepingprimarily the
product of the evolution of economic-rationality; the cost-
profit calculus, in turn reacts on the rationality; bycrystallizing and defining numerically, it powerfully
propels the logic of enterprise
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Communicating information about a business.
Recognized in accounting profession, which published
accounting bulletin & empirical literature, to measure the
communication of accounting concepts.
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As a means of providing the history of the organization &
its transaction with environment.
History of managers stewardship of the owners
resources.
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Both balance sheets & income statement should be
based on valuations basis that is more reflective of
economic reality than historical cost.
Determination of true income (concept of changing of
wealth of the business over a period of time)
Which method best measure, has generated more prolific
debate in accounting literature.
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Process that link information source of transmitter
(accountant), a channel of communication, & set of
receivers (users)
the process of encoding observations in the language of
accounting system, of manipulating the signs & the
statements of the system & decoding & transmitting the
result
The behaviors of the sender is important, (behavioral
research in accounting)
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Demand & supply of accounting information.
Accounting provides ideal ground for policy & contractsbetween the organization & environment.
In accounting research;
the emergence of the image of accounting as a commodityagain provide a striking example of the manner in whichaccounting thought reflects its social content. It has arisen inan are of mushrooming regulation & increasing concern with
the public interest in a situation of scarce resources & manycontemplating demand . It has provided the rationale foraccounting policies which seek to aid the allocation ofresources in the service of public interest.
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Myth that there are an easy way of understanding of
economic world & explaining complex phenomena,
For the users in a more simplified & understandable
manner, thereby creating more myths than realities.
Like witchcraft, accounting embrace a system of values
that regulate human conduct & explains to humans when
things going wrong or right.
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Used to attach the meanings to events & therefore
provide a justification for future occurrence.
Accounting provide a shield of guarantee or a certification
of authority to these numbers & provides a rationale for
actions to be based on them.
Organizational decisions, need to be justified, legitimized,
& rationalized, accounting provides useful means of
action.
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Creating a picture or an image of an organization through
a selective choice of events & accounts impinging (impress)
of an organization.
The image created through selective interpretation &
representation of events in turn creates a stable & certain
environment & basis for decision making.
Also view as financial map-making (complex phenomena
are mapped into financial statement)
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It flexible enough to accommodate various situations,
adopt new solutions, to new problems, & adapt to the
most complex case.
As an experiment, accounting allows itself to go through
trial & error phases towards a search for the most
contingent solution to a given environment & a desire
response & behavior repertoire (The entire range of skills or aptitudes ordevices used in a particular field or occupation).
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Since accounting used to control or influence of actions
of both internal & external users, it become an ideal
target to those seeking & manipulate the nature of
message view by the user.
The method used can be categorized into six board
categories; smoothing, biasing, focusing, gaming, filtering
& illegal acts.
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Popper, K (1968) ,The Logic of ScientificDiscovery-
emphasizes empirical nature of the theory rather than
logical-
Theories are nets cast to catch what we call the world, to
rationalize, to explain and to master it
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Hendriksen (1970): 1the coherent set of hypothetical, conceptual and pragmatic
principles forming the general framework of reference for a field ofinquiry.
2logical reasoning in the form of a set board principles(1)provide a general framework of reference by which acctg practicescan be evaluated and guided the development of new practicesand procedures.
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No theory of accounting was devised from the time of Pacioli down
to the opening of the nineteenth century. Suggestions of theory
appear here and there, but not to the extent necessary to place
accounting on a systematic basis
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McDonald argues that a theory must have threeelements:
1. encoding of phenomena to symbolicrepresentation
2. manipulation or combination according torules
3. translation back to real-world phenomena
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Belkaoui (2000)
..a set of interrelated constructs (concepts),definitions, and
propositions that present a systematic view of phenomena by
specifying relations among variables with the purpose of
explaining and predicting the phenomena.
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Godfrey et. al. (2010), classified accounting theory as:
Theory as Language
Theory as Reasoning
Theory as Script
BKAF3083 2222
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As language as business
Three question that should asked about language, word,
phrases
What effectwill the words have on listeners?
What meaning, if any, do the words have?
Do the word make logicalsense?
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Pragmaticsstudy of the effect of language
Semantics-the study of the meaning of language
Syntacticthe study of the logic or grammar of the
language
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This relation pertains to the effect of words or
symbols on people
How acctg concepts, and their real world
corresponding events or objects, affect peoplebehaviour.
How people react to the same message in
different way-acctg standard-support & lobbying
The relation of signs to users of those signs
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Pragmatics
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Accounting should provide useful
information for decision making to certain
interested parties
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Descriptive pragmatic approach:
based on observed behaviour of accountants
theory developed from how accountants act
in certain situations
tested by observing whether accountants do
act in the way the theory suggests
is an inductive approach
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Criticisms of descriptive pragmatic approach:
does not consider the quality of an accountants action
does not provide for accounting practices to be challenged
focuses on accountants behaviour not on measuring the attributes
of the firm
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Psychological pragmatic approach:
theory depends on observations of the
reactions of users to the accountants
outputs a reaction is taken as evidence that the
outputs are useful and contain relevant
information
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Criticisms of the psychological pragmatic approach:
some users may react in an illogical manner
some users might have a preconditioned response
some users may not react when they should
Theories are therefore tested using large samples of
people
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Semantic inputs are the transactions and exchanges
recorded in vouchers, journals and ledgers
The inputs are then manipulated on thebasis of the premises and assumptions of
historical cost accounting
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Criticised because there is no independent empirical
verification of the calculated outputs
The outputs may be criticised for poor syntax inaccurate
e.g. different types of monetary measures are added
together
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The outputs may be syntactically accurate but
nevertheless be valueless due to a lack of semantic
accuracy (a lack of correspondence with real-world
events, transactions or values)
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Historic cost accounting may produce accurate outputs
but which nevertheless have little or no utility
That is, they are not useful for economic decision making
except to verify accounting entries
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Concern the relationship of word, sign or symbol to a real
world object or event
It is established in relation to individual premises and the
conclusion, but not to the line of the logic( argument)
which can only be assessed for validity
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Semantics
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Premise 1: All asset accounts have debit balances.
Premise 2: The sales returns account is not an asset account.
Conclusion: The sales returns account has a debit balance.
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Example,P1: All assets and contra-assets accounts have debit balances
P2: The sales returns account is not an asset account.
C: The sales returns acct has a debit balance
P1 false, P2 is true, but refer to C it was true bylooking to the real world
In accounting, i.e. we one concept of depreciation
but several different ways of measuring
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Rules of the language employed
Refer to rules of grammar & mathematics
Analytical methodology basically relied upon syllogism
If the combination of premise is valid, so the conclusionwas also true.
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Syntactics
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Premise 1: All accounts relating to assets have debit balances.
Premise 2: The accumulated depreciation account relates to assets.
Conclusion: The accumulated depreciation account has a debit balance.
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Example,P1: All accounts relating to assets have debit balancesP2: The accumulated depreciation account relates to assets
C: The accumulated depreciation account has a debit balances
The syllogism, is clearly incorrect.
If logic is valid if both p is true, the conclusion also true
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1950s and 1960s golden age policy recommendations
what shou ld be
concentrated on deriving:
true income (profit)
practices that enhance decision-usefulness
based on analytic and empirical propositions
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Financial statements should mean what
they say
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True income:
a single measure for assets
a unique and correct profit figure
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Decision usefulness:
the basic objective of accounting is to aid the decision-making
process of certain users of accounting reports by providing useful
accounting data
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The decision process
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Accounting
system of
company X
Prediction
model of
user
Decision
model of
user
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Expanded during the 1970s
Based on experiences or facts of the real world
Explain the reasons for current practice
Predict the role of accounting information in decision-making
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The main difference between normative and positive
theories is that
normative theories are prescriptive
positive theories are descriptive, explanatory or predictive
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Scientific approach:
has an inherent assumption that the world to be researched is an
objective reality
is carried out by incremental hypotheses
has an implied assumption that a good theory holds undercircumstances that are constant across firms, industries and time
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Criticism of the scientific method:
large-scale statistical research tends to lump everything together
it is conducted in environments that are often remote from the
world of or the concerns of accountants
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Naturalistic approach:
implies that there are no preconceived assumptions or theories
focuses on firm-specific real-world problems
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Alternative ways of looking at the world:
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CATEGORY ASSUMPTION
1. Reality as a concrete structure
2. Reality as a concrete process
3. Reality as a contextual field of information
4. Reality as a symbolic discourse
5. Reality as a social construction6. Reality as projection of human imagination
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For categories 1 3 it is more appropriate to use the
scientific approach
For categories 4-6 the naturalistic approach is more
appropriate
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Misconceptions of purpose
Make scientists out of accounting practitioners
Researchers = practitioners
The desire for absolute truth
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The scientific method does not claim to provide truth
It attempts to provide persuasive evidence which may
describe, explain or predict
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Auditing is a verification process that is applied to the
accounting inputs and processes
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Auditors provide an opinion on
whether the financial statements accord with the applicable
reporting framework
whether the statements give a true and fair view
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The normative era of accounting coincided with a
normative approach to auditing theory
The positive ere of accounting has led to a positive
approach to auditing theory
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The debate whether the theory is argument flow:
Generalization to specifics (deductive). Acctant usually deduce
acctg principles or postulates to provide concrete applications or
rules
Specifics to generalizations (inductive).Acctg principles are induced from the best current practice.
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Example,P1: All asset accounts have debit balances.
P2: The cash account is an asset account
C : The cash account has a debit balances
Objective are important part of deductive process. P1 &P2 are more generalize. C is more specifically to cashaccount.
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Advantages of the method; If postulates or premises is false, conclusion may also false
To provide the basis for practical rules.
Criticism; Misunderstand the meaning of theory
The theory not necessarily to be entirely practical
The main objective of theory to provide a framework forthe development of new ideas or new procedures and tohelp making choices among alternative procedures.
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Arguments begins with a set of a particularexamples, claim that it will representative ofsome greater whole, then infer somegeneralization about that whole.
Advantages; Not necessarily constrained by a structure
Free to make relevant observation
Disadvantages Influenced by the idea of relevant relationship/observed
The raw data in acctg is likely to be different.
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Example,P1: The cash account is an asset account and has a debit balance.
P2: The Vehicles account is an asset account and has a debitbalance.
P3: The land account is an asset account and has a debit balance.
C : All asset accounts have debit balances
P1, P2, &P3 is so specific for each account. C isgeneralization from all P.
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The theory may be
To set forth and explain what and how financial information is
presented and communicated to users of acctg data (descriptive
or positive)
To prescribed what data ought to be communicated and how theyought to be presented. (prescriptive or normative)
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1950s & 60s
Explain more on what should be done rather than what
is i.e. analyzing & explaining accepted practice
Attempts to discover the best way of accounting for atransaction & useful in making decision.
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1970s
More on the inductive theory nature
Attempts to discover how management and others
decide which is the best way for them.
More on explanation on what and how, testing
assumptions made by normative theories.
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Criteria of truth
Dogmatic basis
believe what we read Self-evident basis
Reasonableness (determine the truth, e.g. accounting mustusing market price)
Scientific basis
Syntactic (logical reasoning) and induction (refer to
empirical evidence)
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C i i f h
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Criteria of truth
Scientific basis
Popper(try & error: hypothesis & proposition) and
falsification (all hypothesis must be capable of falsification, if no;there is no informative & doesn't not add to scientific progress)
Research programs (encourage discovery of solutions,involving try & error, able to change)
Kuhnian paradigms, or disciplinary matrices(dominance of one paradigm, competing school of thought)
Feyerabends approach (Society are too complex: goodscientist is one who prepares to develop & accepted inconsistent ideas &
theories)
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1. Identify
research problem
2. Develop
theoretical framework
3. State
hypothesis
4. Construct
research design
5. Observe
6. Analyse7. Evaluate8. Assess limitations
and constraints
Theory plane
Observation plane
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A number of conflicting theories have
developed
A theory generally consists of
three parts
There are several criteria for judging a
theory
Persuasiveness of evidence