Exam Prep Flashcards
If you developed a theory to explain how a person’s cultural background influences how they prepare financial statements, would you have developed a positive theory or a normative theory?
positive theory.
theory would be evaluated in terms of how well its predictions (perhaps based on particular cultural attributes of a given population) correlate with the predicted accounting practices (for example, we might have predicted that people from a ‘conservative’ society are more likely to adopt historical cost accounting rather than utilising valuations based on fair values). In developing such a theory we are not attempting to prescribe what accounting methods should be used – which contrasts our research with normative research
In an article that appeared in The Age (‘Way cleared for turnbull to challenge’, by Michelle Grattan), Peter Costello, former federal treasurer is quoted as saying ‘I have a theory that every government wins one more term than it should’. Do you believe he really has a ‘theory’ in terms of the way a ‘theory’ is defined in this chapter?
Arguably, Peter Costello has a hunch, rather than a theory. The Oxford English Dictionary defines a theory as ‘a scheme or system of ideas or statements held as an explanation or account of a group of facts or phenomena’. Theories would not generally be considered to be ad hoc in nature, and should be based on systematic and coherent reasoning. It is not obvious that Peter Costello’s ideas match with our views of what constitutes a theory
Why would it not be appropriate to reject a normative theory of accounting because its prescriptions could not be confirmed through empirical observation?
Prescriptions are clearly not the same thing as predictions. If, for example, a researcher is prescribing a particular approach to accounting (that is, he or she is being ‘normative’ in nature) that does not mean when we look at actual accounting practice we will find that the prescribed method is being used. In fact, the reason why the researcher developed a particular normative theory (a theory that prescribes what should be done) could well be driven by the researcher’s observation of the inadequate practices currently being employed. For instance, Raymond Chambers developed a theory of accounting (labelled Continuously Contemporary Accounting) which prescribes that assets should be valued on the basis of exit (market) values. He did this on the basis of the perceived limitations of historical cost accounting. The fact that almost all reporting entities used historical cost at the time does not of itself invalidate Chambers’ theory.
The IASB is currently developing a revised Conceptual Framework for financial Reporting. If you have been asked to review the framework - which is an example of a normative theory of accounting - why would it be important for you to pay particular attention to how the objective of financial reporting is defined within the framework?
If the revised conceptual framework (which is an example of a normative theory) is based upon, or built upon, a particular assumption then, before we are likely to accept the prescriptions provided by the revised framework we would need to satisfy ourselves that we accept the central assumption. If we reject the central assumption, then no matter how logically developed the theory might be we will reject its prescriptions.
What is the difference between developing a theory by induction and developing a theory by induction and developing a theory by deduction?
As explained in this chapter, theory that is developed through induction is developed as a result of undertaking a series of observations of particular events, and on the basis of these observations, a theory is developed. Early theories of accounting (for example, in the 1960s) were often developed by observing what accountants were actually doing in practice. This led to the formulation of certain conventions and doctrines of accounting which were considered to be theories. As we discussed however, developing theory on the basis of observation typically does not allow us to address the issue of what would be the most appropriate behaviour in particular circumstances (and determining ‘appropriate behaviour’ will in turn be influenced by particular assumptions or value judgments made by the researcher). That is, it does not encourage us to evaluate what the accountants are doing.
By contrast, developing theory on the basis of deduction does not rely upon observation. Rather, it relies upon the use of logic to develop arguments and related theory. Some theories developed through deduction—such as positive accounting theories which are developed and then used to predict particular behaviour—can be tested (but not initially developed) through subsequent observation. Other theories developed through deduction—such as Chambers’ theory of accounting (Continuously Contemporary Accounting)—should not be evaluated through subsequent observation as he was prescribing a particular approach to accounting that was in stark contrast to what accountants were doing at the time.
Is the study of financial accounting theory of waste of time for accounting students? Explain your answer.
the outputs of the accounting system are used in many decisions throughout society and hence it is important to consider how particular accounting methods, or changes thereto, will impact various groups. If we only considered how to calculate accounting numbers, without considering their impacts, then we would be only getting a fraction of the total ‘story’. People involved in accounting logically need to have some perspective about how people will react to different accounting numbers or forms of disclosure; accounting theories can provide us with such insight. Apart from considering how accounting numbers might impact different groups, people involved in accounting should arguably understand the different factors which might have influenced accounting standard-setters when they developed particular requirements. They should also be aware of research that suggests improvements to current practices (with such information perhaps being derived from different normative theories of accounting).
If an accounting researcher adopts a particular accounting theory to predict which firms will make particular accounting disclosures, how much supporting evidence must the researcher gatehr before he or she can claim that the theory is ‘proved’? Explain.
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According to the ‘falsificationists’ what should a ‘good’ theory do?
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What is a ‘hypothesis’ and do you consider that accounting research should necessarily involve the development of empirically testable hypotheses?
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Do we really need financial accounting theory if all we are interested in doing is developing accounting standards?
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What expectations do accounting standard-setters have about the accounting knowledge of finacial statement readers?
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Do you believe that the media portray accounting numbers, such as profits, as some sort of ‘hard and objective performance indicator? Why do you think they might do this, and, if they do, what are some of the implications that might arise as a result of this approach?
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What is ‘creative accounting’ and why does it occur?
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In the early part of the twentieth centruy accounting rules were developed based upon large - scale analysis of what methods accountants were using, and on the basis of the assumptions and conventions that they were adopting. What are some criticisms of adopting thsi approach to develop accounting rules and related theory?
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If regulators acted in accordance with predictions provided by the private interest theory of regulation, which assumes that all individuals (including politicians and regulators) are motivated by their own economic self-interest, what is the likelihood of the introduction of regulations aimed at reducing the problems associated with climate change - particularly if business corporations opposed such regulations?
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