Week 1 Flashcards
Accounting theories can assist with understanding accounting as a….
technical practice and as a social practice
Accounting as technical practice
Under this conception, accounting is “a comprehensive set of techniques, concepts and practices resulting in the preparation of accounting reports”
Accounting as social practice
Under this conception of accounting, accounting is recognised for its effects on the behaviour of people and, therefore, its impacts on organisational and social functioning and development. When we consider not just the technical aspects, but also the social impacts and consequences of accounting, we realise that accountants are potentially very powerful members of society!
Theories can be classified according to how they are developed
based on numerous observations (inductive reasoning), or
on the basis of logic (deductive reasoning)
Theories can also be classified according to their purpose:
‘descriptive,’
‘normative’ (prescriptive), or
‘positive’ (explanatory, predictive)
Inductive reasoning
Observing what happens, then using these observations to come up with generalisable theories (process of induction)
Based on detailed facts and general principles which are eventually used to reach a general conclusion
Reasoning from a specific case (or cases) to derive a general rule
Induction is fallible
at any time, the next observation could ‘disprove’ the theory
Earliest accounting theories and inductive reassoning
The earliest accounting theories (developed in the 1920s) were inductive because they were based on observation of what accountants did
They described existing practice, but didn’t consider whether these practices were ‘right’ or ‘best practice’
Deductive reasoning
Using logical arguments, rather than observation, to develop a theory (process of deduction)
Deductive reasoning starts with a general case and deduces specific instances
Syllogism
The most common form of deductive reasoning is the syllogism. A syllogism comprises 2 or more premises which, if true, lead to a logical conclusion. Provided the original statements (premises) are true and the argument is logical, then the conclusion must be true
Acceptance of a theory developed through logical deduction must be based on:
the logic of the argument, and the accuracy of the premises
the logic of the argument, and the accuracy of the premises
An argument is logical to the extent that if the premises on which it is based are true, then the conclusion must be true. We do not need to refer to ‘real world’ observations to determine the logic of an argument However, although the argument might be logical, if it can be shown that one (or more) of the premises is untrue then the conclusion may be rejected!
Descriptive accounting theories
Early work on developing accounting theories relied upon inductive reasoning. Researchers observed what was done in accounting practice and then described their observations. These observations were used to develop ‘codes of practice’ which represented descriptive theories of accounting E.g. monetary convention, matching principle, doctrine of conservatism
Normative accounting theories
Mid 1960s to 1970s known as the ‘Golden Age’ of accounting research (‘normative’ era). Sought to prescribe particular accounting practices (how accounting should be done). Not driven by existing practice, and hence not typically inductive in nature
Rather, they were deductive in nature and, based on logical argument; sought to develop new methods of accounting.
Normative accounting theory example (using deductive reasoning):
P1 One of the objectives of accounting is to provide information to help people make decisions about whether to invest in a business.
P2 In deciding whether to invest in a business, the current value of the business’s assets is more useful than the assets’ historical cost.
C Therefore accountants should value a business’s assets at their current value, not their historical cost
A present day example of normative theorising is the
Conceptual Framework project
Positive accounting theories
‘Positive’ theories don’t prescribe what should be – they try to explain and/or predict what is or will be. A positive theory usually begins with some assumption(s) and, through logical deduction, makes predictions about the way things will be. Positive accounting theories attempt to explain and predict accounting practice
E.g. Watts and Zimmerman’s Positive Accounting Theory (PAT)
Seeks to predict and explain why accountants choose to adopt particular accounting methods in preference to others
Example 1 of a positive accounting theory (based on deductive reasoning):
It is management’s role to maximise the wealth of the firm. Capitalising research and development costs (R&D) will lead to higher firm profits than if these costs were expensed. Higher firm profits result in greater firm wealth. Therefore, management will direct the firm’s accountants to capitalise R&D
(Explains, predicts, but doesn’t prescribe)
Example 2 of a positive accounting theory (based on deductive reasoning):
In the Australian culture, too much success is seen as ‘greedy’. Firms that are seen as ‘greedy’ will be pressured by consumer groups to lower their prices.
Australian businesses that are very profitable need to show that they are contributing some of their profits to the community so that they don’t appear ‘greedy’. Therefore, very profitable Australian businesses tend to disclose in their annual reports information about how much they have contributed to charities, community projects, etc.
Criticism of normative accounting theories
Lack of empirical observation:
based on personal opinion about what should happen – often rely on value judgements that can differ between individuals
Positive theorists argue it is preferable to provide information about expected implications of actions and let others decide for themselves what they should do
Positive theorists argue it is preferable to provide information about expected implications of actions and let others decide for themselves what they should do – but
Positive theorists also make value judgements. Even the choice of research topic is a value judgement about what is important and worthy of researching. The assumption that human behaviour (including accounting behaviour) is driven by the desire to maximise one’s wealth is a value judgement
Criticisms of positive accounting theories
Don’t prescribe how accounting should be practiced.
Therefore they do not provide guidance to the profession.
Could alienate academic accountants from their counterparts within the profession.
Can we ever ‘prove’ a theory?
Can we expect a theory of financial accounting (and hence, about people) to provide perfect predictions in all cases? A theory might not have perfect predictive capabilities, but still be useful. Can’t say we have actually ‘proved’ a theory, as subsequent observations/events might not be in accordance with the theory. Safer to say that our evidence supports a particular theory (rather than ‘proves’ a theory).
Falsificationists
‘Falsificationists’ believe that theory develops through trial and error, and that ‘good’ theory should generate hypotheses or predictions that have the potential to be rejected. Rejection (‘falsification’) leads to refinement of theory. Falsificationists would argue that a theory can never be ‘proved’, though it might be the ‘best’ available at a particular point in time.
How can accounting theories help the accounting profession?
Without a theoretically informed understanding of accounting it is difficult to:
evaluate the suitability of current accounting practices
develop improved accounting practices where current practices are unsuitable for changed business circumstances
defend the reputation of accounting when accounting practices are blamed for causing companies to fail (as occurred in the aftermath of the global financial crisis)
Distinguish an accountant from a bookkeeper
Bookkeepers apply accounting rules
Accountants:
devise solutions to new, unfamiliar accounting issues
exercise professional judgement
must understand the impact of accounting policy choices
must understand factors likely to influence accounting policy choices – important for auditors, investors/analysts, lenders, and other users of financial reports
