Ch 1 Part 2 Introduction to Accounting Theory

7/30/2019 Ch 1 Part 2 Introduction to Accounting Theory

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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

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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

Documents

Ch 1 Part 2 Introduction to Accounting Theory