Accounting Theory

Fifth Edition

Eldon S. Hendriksen
Michaelf. Van Breda

Chapter 1:
Introduction and Methodology of
Accounting
Approach to Accounting Theory

Classifying Accounting Theories

A Tax Approach

Theory as a Language

A Legal Approach

Theory as Reasoning

An Ethical Approach

Theory as Script

Economic Approaches
A Behavioral Approach
A Structural Approach
Theory Verification
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Chapter 1: Introduction and Methodology of Accounting

What is a theory?
the coherent set of hypothetical, conceptual and
pragmatic principles forming the general
framework of reference for a field of inquiry.

Chapter 1: Introduction and Methodology of Accounting

What is an accounting theory?

logical reasoning in the form of a set of broad
principles that
Provides a better understanding of existing
practices to practitioners, investors, managers,
and students
provide a general framework of reference by
which accounting practice can be evaluated
and
guide the development of new practices and
procedures.

Chapter 1: Introduction and Methodology of Accounting

Whether a theory is accepted depends on

how:

well it explains and predicts reality.

well it is constructed both theoretically and
empirically.
Its implications are acceptable.

Chapter 1: Introduction and Methodology of Accounting

Approaches to Accounting Theory

1. A Tax Approach:
The objectives of tax accounting are very different from those of
financial reporting
Tax is not interested in measuring the income of a company, as
establishing a base for tax purposes

Chapter 1: Introduction and Methodology of Accounting

Positive influence of tax accounting on financial

reporting:
-The provision of depreciation gave rise to depreciation
methods, concepts & calculating depreciation costs.
-Appropriate methods for inventory valuation (Lower of Cost
or market)
- Court cases had considerable influence on development of
accounting concepts
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Chapter 1: Introduction and Methodology of Accounting

Negative influence
reporting:

of

tax

accounting

on

financial

The tendency to accept income tax provisions as accepted

accounting principles and practices. Like following the
depreciation method acceptable for tax purposes regardless
of whether or not it follows good accounting theory in the
situation

Chapter 1: Introduction and Methodology of Accounting

2. A Legal Approach:
In many situations there are economic as well as legal issues.
Lawyers & Accountant look at property and related concepts the
same way, but they dont always arrive at the same conclusion.
Lawyers interested in income available for tax or income available
for dividends.
Accountant interested in increment in value or a measure of
operational efficiency
While Law certainty provides numerous examples that can stimulate
thinking on accounting theory, it is seldom the deciding factor.

Chapter 1: Introduction and Methodology of Accounting

3. An Ethical Approach
Fundamental ethical questions are at the heart of all modern theory
building.
The ethical approach to accounting theory places emphasis on the
concepts of justice, truth, and fairness
Neutrality, absence of bias and representational faithfulness are both
considered necessary characteristics of a reliable accounting
system.

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Chapter 1: Introduction and Methodology of Accounting

The term truth means in accordance with the fact not all who
refer to truth in accounting have in mind the same definition of facts
Many associate the term truth with statements that they believe to
be established principles
This makes the truthfulness of the financial reports depend on the
fundamental validity of the accepted rules and principles on which
the statements are based.
This is an inadequate foundation for measuring truthfulness.

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Chapter 1: Introduction and Methodology of Accounting

4. Economic Approaches:
Accountants have long attempted to interpret accounting concept in
terms of economic concepts
There are 3 different avenues in taking an economic approach to
accounting: macroeconomic, microeconomic, and the corporate
social.
a. Macroeconomics
b. Microeconomics
c. Corporate Social

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Chapter 1: Introduction and Methodology of Accounting

a. Macroeconomic Approach:
Attempts to explain the effect of alternative reporting procedures
on economic measurements and economic activities at a level
boarder than the firm, such as an industry or the national
economy. (What is the effect on the economy?)
b. Microeconomic Approach:
Attempts to explain the effect of alternative reporting procedures
on economic measurements and economic activities at the level
of the firm. (What is the effect on the stockholders?)
c. Corporate Social Accounting:
Attempts to explain the effect of alternative reporting procedures
on the society The cost of the environmental pollution,
unemployment, unhealthful working conditions, . (What is the
effect on other stakeholders)
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Chapter 1: Introduction and Methodology of Accounting

5. A Behavioral Approach:
Attempt to measure and evaluate the economic, psychological, and
sociological effects of alternative accounting procedures and
reporting media, on the users of accounting reports.

6. A Structural Approach:
A classical approach, focuses on the structure of the accounting
system itself. The accountants attempt to classify similar transaction
similarly, to seek consistency in recording and reporting transactions.

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Chapter 1: Introduction and Methodology of Accounting

Classifying Accounting Theories

1. Theory as a Language:
Relies on the notion that the accounting is a language.
* What effect will the words have on listeners?
* What meaning, if any, do the words have?
* Do the words make logical sense?
How to study language?
Pragmatic is the study of the effect of language
Semantics is the study of the meaning of language
Syntactics is the study of the logic or grammar of the language
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Chapter 1: Introduction and Methodology of Accounting

Behavioral & Economic approaches are primarily pragmatic in style.

Structural approach is primarily syntactic.
Many accounting concepts still have no semantic content

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Chapter 1: Introduction and Methodology of Accounting

2. Theory as a Reasoning:
In accounting: The generalizations are often termed postulate.
The Principles are the basis for practical application.
a. Deductive Reasoning:
The arguments flow from generalization to specifics.
Practical applications and rules (principles) are deduced from the
postulates.
Objectives are an important part of the deductive process, because
different objectives can require entirely different structures and
result in different principles.

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Chapter 1: Introduction and Methodology of Accounting

b. Inductive Reasoning:
The arguments flow from specifics to generalizations.
Principles are induced from best current practice, based upon
practical experience, and generalized as whole.
..
If we restricting ourselves to the financial data of a firm for example,
we are drawing on certain postulates regarding the environment of
accounting.
If we restrict ourselves to observing only financial transactions, we
will only confirm existing practice.
Induction & deduction, are complementary, almost all theories will
include some elements of both deductive and inductive reasoning.
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Chapter 1: Introduction and Methodology of Accounting

3. Theory as Script:
a. Descriptive (Positive) theory:
Explain what & how financial information is presented.
Attempts to discover how management and others decide which
is the best way for them.
Inductive theory by their nature are usually positive.
b. Prescriptive (Normative) theory:
What data ought to be communicated and how they ought to be
presented.
Attempts to discover the best way of accounting for a
transaction.
Deductive theories are not necessarily normative.
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Chapter 1: Introduction and Methodology of Accounting

Theory Verification
Verification may be defined as establishing the acceptability, or the
truth, of a theory.
Different theories are judged in different ways.
Normative theories are judged by the reasonableness of their
assumptions.
Positive theories are judged in two different way depending on
whether they have empirical content or not.

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Chapter 1: Introduction and Methodology of Accounting

Syntactic theories are positive theories which have no empirical

content. They are confirmed by logic alone.
Semantic theories are positive theories that do have empirical
content. They are confirmed by research studies. (whether users
understand the information procedures intended meaning)
Pragmatic theories are also positive theories with empirical content
(emphasize the usefulness of accounting to investors and others)

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