SUMMARY

ACCOUNTING THEORY
(SUBJECT CODE: ECAU601401)

Chapter 2
Accounting Theory Construction
(Godfrey et.al. Accounting Theory 7th Ed)

Lecturer:
Mrs. Siti Nuryanah, S.E., M.S.M., M.Bus.Acc., Ph.D.

Group Member
1. Eggie Auliya Husna 1706105246
2. Fendhi Birowo 1706105290
3. M. Avisena 170610
4. Yolanda Tamara 170610

SALEMBA EXTENSION CLASS

ACCOUNTING PROGRAM
FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITY OF INDONESIA
YEAR 2018
MIND MAP FOR CHAPTER 2

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 CHAPTER 2
ACCOUNTING THEORY CONSTRUCTION

A. Pragmatic Theories
Pragmatic Accounting Theory was an era in the period of 1800 until 1955 which often
referred to as ‘general scientific period’. This era was emphasized on providing an overall
framework of accounting to explain why accountants account as they do, especially with the
evidence which based upon observation of practice. Pragmatic theory relies on empirical
observation rather than basing principles on deductive logical approach. Its major focus is on
the use of historical cost approach and application of the conservatism principle.
Pragmatic Theories could be generally classified into 2 categories:
1. Descriptive Pragmatic Approach
The descriptive pragmatic approach is an inductive approach which based on
continual observation of the behaviour of accountants in order to copy their accounting
procedures and principles. This theory can be developed based on how accountants act
in certain situation. Sterling usually called this method ‘anthropological approach’
because of this theory’s nature to construct observation regarding what accountants
actually do.
However, there are several criticisms of this approach, as mentioned below:
 The descriptive pragmatic approach does not include an analytical judgement
of the quality of an accountant’s actions
 The descriptive approach does not provide for accounting techniques to be
challenged, hence it does not allow for any change
 It focuses attention on accountant’s behabiour not mainly on the firm’s
attributes such as assets, liabilities, and profit
2. Psychological Pragmatic Approach
The pshychological pragmatic approach is a theory that require theorists observe
user responses to the accountant outputs (such as financial report). Therefore, a
reaction by the user is taken as evidence that the financial statements are useful and
contain relevant information.
Critics to this theory are:
 Some users may react in an illogical manner
 Some users might have preconditioned response
 Some other users do not react when actually they really should
Those critics could be overcomed by concentrating decision theories and testing
them on large samples of people, rather than on individuals.

Descriptive Pragmatic Approach: Focus on the behaviour of accountants

Psychological Pragmatic Approach: Focus on the response of users to accountant’s output

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B. Syntactic and Semantic Theories
Syntactic theory is a theory where semantic inputs of the system are the transactions and
exhanges recorded in the vouchers, journals, and ledgers of the business. The inputs are then
manipulated on the basis of the premises and assumptions of historical cost accounting.
Some accounting theorists are very critical of this approach, especially in the use of
historical accounting. For example, if historical accounting was used by ignoring inflation and
market value of assets and liabilities, then the syntactic theory only emphasized on semantic
content based of its inputs. There will be no independent empirical operation to verify the
calculated outputs.
To put forward, some critics about syntactic theory and historical accounting are:
 Its has semantic content only on the basis of its inputs
 It ignores some critical measurement of the real world such as inflation and market
value of assets and liabilities
 There is no independent empirical operation to verify the calculated outputs
 Audit process is simply a recalculation, it does not verify the final output correctness
 Accounting report will have little or lack of value in practice
 It could sum several money amounts assigned to specific account
In summary, historical 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. The matching concept and allocation of cost are not really
fit with the accounting purpose in the first place. The assumption of accounting should be a
measurement system which could provide information useful for decision making.

C. Normative Theories
Normative theories come in the period of 1950s to 1960. It was described as the ‘golden
age’ of normative accounting research. Accounting researchers concerned with policy
recommendations and with what should be done. Two terms that is very important in this
theory is the term of ‘true income’ and ‘decision usefulness’.
1. True Income
Accounting theorists tried to figure a single measure for assets and a unique (and correct)
profit figure. However, there was no agreement on what constituted a correct or true
measure of value and profit.
2. Decision Usefulness
It assumes that the basic objective of accounting is to aid the decision making process of
certain users of accounting reports by providing useful, or relevant, accounting
information.

Financial statements should mean what they say

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 Decision usefulness theories of accounting are based on classical economics concepts of
profit and wealth or rational decision making. It usually makes adjustments to historical cost
measures to account for inflation or the market values of assets. This theory is normative in
nature because they make the following assumptions:
 Accounting should be a measurement system
 Profit and value can be measured precisely
 Financial accounting is useful for making economic decisions
 Markets are inefficient or can be fooled by creative accountants
 Conventional accounting is inefficient (in an information sense)
 There is one unique profit measure
But is that information we derive from given sets of operations useful for decision making
process? We could test this assumption by making the output data help the financial decision
making process. For a simpler approach, we indicate this procedures:

Accounting Prediction model Decision model

System of of Users of user
Company X

D. Positive Theories
Positive theory was developed during the 1970s. This theory will test or relate
accounting hypotheses or theories back to experiences or facts some of the real world.
Positive accounting research first focused on empirically testing some of the assumptions
made by the normative accounting theorists. It will also explain the reasons for current practice
and predict the role of accounting information in decision making.
The differences between normative and positive accounting theories are:
Normative Theory Positive Theory
Prescriptive which means it will prescribe  Descriptive which means it describes
how people such as accountants should how people do behave (regardless what
behave to achieve an outcome that is is right)
judged to be right, moral, just, or otherwise  Explanatory which means it explain
a good outcome why people behave in certain manner
 Predictive which means it will predict
what people have done or will do
(regardless what is right or best
behaviour)

Normative Theory is prescriptive

Positive Theory is descriptive, explanatory, and predictive

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 Many positive theory researchers dismiss the importance of normative theory and vice
versa. In fact, the positive theory will actually help provide an understanding of the role of
accounting which in turn can form the basis for developing normative theories to improve the
practice of accounting.

E. Scientific Approach versus Naturalistic Approach

To this point, accounting theory have focused on what may be considered to be a highly
structured approach to theory formulation – the scientific approach. The scientific approach
is generally used in most journals and academic methods, which in turn only accepted
scientific theory constructions. When a researcher sees the real world and find that the current
theory is no longer relevant, they will conduct data gathering, follow up by some observation
and measurement, and then they will start making a new hypotheses based on that. After
applying some kind of statistical method, the formulation will be constructed and the theory
will be tested against the current theory, to proof whether it is right or wrong. This theory will
also have an assumption that it will works constantly across firms, industries, and time. This
scientific approach also used by most researchers in accounting.
Therefore, some great body of scholars give critics to this method. They call the theory
‘naturalistic approach’. 2 major critics are:
1. Large scale of statistical research tends to lump everything together. Some researchers
advocate that naturalistic approach is far more appropriate for gaining new knowledge of
accounting based on 2 assumptions:
 It does not have any preconceived assumptions of theories
 It focuses on firm-spesific problems. The research conducted by naturalistic approach
will be much more flexible, and do not intend to answer the ‘general theories of
accounting’ but it will approach more on ‘spesific real-world situations’
2. It is conducted in environments that are often remote from the world of or the concerns
of accountants. Many researchers suggest that the most appropriate technique for this
research is by conducting case study research to explore and crystalise a specific problem
for naturalistic approach.

F. Other Issues
If accounting researchers hold their ground and will apply the scientific approach to
accounting, there might be some kind of problems of misconceptions. It includes the desire of
absolute truth which in the study of accounting it will means almost impossible to get, because
of the various problems in the real world.
Other issue is about auditing theory. Auditing will verify inputs of accounting and its
processes. It opinions will provide 2 information: whether the financial statements accord with
the applicable accounting framework and whether the statements give a true and fair view.
Normative era of accounting coincided with a normative approach to auditing theory, but the
positive era of accounting has led to a positive approach to auditing theory.