Chapter 1

CHAPTER 1
INTRODUCTION TO
ACCOUNTING THEORY
Historical development of Accounting

Early history of Accounting (b)
Dating back 3000 BC
Chaldean-Babylonian, Assyrian & Sumerian civilization
Organized government, oldest government, oldest written language
Egyptian civilization pivots on which the whole machinery of the
treasury and others departments turned
Chinese civilizations, accounting playing a key & sophisticated role
during Chao Dynasty (1112 256 BC)
Greek civilization, Zenon introduce system of responsibility accounting.
Roman civilization law requires taxpayers to prepare statement of
financial position, civil right = property declare by them
2
The Italian Method

1340 i.e.. development of commercial republic of
Italy, used
double entry bookkeeping method
Medieval (belonging to middle age) accounting i.e.
tools for management control as describes by
Raymond de Rover;
Balancing of the books as primary objective
Developing cost accounting
Introducing reserves
Adjustments (accruals & differed items)
Audited financial statement
But little progress in analysis of financial
statement
Luca Pacolis Contribution

Franciscan monk, 1494 wrote the 1St book, Summa de
Arithmetica Geomatrica, Proportioni et Proportionalita
(Review of Arithmetic, Geometry & Propotions) (he didnt invent
double-entry bookkeeping)
2 chapters, de Computis et Scripturis, describing double

entry bookkeeping
Know as the method of Venice or the Italian method
He stated;
purpose of bookkeeping was to give the trader without delay
information as to his assets & liabilities
All entries has to be double entries, that is, if you make one
creditor, you must make someone debtor
Not only was the name of buyer or seller recorded, as well as

the description of the goods with its weight, size or measurement,
price and term of payment
The receive or disburse, the record was shown of the kind of
currency and its converted value.
He advice the computation of periodic profit and the

closing of the book;
it is always good to close the book each year,
especially if you are in a partnership with others.
Frequent accounting makes for long friendship
Development of accounting
Pragmatic Accounting
18001955
General scientific period
theory based on observations of practice rather than deductive
logic that is critical in current practice.
Overall framework to explain why accountants account as
they do
Wall Street Crash (1929), lead to creation of Securities &
Exchange Commission
Lead to improve financial regulation & reporting
1930s give rise to several notable accounting publications (A
Tentative Statement of Accounting Principles affecting corporate
reports)
In 1938 AICPA released A statement of Accounting Principles
Development in accounting research, the theories to explain
practice become more detail and complex
7
Relevance of accounting history

Important to accounting pedagogy(method & instruction), policy &
practice.
Pedagogy
Educated the members to appreciate intellectual heritage
Advance in thought, major contribution to literature, & of crucial study
maybe lost, fragmented, or inadequately recognized in longer term
unless they are documented and incorporated by scholars
Incomplete or unjustified claim about the past
Policy
Better understanding on accounting problems & their institutional
context as well as the formulation of the public policy
Practice
Better assessment of the existing practice by a comparison method
used in the past.
8
Relevance of accounting history

betterto understand our present & to forecast or
control our future.
Accounting history is the study of the evolution in
accounting thought, practices & institutions in response
to changes in the environment & social needs. It also
considers the effect this evolution has worked on the
environment
Historical research, includes biography, institutional
history, development of thought, general history, critical
theory, taxonomic & bibliographic database.
9
Introduction to Accounting Theory
10
Definition of Accounting
Belkaoui (2004);
Accounting is the art of recording, classifying, & summarizing in a
significant manner & in terms of money, transactions, & events which are,
in part at least, of a financial character, & interpreting the result thereof.
(AICPA)
From broader perspective;

The process of identifying, measuring, & communicating economic
information to permit information judgments & decisions by user of
information
Quantitative information;
Accounting is a service activity. Its function is to provide quantitative
information, primarily financial in nature about economic entities that is
intended, to be useful in economic decisions, in making resolve choices
among alternative course of action.
11
From the definition;

Accounting: an art or science?
Accounting deals with enterprise, which are certainly social
groups;
It is concerned with transactions & other economic events which
have social consequence & influence societal relationship;
It produces knowledge that is useful & meaningful to human
beings being engaged in the activities having social implications;
On the basis of the guidelines available, accounting is a social
science.
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The nature of Accounting

Accounting as;
1.Ideology
2.Language
3.Historical record
4.Current economic reality
5.an information system
6.Commodity
7.Mythology
8.Rationale
9.Imagery
10.
Experimentation
11.
distortion
13
The nature of Accounting as..

1. an ideology (beliefs, ideas, thought, principles)
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; by crystallizing and defining
numerically, it powerfully propels the logic of enterprise
14

2. language of Business
Communicating information about a business.
Recognized in accounting profession, which
published accounting bulletin & empirical
literature, to measure the communication of
accounting concepts.
15

3. historical record
As a means of providing the history of the
organization & its transaction with environment.
History of managers stewardship of the owners
resources.
16

4. reflecting current economic reality
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.
17

5. information system
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)
18

6. commodity (product)
Demand & supply of accounting information.
Accounting provides ideal ground for policy & contracts between
the organization & environment.
In accounting research;
the emergence of the image of accounting as a commodity again
provide a striking example of the manner in which accounting
thought reflects its social content. It has arisen in an are of
mushrooming regulation & increasing concern with the public
interest in a situation of scarce resources & many contemplating
demand . It has provided the rationale for accounting policies
which seek to aid the allocation of resources in the service of
public interest.
19

7. mythology (symbolic rituals/practice)
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.
20

8. rationale
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.
21

9. imagery
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)
22

10. experimentation
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
or devices used in a particular field or
23
occupation).

11. distortion
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.
24
What is an accounting theory?
25
Definition of Theory
Popper, K (1968) ,The Logic of Scientific Discoveryemphasizes empirical nature of the theory rather than
logicalTheories are nets cast to catch what we call the world,
to rationalize, to explain and to master it
Hendriksen (1970):
1the coherent set of hypothetical, conceptual and
pragmatic principles forming the general framework of
reference for a field of inquiry.
2logical reasoning in the form of a set board
principles(1) provide a general framework of reference
by which acctg practices can be evaluated and guided26 26
the development of new practices and procedures
Definition of Theory
McDonald argues that a theory must have three
elements:
1. encoding of phenomena to symbolic representation
2. manipulation or combination according to rules
3. translation back to real-world phenomena
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.
27
27
Accounting Theory Classification

Godfrey et. al. (2010), classified
accounting theory as:
A. Theory as Language
B. Theory as Reasoning
C. Theory as Script
28
28
Accounting Theory as..

A. language
As language as business
Three question that should asked about
language, word, phrases
What effect will the words have on listeners?
What meaning, if any, do the words have?
Do the word make logical sense?
Pragmatics study of the effect of language
Semantics-the study of the meaning of language
Syntactic the study of the logic or grammar of
the language
29
29
i. Pragmatics
This relation pertains to the effect of words or
symbols on people
How acctg concepts, and their real world
corresponding events or objects, affect people
behaviour.
How people react to the same message in
different way-acctg standard-support & lobbying
The relation of signs to users of those signs
Accounting should provide useful
information for decision making to
certain interested parties
30
30
Pragmatic theories
Descriptive pragmatics
observe behavior of accountants
no logical assessment of actions
does not allow for change
Psychological pragmatics
observe reactions of users
31
ii. Semantics (the study of meaning)

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
Premise 1:
Premise 2:
account.
Conclusion:
balance.
All asset accounts have debit balances.

The sales returns account is not an asset
The sales returns account has a debit
32
32
iii.Syntactic (A systematic orderly arrangement)

Rules of the language employed
Refer to rules of grammar & mathematics
Analytical methodology basically relied upon
syllogism (deductive reasoning in which a
conclusion is derived from two premises)
If the combination of premise is valid, so the
conclusion was also true.
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 33
33
debit balance.

B. reasoning
The debate whether the theory is argument flow:
General to specific (deductive).
Acctant usually deduce acctg principles or
postulates to provide concrete applications or
rules
Specific to General (inductive).
Acctg principles are induced from the best
current practice.
34
34
i. Deductive Reasoning
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 cash
account.
Advantages of the method;
If postulates or premises is false, conclusion may also
false
To provide the basis for practical rules.
The main objective of theory to provide a framework for
the development of new ideas or new procedures and to
help making choices among alternative procedures. 35
ii. Inductive Reasoning

Arguments begins with a set of a particular
examples, claim that it will representative of
some greater whole, then infer some
generalization about that whole.
Advantages;
Not necessarily constrained by a structure
Free to make relevant observation
Disadvantages
Influenced by the idea of relevant
relationship/observed
36
ii. Inductive Reasoning..cont

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 debit
balance.
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 is generalization
from all P.
37

C. Script
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 they ought to be
presented. (prescriptive or normative)
38
i. Normative (prescriptive)
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 a
transaction & useful in making decision.
ii. Positive (descriptive)
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.
39
TESTING A THEORY
Criteria of truth
Dogmatic basis
believe what we read
Self-evident basis
Reasonableness
(determine the truth, e.g.

accounting must using market price)
Scientific basis
Syntactic
(logical reasoning)
and
induction (refer
to empirical evidence)
40
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:

good scientist is one who prepares to develop & accepted
inconsistent ideas & theories)
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Accounting Theory Approach
42
THE NATURE OF ACCOUNTING THEORY

APPROACH
The primary objective of accounting theory is to
provide a basis for the prediction and
explanation of accounting behavior and events.
No single comprehensive theory of accounting
exists at present.
theory defined as:a set of inter-related constructs (concept),
definitions and propositions (suggestions) that
present a systematic view of phenomena by
specifying relations among variables with the
purpose of explaining and predicting phenomena.43
The General Acceptance of Accounting Principles (GAAP) guide

the acctg profession to choose acctg techniques and prepare FS
considered to be good acctg practice (normative approach)
The GAAP are subjected to the reexamination & critical analysis
with regards to the changes in environments, values and
information needs.
Changes in principles may occur as a result of providing
solutions to emerging accounting problem and formulating a
theoretical framework.
Provide a rationale for what accountants do or expect to be
doing.
The process of theory construction should be completed by
theory of verification or validation
44
Machlup (1955) defined the process:

The statement implies that the theory should be
subject to a logical or empirical testing to verify its
accuracy.
If the theory is mathematically based, the verification
should be predicted based on logical consistency. (PAT)
If the theory is based on the physical and social
phenomena, the verification based on the
deduced events & observations in the real world.
Therefore, acctg theory should result from both process of
theory construction and verification(reinforce the idea)
A given theory should explain and predict the acctg
phenomena.
If a given theory is unable to produce the expected results,
45
it is replace by a better theory.
APPROACH IN ACCOUNTING THEORY

A The Traditional Approach
B The Regulatory Approach
C The Positive Approach
D The Behavioral Approach
E The Paradigm Approach
46
A.Traditional approaches to
accounting theory
1. Non-theoretical, practical or pragmatic
(informal)
2. Theoretical:
a. Deductive approach
b. Inductive approach
c. Ethical approach
d. Sociological approach
e. Economic approach
47
A. Traditional Approach..
1. Non-theoretical approaches (P&A)
The pragmatic approach:

consists of the construction of a theory that conforms
to real-world practices and suggests practical
solutions
Means that property which fits something to
serve or facilitate its intended purposes
usefulness to users & relevance for decision making
The authoritarian approach:

The formulation of AT, which is employ primarily by
professional organization, consists of issuing
pronouncements for the regulation of accounting
practices
48
A. Traditional Approach..1. Non-theoretical

approaches (P&A)
Both approach assume AT (pragmatic & authoritarian) &
the resulting technique must be predicted on the basis
ultimate use of financial reports, if accounting is to have
useful function.
A theory without practical consequence is a bad theory.
However;
The approaches have been largely unsuccessful in
reaching satisfactory conclusions in their attempt to
construct an AT.
For example; balance sheet approach & profitoriented; pragmatic & authoritarian approach
absence on theoretical foundation.
49
A. Traditional Approach..2. Theoretical approaches

a. The Deductive Approach
Constructions of AT theory begins with basic
propositions & proceeds to derive logical
conclusions about the subject under
considerations.
Move from general to particular
Steps used to derive the deductive approach
1.
2.
3.
4.
Specifying the objectives of financial statements

Selecting the postulates of accounting
Deriving the principles of accounting
Developing the techniques of accounting
50

b. The Inductive Approach
The construction of theory begins with observations &
measurements & moves toward generalized
conclusions.
Lead to Positive approach
Involved four stages, i.e. :1. Recording all observations

2. Analysing and classifying these observations to
detect recurring relationships
3. Inductive derivation of generalisations and principles
of accounting from observations that depict recurring
relationships
4. Testing the generalisations
51
A.Traditional Approach..2. Theoretical approaches

Comparing deductive and inductive approaches:
In the inductive approach, the truth or falsity of
the propositions does not depend on other
propositions, but must be empirically verified
In the inductive approach the truth of the
propositions depends on the observation of
sufficient instances of recurring relationships
Accounting propositions that result from inductive
inference imply special accounting techniques
only with high probability
52
A. Traditional Approach.. 2. Theoretical approaches
Note;
The general proposition formulated through
inductive process
Principles & technique from deductive
process
e.g.; Paton (deductive theorist) & Littleton
(Inductive theorist)
53

C. The Ethical Approach
The basic core consists of the concepts of fairness, justice,
equity and truth
In general, the concept of fairness implies that accounting
statements have not been subject to undue influence or bias
Justice; equitable treatment of all interested parties
Truth; with true & accurate accounting without
misrepresentation
For example:
The committee on auditing procedures refers to concept of fairness
of presentation as:
1. conformity with GAAP
2. disclosure
3. consistency
4. comparability
54

D. The Sociological Approach
Emphasizes the social effects of accounting techniques
According to this approach, a given accounting principle
or technique is evaluated for acceptance on the basis of
its reporting effects on all groups in society
Implies that accounting data will be useful in making
social welfare judgments
Evolution to new accounting sub discipline,
socioeconomic accounting
The main obj encourage business to account their
impact on business activities on social environment
through measurement, internalization & disclosure in
their FS.
Probably play a major role in future formulation of AT. 55

E. The Economic Approach
Emphasizes
controlling
the
behavior
of
macroeconomic indicators that result from the
adoption of various accounting techniques
The choice of different accounting techniques
depends on their impact on the national economic
good
Accounting policies and techniques should reflect
economic reality, and the choice of accounting
techniques
should
depend
on
economic
consequences
e.g. LIFO method during continuing inflation period
56
The Eclectic (combination) Approach to the Formulation

of Accounting Theory
In general, the formulation of

accounting theory and the
development of accounting principles
have followed an eclectic approach.
a combination of approaches,
rather than just one approach.
57
CONTINUE TO SECOND
APPROACH..
58
B.THE REGULATORY
APPROACH
59
B.The Regulatory Approach..

Acctg standards dominate accountants work.
Standards are being constantly changed, deleted and/or
added.
They provide practical & handy rules for the conduct of
the accountants work.
They generally accepted as firm rules, backed by
sanction for nonconformity.
Accounting standards usually consist of three parts:
1. a description of the problem to be tackled
2. a reasoned discussion on ways of solving the
problem, then,
3. in line with the decision or theory, the prescribed
solution
60
B. The Regulatory Approach..

Why Examine Theories of Regulation
Better placed to understand why some accounting
prescriptions become part of legislation while others do
not
accounting standard-setting is a very political process
while some proposed requirements may be technically
sound and logical, they may not be mandated due to
political power or influence of some affected parties
Theories to Explain Regulation
1. Public interest theory
2. Capture theory
3. Economic interest group theory (private interest theory)
61

1. Public Interest Theory
Regulation put in place to benefit society as a
whole rather than vested interests
regulatory body considered to represent
interests of the society in which it operates,
rather than private interests of the regulators
assumes that government is a neutral arbiter
62

Criticisms of Public Interest Theory
Critics question assumptions that economic markets
operate inefficiently if unregulated
question the assumption that regulation is virtually
costless
others question assumption of government neutrality
argue that government will only legislate and groups will
only lobby for regulation if it will increase their own wealth
The regulated seeks to take charge (capture) the
regulator
seek to ensure rules subsequently released are
advantageous to the parties subject to regulation
although regulating initially in the public interest, difficult
for regulator to remain independent
63

2. Capture of Accounting Standard-Setting
Walker (1987) analysed capture of Australian
standard-setting through the ASRB. Argued
that:
the accounting profession lobbied before
the board established to ensure no
independent research capability, no
academic as chair, to receive admin officer
not a research director
priorities only set after consultation with
AARF
ASRB fast-tracked AARF submissions but
not others
64
majority of board membership were

2. Capture of Accounting Standard-Setting
Criticisms of Capture Theory
No reason to suggest that regulated industry the only
interest group able to influence the regulator
No reason why regulated industries only able to capture
existing agencies rather than procure the creation of an
agency
No reason why regulated couldnt prevent creation of the
regulatory agency
65

3. Economic Interest Group Theory
Assumes groups will form to protect particular
economic interests
groups are often in conflict with each other and
will lobby government to put in place legislation
which will benefit them at the expense of others
no notion of public interest inherent in the theory
regulators (and all other individuals) deemed to
be motivated by self interest
The regulator is not a neutral arbiter
but is seen as an interest group itself
regulator motivated to ensure re-election
66
or maintenance of its position of power

3. Economic Interest Group Theory.
regulation serves the private interests of politically
effective groups
those groups with insufficient power will not be able to
effectively lobby for regulation to protect its own interests
Examples - Application to Accounting Standard-setting
Industry groups may lobby to accept or reject a
particular accounting standard
eg. insurance oil & gas industry
large politically sensitive firms found to lobby in favour of
general price level accounting in US (led to reduced
profits)
accounting firms lobbying to protect their own interests 67

Accounting Regulation as an output of a
Political Process
The view that financial accounting should
be objective, neutral and apolitical can be
challenged
will inevitably be political as it affects
wealth distribution within society
standard-setters encourage affected
parties to make submissions on drafts of
proposed standards
68

If standard-setters give consideration to views in
submissions, accounting standards and therefore
financial reports are the result of various social and
environmental considerations
tied to the values, norms and expectations of the
society in which standards are developed
questionable whether financial accounting can claim
to be neutral and objective
69

Compliance with accounting standards usually seen to
indicate financial statements are true and fair ???
can accounts based upon standards determined from
various economic and social consequences be
deemed to be true?
Users may not be aware that financial reports are the
outcome of various political pressures
should regulators consider preparers views given that
standards are designed to limit what preparers do?
70

Influence of the Accounting Profession on Standards
Standards that do not have support from accountants

and/or the business community could result in:
1. lobbying by particular interest groups
2. non-compliance
3. refusal of companies to contribute to or participate in
the standard-setting process
4. threat of governmental regulatory intervention
It is in the AARFs best interests to issue standards that
are accepted by the business community and the
accounting profession
71

Private-sector Regulation of Accounting Standards
Advantages
The AASB is responsive to various constituents
The AASB attracts as members people who possess
the necessary technical knowledge to develop and
implement alternative measurement and disclosure
systems
The AASB is successful in generating a reasonable
amount of response from its constituency base and in
responding to this input
72

Private-sector Regulation of Accounting Standards
Disadvantages
The AASB lacks statutory authority and faces the
challenge of being overridden by government
The AASB has been accused of lacking independence
from dominating interests, such as the accounting
profession
The AASB has often been accused of responding too
slowly to major issues that are of crucial importance to
some of its constituents
73

Arguments in favor:
The ASIC acts as creative irritant and as a catalyst for
change, since the private sector and market forces do not
provide the leadership necessary to effect such change
The structure of securities regulation established by the
1991 Corporations Law serves to protect investors against
perceived abuses
The ASIC is motivated by the desire to create a level of
public disclosure deemed necessary and adequate for
decision making
Unlike the AASB, the ASIC is secured greater legitimacy
through its statutory authority
Private-sector objectives may sometimes contradict the
public interest.
74

Arguments against:
There is a high corporate cost for compliance
with government regulation of information
Bureaucrats have a tendency to maximise the
total budget of their bureau
There is the danger that standard setting may
become increasingly politicised
Government regulation backed by police
power may hinder the conduct of research and
experimentation of accounting policy and is
not essential to achieving standardisation of
75
measurement

Accounting Standards Overload
Too many standards

Too detailed standards
No rigid standards, making selective application difficult
General-purpose standards fail to provide for differences
in preparers, users and CPAs needs
General-purpose standards fail to provide for differences
between:
public and non-public entities
annual and interim financial statements
large and small enterprises
credited and non-audited financial statements
Excessive disclosures and/or complex measurements
76

Effects of Accounting Standards Overload
Accountants may lose sight of their real jobs

because of the excessive data required to
comply with standards
Audit failures may result because the accountant
may forget to perform basic audit procedures
The proliferation of complex accounting
regulations may lead to non-compliance
77

Solutions to the Standards Overload Problem
The AICAP Special Committee on Accounting Standards

evaluated the following possible approaches:
no change
a change from the present concept of a set of unitary
GAAP for all businesses, to two sets of GAAP
change GAAP to simplify application to all business
enterprises
establish differential disclosure and measurement
alternatives
78
C. The Positive Approach
79

The subject matter of positive
approach is:
existing accounting practices
managements attitudes towards those
practices
Proponents of the positive approach

argue that the techniques can be
derived from and justified on the basis
of their tested use, or that
management plays a central role in
determining the techniques to be
80
implemented

Basic subject matter:
information is an economic commodity
acquisition of information amounts to a problem
of economic choice
Accounting information is evaluated in terms

of its ability to improve the quality of the
optimal choice in a basic-choice problem
that must be resolved by an individual
The information system with the highest
expected utility is preferred
81
C. The Positive Approach..

Positive theory of accounting
The positive theory of accounting is based on

the propositions that managers, shareholders
and regulators/politicians are rational and
attempt to maximize their utility
Their choice of accounting policy rests on
comparing the relative costs and benefits of
alternative accounting procedures so as to
maximize their utility
82

The central ideal of the positive approach
1. To enhance the reliability of prediction, based
on the observed smoothed series of
accounting numbers along a trend considered
best or normal by management
2. To reduce the uncertainty resulting from the
fluctuations of income numbers in general and
the reduction of systematic risk in particular by
reducing the covariance of the firms returns
with market returns
83

The central problem in positive theories
The central problem is to determine how accounting
procedures affect cash flows, and therefore
managements utility
Theoretical assumptions guiding resolution of the
problem are:
the agency theory evolves to a view of the firm as a
nexus of contracts
given this nexus of contracts perspective, the role of
accounting information is to monitor and enforce
these contracts to reduce the agency costs of certain
conflicts of interest
84

The agency problem (dominant theory in positive
approach)
The basic agency problem is enriched by different

options concerning:
1. the initial distribution of information and beliefs
2. the description of the number of periods
3. the description of the firms production function in
terms of:
amount of capital supplied by the principal
agents level of effort
an exogenously determined, uncertain-state
realisation
85

The agency problem (dominant theory in
positive approach)
4. the description of the feasible set of actions from
which the agent chooses
5. the description of the labour and capital markets
6. the description of the feasible set of information
systems
7. the description of the legal system that specifies
the type of behavior that can be legally enforced,
and what is admissible evidence
8. the description of the feasible set of payment
systems
86

The agency problem (dominant theory in
positive approach)
9.
the description of the solution to the basic

agency model
10. the role of self-interest
11. the solution concept and the nature of optimality
87

Income smoothing
Propositions on income smoothing

1. The criterion a corporate management uses to
select among accounting principles is the
maximisation of its utility or welfare
2. The utility (effectiveness) of management
increases with:
job security
the level and rate of growth in managements
income
the level and rate of growth in the
corporations size
88

Income smoothing
Propositions on income smoothing
3. The achievement of the management goals
stated in proposition to depends in part on the
stockholders satisfaction with the corporations
performance
4. Stockholders satisfaction increases with the
average rate of growth in the corporations
income
89
D. The Behavioural Approach
90
D. The Behavioural Approach..

Most traditional approaches accounting theory
construction have failed to consider user behavior in
particular and behavioral assumptions in general
The behavioral approach to accounting theory formulation
emphasizes the relevance to decision-making of the
information being communicated, and of the individual
and group behavior caused by the information being
communicated
The behavioral approach to accounting theory formulation
is concerned with human behavior as it relates to
accounting information and problems
91

A new multidisciplinary area in the field of accounting
has been conveniently labeled behavioral accounting
The basic objective of behavioral accounting is to
explain and predict behavior in all possible accounting
contexts
92

Behavioural effects of accounting information
A more recent and exhaustive attempt by Dyckman,

Gibbins and Swieringa illustrates the nature of studies
of the behavioral effects of accounting information
We may divide these studies into five general classes:

1. adequacy of disclosure
2. usefulness of financial statement data
3. attitudes about corporate reporting practices
4. materiality judgements
5. linguistic effects of alternative accounting
procedures
93
D. The Behavioural Approach.. effects of acc. information

(1) Adequacy of disclosure
Three approaches were used to examine the adequacy of
disclosure:
1. the 1st examined the patterns of use of data from the
viewpoint of resolving controversial issues concerning the
inclusion of certain information
2. the 2nd examined the perceptions and attitudes of different
interest groups
3. the 3rd examined the extent to which different information
items were disclosed in annual reports and the
determinants of any significant differences in the adequacy
of financial disclosure among companies
() The research on disclosure adequacy and use showed:
. general acceptance of the adequacy among fin. statements
. recognition that the differences in disclosure adequacy among
financial statements are due to such variables as company size,94
profitability, and size and listing status of the auditing firm
D. The Behavioural Approach.. effects of acc.

information
(2) The usefulness of financial statement data
Two approaches were used to examine the usefulness
of financial statement data:
1. the first examined the relative importance of the
investment analysis of different information items to
both users and preparers of financial information
2. the second examined the relevance of financial
statements to decision-making, based on laboratory
communication of financial statement data in terms
of readability and meaning to users in general
95

information
The overall conclusions of these studies were
that:
some consensus (agreement) exists
between users and preparers regarding the
relative importance of the information items
disclosed in financial statements
users do not rely solely on financial
statements when making their decisions
96

information
(3) Attitudes about corporate reporting practices
Two approaches were used to examine attitudes about
corporate reporting practices:
1. the first examined preferences for alternative
accounting techniques
2. the second examined attitudes about general
reporting issues, such as how much information
should be available, how much information is
available, and the importance of certain items
. These research items showed the extent to which some
accounting techniques proposed by the authoritative
bodies are accepted, and also brought to light some
attitude (stance) differences among professional groups97
concerning reporting issues
D. The Behavioural Approach.. effects of acc. information
(4) Materiality judgments

Two approaches were used to examine materiality
judgments
1. the first examined the main factors determining the
collection, classification and summarisation of
accounting data
2. the second focused on what items people consider
to be material, and sought to determine the degree
of difference in accounting data that is required
before the difference is perceived as material
These studies indicated that several factors appear to

affect materiality judgements, and that these
judgements differ among individuals
98

information
(5) Linguistic effects of accounting data and

techniques
Linguistics and accounting have many
similarities
Belkaoui argues that accounting is a language
and that according to the Sapir-Whorf
hypothesis its lexical (relating to words)
characteristics and grammatical rules will
affect both the linguistic and the non-linguistic
behavior of users
99

information
Linguistic effects of accounting data and techniques (contd)..
Four propositions derived from the linguistic relativity paradigm

to conceptually integrate the research findings of the impact of
accounting information on the users behavior, are as follows:
1. users who make certain lexical (relating to word) distinctions
in accounting are enabled to talk and/or solve problems that
cannot be solved by users who do not
2. users who make certain lexical distinctions in accounting
are enabled to perform tasks more rapidly or more
completely than those who do not
3. users who possess the accounting (grammatical) rules are
more predisposed (liable) to different managerial styles or
emphases than those who do not.
4. accounting techniques may tend to facilitate or render more
difficult various managerial behaviors on the part of users.
100
LAST.COMBINED ANY A TO D
101
Accounting Paradigms
102
A paradigm is a fundamental image of the subject matter
of science.
It serve to define what should be asked, & what rules
should be followed in interpreting the answer obtained.
The paradigm is the broadest unit of consensus within a
science & serves to differentiate one scientific
community from another.
It subsumes, defines, & interrelates the exemplars,
theories, methods, & instruments that exists within it.
103
The value of the predication of a theory to users
influences its uses, it does not solely determined the
success
Because cost of errors & the implementing vary, several
theories about the phenomena can exist simultaneously
for predictive purposes.
However, only one will generally accepted by theorist.
In accepting one theory over another, theorist will be
influenced by the intuitive appeal of the theorys
explanation for the phenomena & the range of
phenomena it can explain & predict as well as by the
usefulness of the predictions to users.
104
AAA publication of Statement of Accounting Theory &
Theory Acceptance;
1.
2.
3.
4.
The anthropological / inductive paradigm

The true-income / deductive paradigm
The decision usefulness / decision-model paradigm
The decision usefulness / decision maker/
aggregate market- behavior paradigm
5. The decision usefulness / decision-maker/ individual
user paradigm
6. The information / economic paradigm
105
1. The anthropological / inductive paradigm
Concern for inductive approach to construction of
accounting theory & a believe the value of accounting

practice.
The research concern on significance of historical cost in
term of accountability & decision making.
Those who adopt this paradigm, the basic subject mater
is;
Existing accounting practice
Management attitude towards those practice
(management plays a central role in determined
technique to be implemented)
1. The anthropological / inductive paradigm
Four theories under this paradigm
I. Information economics
II. The agency model
III. The income smoothing / earning management
hypothesis
IV. The positive theory of accounting
107
2. The true-income / deductive paradigm
The basic subject matter is a concept of ideal income
based on some other method than the historical cost
method.
It generally employed analytic reasoning to justify the
construction of an accounting theory or to argue the
advantage of particular asset-valuation / income
determination model other than historical-coat
accounting.
The theories;
I.
Price level adjusted accounting;
II. Replacement cost accounting;
III. Deprival-value accounting
IV. Net realizable value accounting
V. Present-value accounting
108
3. The decision usefulness / decision-model paradigm
Rely on empirical technique to determined

predictive ability of selected items of information.
Two related theories;
i. Decision models associated with business
decision making (EOQ, Capital Budgeting
etc.)
ii. Deals with different economic events that
may effect a going concern.
109
4. The decision usefulness / decision maker/ aggregate
market- behavior paradigm
Important relationship between ccounting data and

market behavior.
Aggregate market behavior & accounting variables is
based on theory market efficiency.
Those theory include;
I. The efficient market model
II. The efficient market hypothesis
III. The capital asset pricing model
IV. The arbitrage pricing theory
V. The equilibrium theory of option pricing
110
5. The decision usefulness / decision-maker/
individual user paradigm
Is the study of how accounting functions & reports
influence the behavior of accountants & non
accountants.
The basic subject matter is the individual-user response
to accounting variables.
The objective is to understand, explain & predict human
behavior within an accounting context.
The theories include;
I.
II.
III.
IV.
Cognitive relativism in accounting

Cultural relativism in accounting
Behavioral effect of accounting information
Linguistic relativism in accounting
111
6. The information / economic paradigm
The usefulness of information to the future development
of accounting theory.
The basic subject matter is;
Information is an economic commodity
The acquisition of information amounts to a problem
of economic choice
Generally employ analytic reasoning based on statistical
decision theory & economic theory of choice.
Central to the information/economic paradigm is the
traditional economic assumption of consistent, rational
choice behavior.
112
Conclusion
113
Conclusion
As a conclusion;
No single governing theory of acctg is rich enough
to encompass the full range of user-environment

specifications effectively;
Their existence in accounting literature not a theory
of accounting but collections of theories which

can be array over the differences in user
environment specification.
Conclusion
To test the theory, according to Propper;
1. Internal consistency
2. Logical form (empirical or scientific theory)
3. Survive of various test
4. Demands from practice
.No necessarily adopt the same steps; theorists ???
END OF CHAPTER ONE

Chapter 1

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Chapter 1

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CHAPTER 1

Historical development of Accounting

The Italian Method

Luca Pacolis Contribution

2 chapters, de Computis et Scripturis, describing double

Not only was the name of buyer or seller recorded, as well as

He advice the computation of periodic profit and the

Relevance of accounting history

Relevance of accounting history

Introduction to Accounting Theory

From broader perspective;

From the definition;

The nature of Accounting

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

The nature of Accounting as..

What is an accounting theory?

Accounting Theory Classification

Accounting Theory as..

ii. Semantics (the study of meaning)

All asset accounts have debit balances.

iii.Syntactic (A systematic orderly arrangement)

Accounting Theory as..

ii. Inductive Reasoning

ii. Inductive Reasoning..cont

Accounting Theory as..

(determine the truth, e.g.

Kuhnian paradigms, or disciplinary

(Society are too complex:

Accounting Theory Approach

THE NATURE OF ACCOUNTING THEORY

The General Acceptance of Accounting Principles (GAAP) guide

Machlup (1955) defined the process:

APPROACH IN ACCOUNTING THEORY

The pragmatic approach:

The authoritarian approach:

A. Traditional Approach..1. Non-theoretical

A. Traditional Approach..2. Theoretical approaches

Specifying the objectives of financial statements

A. Traditional Approach..2. Theoretical approaches

Involved four stages, i.e. :1. Recording all observations

A.Traditional Approach..2. Theoretical approaches

A. Traditional Approach.. 2. Theoretical approaches

A. Traditional Approach..2. Theoretical approaches

A.Traditional Approach..2. Theoretical approaches

A.Traditional Approach..2. Theoretical approaches

The Eclectic (combination) Approach to the Formulation

In general, the formulation of

B.The Regulatory Approach..

B. The Regulatory Approach..

B. The Regulatory Approach..

B. The Regulatory Approach..

B. The Regulatory Approach..

B. The Regulatory Approach..

B. The Regulatory Approach..

B. The Regulatory Approach..