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ATPB 313

Accounting Theory & Practice


Sem 2 2013/2014
(updated October 2013)

Topic 2:
OVERVIEW OF ACCOUNTING THEORY

REF: 1 & 2 (Godfrey et al 2010)


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At the end of this lecture, students
should be able to:
Describe how
Discuss an Describe how
Describe the accounting
overview of accounting
development theories are
what theories are
of accounting constructed
accounting formulated
theory and
theory is and tested
measured

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Accounting theory - logical reasoning in the form
of a set of broad principles that:

provide a general guide the development


framework of reference by of new practices and
which accounting practice procedures
can be evaluated

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The acceptance of
Main objectives of
a theory will
accounting theory Explain why &
depend on:
How well it
how current
explains and
accounting
predicts reality
practice evolved

How well it is Suggest


constructed improvements

How acceptable Provide the


are the basis for
implications of development of
the theory such practice

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1800-1955 1956-1970 1970-present
General Normative Specific
Scientific Period Period Scientific theory
1400-1800 • Observe what • Prescribe what • Describe,
actually should happen explain and
Pre-theory happened • 2 group predict
period • Based on dominated accounting
• No theory of empirical • Limitation of practice
accounting was analysis i.e. the theory • i.e.: bonus plan
devised relying on real- • Do not involve hypothesis
world hypothesis testing
observations • Based on value
judgment
not simply on
logic

Positive
accounting
Pragmatic
accounting
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5. Behavioural Research

Concerned the broader


Result from the narrow sociological implications of
approach of positive accounting numbers and the Emerged in 1950s
theorists associated actions of ‘key
players’

6. Current development

Corporate collapses e.g. Enron & WorldCom has triggered


question on whether a comprehensive theory of the
impact of accounting on behaviour had been developed

increase in legislative reporting


convergence
requirements.
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FORMULATING
ACCOUNTING THEORY

Deductive Inductive

General to specific Specific to general

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Deductive
 Drawing specific conclusion from detailed observations and
measurements
 A "top-down" approach.

Deduction
P1 all asset accounts have debit balance.
P2 The plant & machinery account is an asset account.
Conclusion the plant & machinery account has a debit balance 8
Inductive
• From specific observations to a general conclusion
• A "bottom-up" approach

Induction
P1 the plant and machinery account is an asset account and has a debit
balance.
P2 the motor vehicle account is an asset account and has a debit balance.
P3 the land is an asset account and has a debit balance.
Conclusion all asset accounts have debit balance.
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Theory development eventually must relate to the real world.

Theoretical structure

Syntactic Pragmatic

Semantic

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In developing theory using scientific approach, we need to test
a theory using criteria of truth.
Theory testing

Dogmatic self-evidence
Scientific
Syntactic

Induction
Falsification/Popper
Research program /Lakatos

Kuhnian
Feyeraband 11
Dogmatic Accept the statements made by people who has the authority
basis
Self-evident The justification of self-evidence as a way to determine truth is the reasonableness,
sensibility, or obviousness of a statement based on our general knowledge,
experience, or observation

SCIENTIFIC
Syntactic Statements ascertained as valid or invalid by logic or reasoning alone

Induction Statements whose truth or falseness can be known only by reference to empirical
evidence or its correspondence with observations of real-world phenomena
Falsification • the trial and error testing of speculative hypothesis
(Popper) • can never be proven absolutely true, but can be rejected when shown to be false

Research • hard core of the research program which stipulate the basic assumptions of
Programs science
(Lakatos) • forms a protective belt of hypothesis
Kuhnian Revolutionary i.e. involves the abandonment of one theory and replace by another
paradigms incompatible theory.

Feyerabend’s There is no single scientific way of getting ideas.


approach

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 A useful way to study & assess accounting theories is to classify
them according to the assumptions they rely on, how they are
formulated and their approach to explaining & predicting actual
events.
 Accounting theory classification:

Pragmatic Syntactic Semantic

Normative Positive Naturalistic

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THEORIES EXPLANATION
Pragmatic Theories
Descriptive pragmatic Observe behavior of accountants
approach
Psychological Observe users’ responses to the accountants outputs i.e.
pragmatic approach financial reports

THEORIES EXPLANATION
Normative Theories • How to derive the ‘true income’ for an accounting period
(1950s and 1960s) • Type of information useful for economic decisions.
Positive Theories • Testing theories back to the experiences or facts of the real
(1970s) world (to find the reasons)
• i.e. questionnaires/survey
Alternative • Tries to explain complex & unique situations using an
Naturalistic unstructured approach.
approaches • Use case studies & individual experiences
• Try not to generalize.
Syntactic • rely on logical argument based on a set of premise.
Semantic • how theories correspond to real-world events.
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Syntactic and Semantic Theories
 A theory that has both syntactic and semantic element

 E.g. historical cost:

 Proponents:

 Syntactic: Logic in the sense it is the value recorded on the day


transaction is made
 Semantic: The cost recorded based on real vouchers
 Opponents:
 Syntactic: Poor as different monetary measures are added
 Semantic: Do not consider inflation and no independent
empirically observable correspondent to concepts such as profit
or assets.

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Issues for auditing theory construction

Development of a
theory of auditing
(lag in 1960s)
Early writers attempted
Development of a theory to document the process
of accounting of auditing and the
duties of expected of
auditors.

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Accounting theory Formulate: Parts of Testing:
Definition: • Deductive: Theory: 1.Dogmatic .
Logical reasoning in the form of a set of general to specific 1.Syntactic . 2.Self-evident
broad principles to provide a general • Inductive: specific 2.Semantic 3.Scientific:
framework of reference by which to general 3.Pragmatic • Syntactic
accounting practice can be evaluated & • Induction
guide the development of new practices • Falsification/Popper
and procedures. • Research program
Objective: /Lakatos
Explain current accounting practice
Theory Construction: • Kuhnian
1.Pragmatic – behavior of accountants & •Feyeraband
evolved, suggest improvements &
users of accounting information
provide the basis for development of
2.Syntactic – rely on logical argument
such practice.
based on a set of premise.
3.Semantic – how theories correspond to
real-world events.
4.Normative – rely both on semantic &
Development of Accounting syntactic approach.
Theory 5.Positive – test hypothesis against actual
1.Pre-theory period (1400-1800) events.
2.General Scientific Period (1800 – 1955) 6.Naturalistic – consider individual cases &
3.Normative Period (1956 – 1970) try not to generalize.
4.Specific scientific theory/Positive Era
(1970 –present)

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Q1 Useful theories must eventually relate to the real world.
Using examples, please discuss THREE distinct
relationships of theories which are: syntactic, semantic and
pragmatic.
[6 marks]

Q2. Accounting theorist attempted to established norms for best


practice during the normative period. While, specific scientific
theory is to explain and predict accounting practice.
i. Explain two groups dominated during the normative period.
[4 marks]
ii. Explain the reasons why the specific scientific theory
arises.
[6 marks]

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Q3 Explain TWO (2) limitations of self evidence. Discuss with example.
[4 marks]
Q4 In your opinion, can accounting theory be constructed as a purely
syntactical exercise without involvement by other approaches?
Provide your reasoning.
[4 marks]
Q5 Is it important to account for the effects of inflation on deriving the
‘true income’ in normative theory? Provide your reasoning.
[4 marks]

Q6 What role(s) can theory play in relation to accounting? Give an


example. [4 marks]

Q7 Explain FOUR (4) main differences between normative and positive


theories. [8 marks]
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