Topic 1 Accounting Theory 1 2002

Topic 1 Accounting Theory

BAO 3309 Advanced Financial Accounting

2

Learning Objectives

Appreciate what is meant by ‘accounting theory’ and the purpose it has served over time

Explain the importance of understanding ‘accounting theories’


3

Key Terms

Theory Accounting theory Nature and role of accounting Descriptive, normative and positive theories Postulates, concepts and principles Conceptual framework


4

Definition of Theory

What is a theory?– …the coherent set of hypothetical, conceptual and

pragmatic principles forming the general framework of reference for a field of inquiry (Hendriksen)

– theories are composed of words or other symbols…they are statements and do not have a physical form


5

Why do we need theory?

To Systematically Create New Knowledge!


6

Accounting Theory

– …logical reasoning in the form of a set of broad principles that:

• provide a general framework of reference by which accounting practice can be evaluated and

• guide the development of new practices and procedures (Hendriksen).


7

What is the Nature of Accounting? …the process of identifying, measuring and

communicating economic information to permit informed judgements and decisions by users of information (AAA, A statement of Basic Accounting Theory)


8

The Measurement-Communication System (Sterling 1967)

Accountant: Metrician- Transmitter

Receiver:Decision-Maker

Identified Objectives:

Firm EnvironmentPicture of the firm

Message Decision

a b

c

d e

f


9


a). The accountant observes the transactions and events of the firm;

b). Measures them in a way which is conducive to the preparation of a message in the form of a financial report;

c). After the transactions and events have been measured, the accountant prepares a message in the form of a financial report;

d). The receiver interprets the message; e). Obtains an image of the firm; f). Which is then used as the basis for decisions.


10


The system involves HUMAN BEHAVIOUR

Accounting practitioners - concerned with procedures largely determined by convention or authority

Accounting researchers - systematic study of accounting. Development of theories.


11

Function of Theories

Theories which explain (e.g. accountants do not do X because of Y)

Theories which predict (e.g. cosmetic accounting policy changes will have no impact on share price)

Theories which recommend/ prescribe (e.g. current cost accounting should be used to provide more useful information)


12

Accounting Theory Eras

‘General Scientific Period’ (up to 1955??)– ‘What is’ theories (descriptive)– Based on observations– Empirical analysis– e.g. Choose ‘best’ depreciation method based

on the one that has been used the most


13


‘Prescriptive/Normative Period’ 1956 +– ‘What should be’ (prescriptive)– Norms for best practice– Not necessarily based on observation– e.g. the development of current value

accounting systems in the late 1960s - early 1970s


14

Some prescriptive theories

Decision usefulness theories– Decision makers: ask the users what they want– Decision models: researcher deduces what is

necessary for efficient decisions to be made

Measurement Issues and Concept of Income Conceptual framework projects


15


‘Positive Period’: 1975 +– ‘Specific scientific theory’– Dissatisfaction with normative theories– Normally based on observation– Seek to explain and predict


16

Some descriptive/positive theories

capital market based research contracting theory behavioural research


17

Evaluating theories

Consider logic and evidence

Using ‘all’ instead of ‘some’

Repeated ‘affirmation’ Argument by analogy

only

Use of emotional words False credentials Appeal to authority Change in the meaning of

terms during arguments


18

Recap

Nature of accounting:– The Measurement Communication System

Accounting theories– prescriptive (normative)

– descriptive (positive)

NOW– The Conceptual Framework (a prescriptive model) and

the Measurement-Communication System


19


Accountant: Metrician- Transmitter

Receiver:Decision-Maker

Identified Objectives:

Firm EnvironmentPicture of the firm

Message Decision

a b

c

d e

f

REGULATION WHO ARE THEY?

INFORMATION RELEVANT TO USERS’ NEEDS?


20

Historically

Accounting seen as pragmatic, procedural endeavour

Rules, practices and procedures developed on an ad-hoc basis usually in response to recording and reporting issues that presented themselves for resolution

Repetition and general acceptance has provided support and legitimacy to the practitioners’ rules.


21

GAAP

Think of Generally Accepted Accounting Practices:– What are some conventions?– What are some doctrines?– What are some principles?

22BAO 3309 Advanced Financial Accounting

Objectives of Financial Statements

Postulates of Accounting

Theoretical Concepts of Accounting

Principles of Accounting

Accounting Techniques

Hierarchy of the Elements of Structure of Accounting Theory


23

Postulates, Concepts and Principles

Difficulty due to lack of precise terminology

“Each book usually contains a mixture of axioms, conventions, generalisations, methods, rules, postulates, practices, procedures, principles and standards. These terms cannot all be synonymous.” Littleton


24

Entity Postulate

Going ConcernPostulate

Accounting Period

Postulate

Unit of MeasurePostulate

Accounting Postulates

Accounting Postulates


25

Proprietary Theory

Entity Theory

Fund Theory

Theoretical Concepts

Theoretical Concepts


26

AccountingPrinciples

Cost

RevenueRecognition

Matching

ConsistencyFull

Disclosure

Conservatism

Uniformity &Comparability

Materiality

Accounting Principles


27

Criticisms of development of accounting rules Concern that descriptive method of inferring

GAAP from practices gives no guidance for dealing with unusual or different situations

Piecemeal approach introduced inconsistencies ‘Creative’ accounting

SO … due to


28

– problems from a lack of a general theory– permissiveness of accounting practice– inconsistency of practices– defense against political interference

a normative method of theory development was proposed (CONCEPTUAL FRAMEWORK). It is premised on user needs driving the formulation of rules and other operational procedures for use in practice.


29

What is the conceptual framework?

… a coherent system of interrelated objectives and fundamentals that is

expected to lead to consistent standards and that prescribes the

nature, function and limits of financial accounting and reporting. (FASB)

… a coherent system of interrelated objectives and fundamentals that is

expected to lead to consistent standards and that prescribes the

nature, function and limits of financial accounting and reporting. (FASB)


30

Summary

Meaning of theory History of accounting ‘theories’ Types of accounting theories Evaluating accounting theories Importance of theory in the development

of accounting practices

Documents

Topic 1 Accounting Theory 1 2002