CHAPTER 2 ACCOUNTING THEORY CONSTRUCTION

1.2 Introduction to Accounting Theory 1.2.1 Overview of Accounting Theory 1.2.2 Nature and Purpose of Theory 1.2.3 Theory and Method 1.2.4 Accounting Theory Construction and Formulation Approaches to the Development of Accounting Theory: Paradigms in Accounting Research Pragmatic theories Syntactic & semantic theories Normative theories Positive theories

 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.
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 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;

It is primarily mental in nature;

On the basis of the guidelines available, accounting is a social science.
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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
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 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 costprofit calculus, in turn reacts on the rationality; by crystallizing and defining numerically, it powerfully propels the logic of enterprise
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 Communicating information about a business. Recognized in accounting profession, which published accounting bulletin & empirical literature, to measure the communication of accounting concepts.

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

 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.

 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)

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 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.

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 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.

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 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.

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 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)

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 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 occupation).

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 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.

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 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

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 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 guided the development of new practices and procedures.

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No theory of accounting was devised from the time of Pacioli down to the opening of the nineteenth century. Suggestions of theory appear here and there, but not to the extent necessary to place accounting on a systematic basis

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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

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 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.

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Godfrey et. al. (2010), classified accounting theory as:

Theory as Language Theory as Reasoning Theory as Script

BKAF3083

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 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?

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 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

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 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

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 Pragmatics

Accounting should provide useful information for decision making to certain interested parties

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Descriptive pragmatic approach:

based on observed behaviour of accountants theory developed from how accountants act in certain situations tested by observing whether accountants do act in the way the theory suggests is an inductive approach

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 Criticisms of descriptive pragmatic approach:

does not consider the quality of an accountants action does not provide for accounting practices to be challenged focuses on accountants behaviour not on measuring the attributes of the firm

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Psychological pragmatic approach:

theory depends on observations of the reactions of users to the accountants outputs a reaction is taken as evidence that the outputs are useful and contain relevant information

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 Criticisms of the psychological pragmatic approach:

some users may react in an illogical manner some users might have a preconditioned response some users may not react when they should

Theories are therefore tested using large samples of people

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 Semantic inputs are the transactions and exchanges recorded in vouchers, journals and ledgers

The inputs are then manipulated on the basis of the premises and assumptions of historical cost accounting

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 Criticised because there is no independent empirical verification of the calculated outputs The outputs may be criticised for poor syntax inaccurate e.g. different types of monetary measures are added together

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 The outputs may be syntactically accurate but nevertheless be valueless due to a lack of semantic accuracy (a lack of correspondence with real-world events, transactions or values)

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 Historic 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

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 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

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 Semantics

Premise 1: Premise 2:

All asset accounts have debit balances. The sales returns account is not an asset account.

Conclusion:

The sales returns account has a debit balance.

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 Example,
P1: All assets and contra-assets accounts have debit balances P2: The sales returns account is not an asset account. C: The sales returns acct has a debit balance

P1 false, P2 is true, but refer to C it was true by looking to the real world In accounting, i.e. we one concept of depreciation but several different ways of measuring

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Rules of the language employed Refer to rules of grammar & mathematics Analytical methodology basically relied upon syllogism If the combination of premise is valid, so the conclusion was also true.

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 Syntactics

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 debit balance.

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 Example,
P1: All accounts relating to assets have debit balances P2: The accumulated depreciation account relates to assets C: The accumulated depreciation account has a debit balances

The syllogism, is clearly incorrect. If logic is valid if both p is true, the conclusion also true

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 1950s and 1960s golden age

policy recommendations what should be concentrated on deriving:

true income (profit) practices that enhance decisionusefulness

based on analytic and empirical propositions

Financial statements should mean what they say

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 True income:
a single measure for assets a unique and correct profit figure

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 Decision usefulness:
the basic objective of accounting is to aid the decision-making process of certain users of accounting reports by providing useful accounting data

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The decision process

Accounting system of company X

Prediction model of user

Decision model of user

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Expanded during the 1970s Based on experiences or facts of the real world Explain the reasons for current practice Predict the role of accounting information in decisionmaking

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 The main difference between normative and positive theories is that

normative theories are prescriptive positive theories are descriptive, explanatory or predictive

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 Scientific approach:
has an inherent assumption that the world to be researched is an objective reality is carried out by incremental hypotheses has an implied assumption that a good theory holds under circumstances that are constant across firms, industries and time

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 Criticism of the scientific method:

large-scale statistical research tends to lump everything together it is conducted in environments that are often remote from the world of or the concerns of accountants

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 Naturalistic approach:
implies that there are no preconceived assumptions or theories focuses on firm-specific real-world problems

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 Alternative ways of looking at the world:

CATEGORY ASSUMPTION 1. 2. 3. 4. 5. 6. Reality as a concrete structure Reality as a concrete process Reality as a contextual field of information Reality as a symbolic discourse Reality as a social construction Reality as projection of human imagination

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 For categories 1 3 it is more appropriate to use the scientific approach For categories 4-6 the naturalistic approach is more appropriate

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Misconceptions of purpose Make scientists out of accounting practitioners Researchers = practitioners The desire for absolute truth

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 The scientific method does not claim to provide truth It attempts to provide persuasive evidence which may describe, explain or predict

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 Auditing is a verification process that is applied to the accounting inputs and processes

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 Auditors provide an opinion on

whether the financial statements accord with the applicable reporting framework whether the statements give a true and fair view

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 The normative era of accounting coincided with a normative approach to auditing theory The positive ere of accounting has led to a positive approach to auditing theory

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 The debate whether the theory is argument flow:

Generalization to specifics (deductive). Acctant usually deduce acctg principles or postulates to provide concrete applications or rules Specifics to generalizations (inductive). Acctg principles are induced from the best current practice.

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 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.

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 Advantages of the method;

If postulates or premises is false, conclusion may also false To provide the basis for practical rules.

Criticism;
Misunderstand the meaning of theory The theory not necessarily to be entirely practical

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.

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 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 The raw data in acctg is likely to be different.

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 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.

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 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)

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 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.

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 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.

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 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)

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 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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Theory plane
2. Develop theoretical framework

3. State hypothesis

4. Construct research design

1. Identify research problem

5. Observe

8. Assess limitations and constraints

7. Evaluate

6. Analyse
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Observation plane

A number of conflicting theories have developed A theory generally consists of three parts There are several criteria for judging a theory Persuasiveness of evidence

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