Accounting theory formulation and classifications

Accounting Theory Classifications
Managerial Accounting (Comilla University)
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Accounting Theory Classifications
Managerial Accounting (Comilla University)
Scan to open on Studocu
Studocu is not sponsored or endorsed by any college or university
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CONCEPT OF ‘THEORY’ AND
‘ACCOUNTING THEORY’
Theory
The simplest form of a theory is a statement of a belief
expressed in a language. A theory is a logical combination of
interrelated concepts, definitions and propositions that describe
a systematic view of phenomena by establishing relations among
variables, with the purpose of explaining and predicting the
phenomena. The term ‘theory’emphasises generalisations which
help in systematic organisation and grouping of data and thereby
establish significant relationships in respect of such data.
The theory is “a cohesive set of hypothetical, conceptual,
and pragmatic principles forming a general frame of reference
for a field of study.”1 According to Most2, “a theory is a systematic
statement of the rules or principles which underlie or govern a
set of phenomena. A theory may be viewed as a framework
permitting the organisation of ideas, the explanation of phenomena
and the prediction of future behaviour.”
Choi and Mueller assert that theory is:
(i) An integrated group of fundamental principles
underlying a science or its practical applications.
(ii) Abstract knowledge of any art as opposed to the practice
of it.
(iii) A closely reasoned set of propositions derived from and
supported by established evidence and intended to serve
as an explanation for a group of phenomena.
(iv) An arrangement of results or a body of theorems
presenting a systematic view of some subject.3
Theories are logical arguments; their concluding statements
of belief (whether they are explanations, predictions or
prescriptions) are hypotheses, such theories comprise a set of
premise (statements) that are logically connected to give rise to
one or more hypotheses. Although the terms ‘theory’,
‘proposition’ and ‘hypothesis’ are often used interchangeably,
strictly speaking they have different meanings. Theory is the
logical flow of argument leading from fundamental assumptions
and connected statements to final conclusions. It includes
assumptions, statements, the argument connecting the
assumptions and statements to come to conclusions, and the
conclusions.
Propositions are statements emanating from a theory that
are expressed in conceptual terms (e.g., a theory about managers’
reporting incentives might lead to the conclusion ‘Managers are
likely to use profit-increasing methods of accounting when their
remuneration increases as a consequence’). Hypotheses are
propositions that have been operationalised so that they can be
tested (e.g., the proposition about managers’ reporting incentives
could be operationalised as ‘Firms with profit-based compensation
plans use straight-line depreciation rather than accelerated
depreciation’; this hypothesis can be tested by observing which
methods of depreciation are used by firms with profit-based
management compensation plans).
The rules or principles which are found in theory are based
upon knowledge preferably derived from research which is
conducted to test certain hypotheses. A theory, therefore, is
essentially a set of acceptable hypotheses. The formulation and
establishment of theories requires the application of logic and
reasoning about the problems implied in the data under
observation, as a means of sorting out the most basic relationships.
The relationship between theory and practice is essential to the
establishment of a good theory. In fact, the reliability of a theory
depends not only upon the facts and practices to which it refers,
but also upon an interpretation of those facts which need to be
continuously evaluated to ensure its accuracy and validity.
Accounting Theory
According to Webster’s Third New International Dictionary,
theory represents “the coherent set of hypothetical, conceptual,
and pragmatic principles forming the general frame of reference
for a field of inquiry.”
The term ‘accounting theory’ has been defined by many.
Hendriksen4 defines accounting theory as:
“Logical reasoning in the form of a set of broad principles
that (1) provide a general frame of reference by which accounting
practice can be evaluated, and (2) guide the development of new
practices and procedures. Accounting theory may also be used to
explain existing practices to obtain a better understanding of them.
But the most important goal of accounting theory should be to.
provide a coherent set of logical principles that form the general
frame of reference for the evaluation and development of sound
accounting practices.”
The goal of accounting theory is to provide a set of principles
and relationships that explains observed practices and predicts
unobserved practices. That is, accounting theory should be able
to both explain why business organizations elect certain
accounting methods over other alternatives and predict the
CHAPTER 3
Accounting Theory : Formulation
and Classifications
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Accounting Theory : Formulation and Classifications 37
attributes of firms that elect various accounting methods.
Accounting theory should also be verifiable through accounting
research. However, theory cannot be divorced from practice. The
theory underlies practices, explains and attempts to predict them.
There is not and cannot be any basic contradiction between theory
and facts.Atheory is an explanation. However, every explanation
is not a theory in the scientific meaning of the word.5 The objective
of accounting theory is to explain and predict accounting practice.
Explanation provides reasons for observed practice. For example,
an accounting theory should explain why certain firms use LIFO
method of inventory rather than the FIFO method. Prediction of
accounting practices means that the theory can also predict
unobserved accounting phenomena. Unobserved phenomena are
not necessarily future phenomena; they include phenomena that
have occurred but on which systematic evidence has not been
collected.6 It is significant to observe that accounting theory may
be based on empirical evidence and practices as well as accounting
theory may be formulated using hypothetical and speculative
interpretations.
ROLE OF ACCOUNTING THEORY
Accounting theory has great utility for improving accounting
practices, resolving complex accounting issues and contributing
in the formulation of a useful accounting theory. Accounting
theory has many advantages. Some of them are listed below:
(1) Accounting theory has a great amount of influence on
accounting and reporting practices and thus serves the
informational requirements of the external users. In fact,
accounting theory provides a framework for (i) evaluating current
financial accounting practice and (ii) developing new practice.
Whenever the need for a new application of practice arises, the
accounting theory should provide accountants with guidance on
the most appropriate procedures to adopt in the circumstances. If
accounting practices emerges from the application of rigorously
constructed accounting theory, then practice has been tested for
logic, consistency and usefulness. The corporate managements
and accountants, after having knowledge of accounting theories,
may respond to the needs of users of accounting information.
Many users, especially external, use annual reports to make
investment and other decisions. Investors, creditors, lenders have
to assess the earnings prospects of companies by examining the
implications of the different accounting procedures.All the users
are interested to know the effect of alternative reporting methods,
on their decisions (welfare). For example, corporate executives
want to know how straight-line method of depreciation affects
their welfare vis-a-vis accelerated depreciation. Similarly, if a
company is concerned about the market value of its shares, the
accounting methods effects on share prices are to be analysed.
The corporate executives search accounting theory which better
explain the relationship between external annual reports and share
prices.
However, determining the relationship between accounting
procedures and users benefits is very difficult. For example. the
relation between accounting alternatives and company share
prices is complex and cannot be determined just by observing
whether share prices change when accounting procedures change.
Likewise, the effects of alternative accounting procedures and
reporting methods on business profit and other variables are
complex and cannot be determined by mere observation. For
example, share price changes may not be necessarily due to
changes in accounting procedures or vice versa; that is, changes
in both could be result of some other event. In such a case,
changing accounting procedures would not necessarily produce
a share price effect. Such situations and other similar experiences
require accounting theory that explains the relation between the
variables and determine the significance of a particular variable.
Nevertheless, there are good reasons why certain things (practices)
rather than others, should be done; and there are reasons why
certain ways are superior to other ways. These reasons make up
the theory. Whether we are conscious of them or not, there are
reasons beneath everything we do. Knowing what they are, will
provide a better understanding of our aims and thus help us to
discriminate among possible actions.7
To conclude, accounting theory aims to serve practice even
when it advances reasons against a familiar practice.Aknowledge
of accounting theory equips a person to exercise independent
judgement with confidence besides enabling him to react
according to the circumstances.
(2) Secondly, accounting theory literature is useful to
accounting policymakers who are interested in making the
accounting information useful. The researches, empirical evidence
and investigation can be used and incorporated by the policy-
makers in formulating accounting policies. Theories are helpful
as they apprise policymakers of the underlying issues and clarify
the trade-offs implicit in various theory approaches. According
to Taylor and Underdown:8
“....The system of financial accounting and reporting is not
static but responds to the characteristics of the environment in
which it operates. It must be stressed, however, that all changes
in financial accounting and reporting do not occur in a random
way. It is one of the functions of accounting policymakers such
as the accountancy profession, accounting standards setting
bodies, the formulators of company law, and bodies like the Stock
Exchange to evaluate current practice and formulate and
implement proposals for its reform. They are guided in this by
accounting theory.Although there is no single, generally accepted
body of accounting theory, much work has been done by
academics and policymakers to develop accounting theory in ways
which might facilitate the improvement of financial accounting
and reporting.”
However, according to American Accounting Association’s
Committee onAccounting Theory and TheoryAcceptance (1977),
the primary message to policymakers is that until consensus is
available, the utility of accounting theories in aiding policy
decisions is partial. Competing theories merely provide a basis
for forming opinions on what must remain inherently conflicting
and subjective judgements. While it is true that consensus will
frequently develop on certain points, usually this consensus only
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38 Accounting Theory and Practice
narrows the range of disagreement; it often does not resolve the
basic issue that gives rise to the underlying problem.
In the absence of consensus acceptance, it is unrealistic to
expect accounting theory to provide unequivocal policy guidance.
Different theories will point to different policies. These theories
arise from different sets of situations (paradigms). Since there is
no rigorous analytical means for choosing between paradigms,
there is similarly no rigorous means for choosing between theories
or their derivative policy implications. In fact, in accounting
theory debate there is no ultimate theoretical truths. Therefore, it
is difficult to impose theory consensus.Whatever future influences
theory have on policymaking, will be achieved by continued
argumentation, new theory development, and debate, not by fiat.
Accounting theory is developed and refined by the process
of accounting research. Accounting theory or theories are
formulated as a result of both theory construction and theory
verification. A given accounting theory explains and predicts
accounting phenomena, and when such phenomena occur, they
prove and verify the theory. If a given theory does not act in
practice and fails to produce the expected results, it is replaced
by a (new) better or more useful theory. The purpose of the new
theory or the improved theory is to make the unexpected expected,
to convert the anomalous occurrence into an expected and
explained occurrence.9
CLASSIFICATIONS (LEVELS) OF
ACCOUNTING THEORY
At present, a single universally accepted accounting theory
does not exist in accounting. Instead, different theories have been
proposed and continue to be proposed in the accounting literature.
The following are the main classifications of accounting theory:
(1) ‘Accounting Structure’ Theory
(2) ‘Interpretational’ Theory
(3) ‘Decision Usefulness’ Theory
‘Accounting Structure’ Theory
‘Accounting structure’ theory, known by different names
such as classical theory, descriptive theory, traditional theory,
attempt to explain current accounting practices and predict how
accountants would react to certain situations or how they would
report specific events. This theory relates to the structure of the
data collection process (accounting) and financial reporting. Thus,
this theory is directly connected with accounting practices, i.e.,
what does exist or what accountants do. The principal contributors
to the accounting structure theory are identified chronologically
as follows:
WilliamA. Paton, Accounting Theory with Special Reference
to Corporate Enterprise (1922).
Henry Rand Hatfield, Accounting—Its Principles and
Problems (1927).
Henry W. Sweeney, Stabilised Accounting (1936).
Stephen Gilman, Accounting Concepts of Profit (1939).
W.A. Paton andA. C. Littleton, An Introduction to Corporate
Accounting Standards (1940).
A. C. Littleton, Structure of Accounting Theory (1953).
Maurice Moonitz, The Basic Postulates of Accounting (1961).
Robert R. Sterling and Richard E. Flaherty, “The Role of
Liquidity in Exchange Valuation,” Accounting Review (July
1971).
Robert R. Sterling, John O.Tollefson, and Richard E. Flaherty,
“Exchange Valuation: An Empirical Test,” Accounting Review
(Oct.1972).
Yuji Ijiri, Theory of Accounting Measurement (1973).
This theory, basically concerned with observing the
mechanical tasks which accountants traditionally perform, is
based on the assumption that the objective of financial statement
is associated with the stewardship concept of the management
role, and the necessity of providing the owners of businesses with
information relating to the manner in which their assets (resources)
have been managed. In this view, company directors occupy a
position of responsibility and trust in regard to shareholders, and
the discharge of these obligations requires the publication of
annual financial reports to shareholders. Ijiri10 explains traditional
accounting practice; however, he does place emphasis on the
historical cost system. Sterling advises “to observe accountants’
actions and rationalise these actions by subsuming them under
generalised principles.” Theories explaining traditional accounting
practice are desirable to obtain greater insight into current
accounting practices, permit a more precise evaluation of
traditional theory and an evaluation of existing practices that do
not correspond to traditional theory. Such theories relating to the
structure of accounting can be tested for internal logical
consistency, or they can be tested to see whether or not they
actually can predict what accountants do.11
Limitations
(1) The ‘accounting structure’ theory concentrates on
accounting practices and the behaviour of practising accountants.
The accounting practice begins with observable occurrences
(transactions), translates them into symbolic form (money values)
and makes them inputs (e.g., sales, costs) into the formal
accounting system where they are manipulated into outputs
(financial statements).Accounting practices followed in this way
may not reflect the real business situation and real world
phenomena. The traditional theory is not concerned with judging
the usefulness of the output of accounting practice, but
concentrates upon judging the means of manipulation of input
into output.
(2) Inconsistencies in traditional theory have given rise to
alternative accepted principles and procedures which give
significantly divergent reported results.Accrual accounting results
in allocations which provide a variety of alternative accounting
methods for each major event—e.g., LIFO and FIFO valuations
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of stock—and different accountants may prefer different methods
depending upon how they are affected. Moreover, the traditional
approach is inconsistent with theories developed in related
disciplines. For example, the historical cost concept of valuation
is externally inconsistent with current value concepts.
Finally, good theory should provide for research to assist
advances in knowledge. The conventional approach tends to
inhibit change, and by concentrating upon generally accepted
accounting principles makes the relationship between theory and
practice a circular one.
‘Interpretational’ Theory
Truly speaking, ‘accounting structure’and ‘interpretational’
theories are part of the classical accounting theory (model). The
principal writers under ‘accounting structure’ such as Hatfield,
Littleton, Paton and Littleton, Sterling and Ijiri are mainly
positivist, inductive writers, concerned with traditional accounting
practice in terms of historical cost system, with some deviations
such as the lower of cost or market. Accounting practices under
accounting structure theory are the result of recording business
events as they take place. Such practices lack application of
judgement and consequences.
Interpretational theory attempts to give some meaning to
accounting practice. The theory based on ‘accounting structure’
only, although logically formulated, does not require meaningful
interpretation of accounting practices and analysis of accounting
activities. Interpretational theory emphasises on giving
interpretations and meaning as accounting practices are followed.
This theory provides a suitable basis for evaluating accounting
practices, resolving accounting issues and making accounting
propositions.12 The principle writers in interpretational theory
are the following:
John B. Canning, The Economics of Accountancy (1929).
Sidney S. Alexander, Income Measurement in a Dynamic
Economy (1950).
Edgar O. Edwards and Philip W. Bell, The Theory and
Measurement of Business Income (1961).
Robert T. Sprouse and Maurice Moonitz, A Tentative Set of
Broad Accounting Principles for Business Enterprises (1962).
The above writers in interpretational theory are more analysts
and explicators than advocates and preachers. They analyse and
assess what accountants do and seek to do, they undertake to
explain a phenomenon to accountants, and help in understanding
the implications of using accounting concepts in the real business
situation. For example, Sprouse and Moonitz suggest that the
assets valuations should be made in terms of their future services.
In ‘accounting structure’ theory, accounting concepts are
uninterpreted and do not reflect any meaning except actual data
resulting from following specific accounting procedures. Asset
valuations, for example, are the result of following a specific
method of inventory valuation and depreciation. Similarly, specific
rules are followed for the measurement of these revenues and
expenses. Interpretational theory gives meaningful interpretations
to these concepts and rules and evaluate alternative accounting
procedures in terms of these interpretations and meanings. For
example, it can be said that FIFO is the most appropriate if objective
is to measure current value of inventories. In this case, selection
of FIFO in interpretational theory is made with a view to suggest
specific result and interpretation. It is argued that empirical enquiry
should be made to determine whether information users attach
the same interpretations and meanings which are intended by
producers of information. Items of information vary as to degree
of interpretation; some items by nature reflect higher degree of
interpretation and some items are subject to many interpretations.
For example, the item cash in balance sheet is fairly well
understood by users to mean what preparers intend it to mean.
On the contrary, the items like deferred expenses and goodwill
may not reflect any specific interpretation. The role of
interpretational theories is to build a correspondence between
the interpretations of producers and users as to accounting
information. This theory attempts to find ways to improve the
meaning and interpretations of accounting information in terms
of experiences about human behaviour and information
processing capacity.
As stated earlier, ‘accounting structure’ and interpretational
theories both are known as classical accounting models. The
writers (mentioned above) under both the theories are, in every
sense, reformers. Interpretational theorists differ from ‘accounting
structure’ theorists more in degree than in kind; the former are
motivated less by missionary zeal than by a desire to analyse,
criticise, and suggest, and are primarily deductivists. Many of
the prominent interpretational theorists advocate current cost or
values. It is said that interpretational theorists may have observed
the behaviour of investors and other economic decision makers
and concluded with a validated hypothesis that such decisions-
makers seek current value, not historical cost, information. In
spite of the difference in emphasis of ‘traditional’ and
‘interpretational’ theorists, broadly, both are concerned with
designing financial reports that communicate relevant information
to users of accounting information.
‘Decision-Usefulness’ Theory
The decision-usefulness theory emphasises the relevance
of the information communicated to decision making and on the
individual and group behaviour caused by the communication of
information. Accounting is assumed to be action-oriented—its
purpose is to influence action, that is, behaviour; directly through
the informational content of the message conveyed and indirectly
through the behaviour of preparers of accounting reports. The
focus is on the relevance of information being communicated to
decision makers and the behaviour of different individuals or
groups as a result of the presentation of accounting information.
The most important users of accounting reports presented to
those outside the firm are generally considered to include
investors, creditors, customers, and government authorities.
However, decision usefulness can also take into consideration
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the effect of external reports on the decisions of management and
the feedback effect on the actions of accountants and auditors.
Since accounting is considered to be a behavioural process, this
theory applies behavioural science to accounting. Due to this,
decision-usefulness theory is sometimes referred to as
behavioural theory also. In the broader perspective,
decisionusefulness studies analyses behaviour of users of
information. A behavioural theory attempts to measure, and
evaluate the economic, psychological and sociological effects of
alternative accounting procedures and modes of financial
reporting.
In adopting the decision-usefulness theory or approach, two
major aspects or questions must be addressed. First, who are the
users of financial statements? Obviously, there are many users. It
is helpful to categorize them into broad groups, such as investors,
lenders, managers, employees, customers, governments,
regulatory authorities, suppliers, etc. These groups are called
constituencies of accounting. Second, what are the decision
models or problems of financial statement users? By
understanding these decision models preparers will be in a better
position to meet the information needs of the various
constituencies. Financial statements can then be prepared with
these information needs in mind and in this way financial
statements will lead to improved decision making and are made
more useful.
(i) Decision Models
Most of the earliest research on decision-usefulness implicitly
adopted the decision model emphasis although the assumed
decision model was often not specified in detail. The decision
model emphasis has now achieved professional recognition and
broad exposure through publications of different accounting
bodies all over the world. For instance, the American Institute of
Certified Public Accountants (AICPA) Study Group on the
Objectives of Financial Statements, also known as Trueblodd
Report, stated that “the basic objective of financial statements is
to provide information useful for making economic decisions.”13
The Financial Accounting Standards Board14 (USA) has also
formulated the similar objective:
‘Financial reporting should provide information that is useful
to present and potential investors and creditors and other users
in making rational investment, credit and similar decisions. The
information should he comprehensible to those who have a
reasonable understanding of business and economic activities and
are willing to study the information with reasonable diligence.”
The decision model approach first began to appear in the
literature in the 1950s. Prior to 1950s, a number of carefully
prepared works on accounting theory did refer to users of
accounting information but the theoretical structures in those
works were not demonstrably based on the alleged information
needs of users. For example, the 1937 “Tentative Statements” of
the American Accounting Association (AAA) included but did
not build upon, this paragraph:
“The most important applications of accounting principles
lie in the field of corporate accounting, particularly in the
preparation of published reports of profits and financial position.
On the interpretation of such reports depend so many vital
decisions of business and government that they have come to be
of great economic and social significance.”15
Patton and Littleton16 gave user needs even more prominent
attention, including them in their statement of the purpose of
accounting: “The purpose of accounting is to furnish financial
data concerning a business enterprise, compiled and presented to
meet the needs of management, investors, and the public.”
During the 1950s, there was a strong user-oriented movement
in the managerial accounting literature. That movement may have
served as the stimulus for the initial acceptance of the decision-
usefulness objective in external reporting at that time. For instance,
Chambers’ articles17, “Blueprint for a Theory of Accounting,”
published in 1955 stressed that “the basic function of
accounting...(is) the provision of information to be used in making
rational decisions.” Staubus18 emphasised that “accountants
should explicitly and continuously recognise an objective or
objectives of accounting, and “that a major objective of
accounting is to provide quantitative economic information that
will be useful in making investment decisions.”
The current status of the decision-usefulness, decision model
approach to accounting theory may be summarised as follows:
(i) The objective of accounting is to provide financial
information about the economic affairs of an entity to
interested parties for use in making decisions. This
objective statement is a premise which most people seem
to find acceptable, subject to slight variations.
(ii) To be useful in making decisions, financial information
must possess certain normative qualities such as
relevance, reliability, objectivity, verifiability, freedom
from bias, accuracy, comparability, understandability,
timeliness and economy.Aset of such desirable qualities
is used as criteria for evaluating alternative accounting
methods. The relevance criteria is used to select the
attribute(s) of an object or event to be emphasised in
financial reporting. Information about an attribute of an
object or event is relevant to a decision if knowledge of
that attribute can help the decision maker determine
alternative courses of action or to evaluate an outcome
of an alternative course of action.
(iii) The decision-usefulness approach provides for the
development of the theory on the basis of knowledge of
decision processes of investors, taxing authorities, labour
union, negotiators, regulatory agencies, and other
external users of accounting data, as well as managers.
To date, however, only the decision of investors (in the
broad sense) have served as the basis for fairly complete
theories of external reporting.
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(ii) Decision Makers
The previous section has dealt with decision models; this
section focuses on decision makers and review certain empirical
research bearing upon various issues of financial reporting. Such
research can be classified according to the level at which the
behaviour of decision makers is observed: the individual level or
the aggregate market level.
Individual User Behaviour
Empirical research involving observation of individual
behaviour as it relates to accounting information has ordinarily
been associated with the term behavioural accounting research
(BAR). The objective of BAR is to understand, explain, and
predict aspects of human behaviour relevant to accounting
problems. Behavioural accounting research is relatively new.
Devine’s19 critical remarks in 1960 expose the failure of
accountants to examine user behaviour empirically before that
time:
“Let us now turn to ... the psychological reactions of those
who consume accounting output or are caught in its threads of
control. On balance, it seems fair to conclude that accountants
seem to have waded through their relationships to the intricate
psychological net work of human activity with a heavy handed
crudity that is beyond belief. Some degree of crudity may be
excused in a new discipline, but failure to recognise that much of
what passes as accounting theory is hopelessly entwined with
unsupported behaviour assumption as unforgivable.”
BAR studies ordinarily lack any agreed upon basis by which
their results may be assessed. Instead, BAR has been primarily
concerned with studying the techniques of data collection and
analysis; there has been little attempt to develop a theoretical
framework that would support the problems or hypotheses to be
tested. Instead, the studies generally have focussed on the
behavioural effects of accounting information or on the problems
of human information processing.
BAR studies may be divided into five general classes
according to financial statement disclosure and the usefulness of
financial statement data: (i) the adequacy of financial statement
disclosure, (ii) Usefulness of financial statement data, (iii) attitudes
about corporate reporting practices, (iv) materiality judgements,
and (v) the decision effects of alternative accounting procedures.
In testing for the adequacy of financial statement disclosures,
researchers have used many different strategies. For example,
one strategy develops a description of user’s approach to financial
statement analysis in order to evaluate the reasoning underlying
that approach; it then assesses the implications of that approach
reasoning for various disclosure issues.20 Another strategy focuses
on certain interest groups and surveys their perceptions and
attitudes about disclosures.21 A third strategy has been to
determine the extent to which specific items of important
information are disclosed in corporate annual reports, using a
normative index of disclosure as a basis for assessment.22 The
research on adequacy of financial disclosure showed a general
acceptance of the adequacy of available financial statements, a
general understanding and comprehension of these financial
statements, that the differences in disclosure adequacy among
the financial statements were due to such variables as company
size, profitability, size of the auditing firm and listing status.
A second set of studies has focused on the usefulness of
financial statement information to investors in making resources
allocation decision. In this regard, three approaches have been
used. The first approach examined the relative importance to
investment analysis of different information items to both users
and preparers of financial information.23 The second approach
examined the relevance of financial statements to decision-making
using laboratory experimentation.24 The third approach examined
the effectiveness of the communication of financial statement data
in terms of readability and meaning to users in general.25 The
overall conclusion of these studies are (i) that some consensus
exists between users and preparers on the relative importance of
the information items disclosed in financial statements, and
(ii) that users do not rely solely on financial statements for their
decisions.
A third set of studies has attempted to measure the attitudes
and preferences of various groups toward current and proposed
corporate reporting practices. Two approaches have been used in
this regard. The first approach examined preferences for
alternatives accounting techniques.26 The second approach
examined the attitudes about general reporting issues, such as
about how much information should be available, how much
information is available, and the importance of certain items.27
A fourth set of studies has focused on materiality judgements
that affect financial reporting. Two approaches were used to
examine the materiality judgements. The first approach examined
the main factors that determine the collection, classification, and
summarisation of accounting data.28 The second approach focused
on what people consider material. This second approach sought
to determine how great a difference in accounting data is required
before the difference is perceived as material by the users.29 These
studies indicate that several factors appear to affect materiality
judgements and that these judgements differ among individuals.
Finally, in fifth set of studies, the decision effects of various
accounting procedures were examined primarily in the context of
the use of different inventory techniques, of price-level
information, and of non-accounting information.30 The results
indicate that alternative accounting techniques may influence
individual decisions and that the extent of influence may depend
on the nature of the task, the characteristics of the users, and the
nature of the experimental environment.
Evaluation of Behavioural Accounting Research
(BAR)
Most of the BAR attempts to establish generalisations about
human behaviour in relation to accounting information. The
implicit objective of all these studies is to develop and verify the
behavioural hypotheses relevant to accounting theory, which
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are hypotheses on the adequacy of disclosure, the usefulness of
financial statement data, attitudes about corporate reporting
practices, materiality judgements, the decision effects of
alternative accounting procedures, and components of an
information processing model—input, process, and output. This
implicit objective has not yet been reached, however, because
most of the experimental and survey research in behavioural
accounting suffers from a lack of theoretical and methodological
rigour.
BAR has been done mostly without explicit formulation of
a theory. This lack of a theory imposes limitations on an acceptable
and meaningful evaluation and interpretation of the results.
Laboratory experimentation is generally favoured in BAR because
it can isolate variables and effects to provide unambiguous
evidence about causation and allow better control over extraneous
variables. The failure to ensure validity, however, causes
significant problems with laboratory experiments.31 In general,
students have been used as surrogates of business people. But do
students and business people react similarly to stimuli? Several
have examined the surrogation problem without any conclusive
results.32 Similarly, the experiment as a social contract implies a
role relationship between the subject and the experiment. Some
aspects of this relationship may threaten the validity of the
experiment.
Aggregate Market Behaviour
The decision-usefulness accounting theory emphasises not
only, ‘Individual User Behaviour’, but ‘Aggregate Market (User)
Behaviour’ also. In fact, aggregate market behaviour is a
manifestation of individual action. However, according to
proponents of market level research, there are factors that are
difficult to stimulate in individual level research (such as
competing information sources, incentives, and user interactions)
that are important in study of groups; those factors thus prohibit
a simplistic extension from the individual to the aggregate.33
Indeed, they may be so significant that theories about individual
behaviour and theories about market behaviour becomes, in fact,
theories about distinctly different things. Therefore, some
researchers believe that aggregating individual users responses
may not provide an apt description of marketwide user behaviour.
The early research regarding relations between accounting
information and market behaviour has been based on the theory
of capital market efficiency. This theory implies that an alteration
in the information set will result in a prompt transition to a new
equilibrium. The theory is not specific with respect to the
information set, and technical problems arise when it is admitted
that the price actually reflects the underlying information.34 The
prompt adjustment to a new equilibrium in conjunction with the
dissemination of accounting data is consistent with the notion
that those data are useful or possess pragmatic information
content. Following that logic, researchers have assessed the
pragmatic information content of various accounting data by
studying the timing of the incidence of abnormal returns.
A number of studies have been conducted along these lines.
Ball and Brown35, Beaver36, and Gonedes37 consistently observed
abnormal returns in conjunction with the announcement of the
annual earnings number. May38 observed similar reactions to the
quarterly announcement of firm earnings. In other words, these
studies are consistent with the notion that financial reports are
useful. However, the mere presence of an abnormal return
coincidental with the publication of accounting earnings provides
a somewhat tenuous basis from which to infer that the observed
price movement was caused by the earnings signal. In some cases,
users of accounting information react when they should not react
or should not react the way they did. Also, users’ aggregate
behaviour may not be due to any information content. These fears,
however, are not real and lose their validity in view of the theory
of Efficient Market Hypothesis.
The above classifications of accounting theory indicates
differences in problems addressed, assumptions made, and
research methods used, by the various writers. While the
differences in these theories are fundamental and issues and
conclusions are often inconsistent, theorists have had little success
in reconciling their differences or in persuading critics that their
theory is superior to others. In future, the debate on (appropriate)
accounting theory will continue and no closure appears to be
nearer in construction of accounting theory at this time. The
existence of continuing disagreement (recognising at the same
time that competing theories exist) is noticed in almost all
disciplines and not only in accounting. This proves that theory
progress in accounting as well as in other disciplines is a difficult
task. Watts and Zimmerman39 rightly comment:
“We cannot find a theory that explains and predicts all
accounting phenomena. The reason is that theories are
simplifications of reality and the world is complex and changing.
Theorists try to explain and predict a class of phenomena and, as
a consequence, try to capture in their assumptions the variables
common to that class. The result is that facts particular to a given
observation or subset of observations and not common to the
whole class are ignored and are incorporated into the theory’s
assumptions. Ignoring these facts (or omitted variables)
necessarily leads to a theory not explaining or predicting every
observation...the mere fact that a theory does not predict perfectly
does not cause researchers or users to abandon that theory.”
DEDUCTIVE AND INDUCTIVE
APPROACH (OR REASONING) IN
THEORY FORMULATION
The terms deductive and inductive indicate the type of
research methodology or reasoning used in formulating an
accounting theory.
Deductive Approach
A deductive system is one in which logical reasoning is
employed to derive one or more conclusions from a given set of
premises. Empirical data are not analyzed in purely deductive
systems. A simple example of a deductive system is as follows:
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Premise 1: A horse has four legs.
Premise 2: Rakesh has two legs.
Conclusion 1: Rakesh is not a horse.
In this simple case, only one conclusion can be derived from
the premises. In a more complex system, more than one conclusion
can be derived. However conclusions must not be in conflict with
one another. Notice that no other conclusion relative to Rakesh
could possibly be reached from the given premises.
Of course, if we are applying this theory to a real being named
Rakesh, as opposed to analyzing the logic of a set of sentences,
we have to see and, if necessary, examine Rakesh to determine
his status. At this point we are in the inductive realm—because
we are judging the theory not simply by its internal logic but
rather by observing the evidence itself. For example, Rakesh might
be a horse that had two legs amputated. Assuming that the
reasoning is valid, only questioning premises or conclusions
empirically can challenge a deductive theory.
The deductive approach first establishes the objectives of
accounting and then derives principles and procedures for
recording consistent with these objectives. The deductive
approach begins with basic accounting objectives or propositions
and proceeds to derive by logical means accounting principles
that serves as guides and bases for the development of accounting
techniques. The deductive approach includes the following steps:
(i) Determining the objectives (general or specific) of
financial reporting.
(ii) Selecting the postulates of accounting.
(iii) Developing a set of definitions.
(iv) Formulating principles of accounting or generalised
statements of policy.
(v) Applying the principles of accounting to specific
situations, and
(vi) Establishing procedures, methods and rules.
In deductive approach, all subsequent steps (mentioned above
in points (ii) to (vi)) follow the objectives formulated. Therefore,
the development of objectives is first and prime task as different
objectives might require logically different sets of postulates,
principles, techniques etc. For example, principles and rules for
determining income may vary between the objectives of
determining taxable income and business income.Although there
is a demand to apply the same set of rules for tax accounting and
financial accounting to avoid confusion, but, since the basic
objectives are different, it is not likely that the same principles
and techniques will meet the different objectives equally well.
Similarly different income concepts are found in accounting and
therefore the differing income concepts require different principles
and procedures to be developed in conformity with respective
income concepts. In spite of the existence of different income
concepts (and concepts relating to different accounting issues),
it has been argued that there is a need for a single all pervasive
concept of income which could serve different objectives and
different users. A single income concept and its ability to meet
the requirement of different users, is still a debatable question in
accounting. On the other hand, it would not be beneficial to have
different sets of principles for different purposes accepted in
accounting. Some compromises must be made, but there should
also be some freedom to serve different objectives as well. Thus,
accounting theory should be flexible enough to satisfy the needs
of different objectives, but rigid enough to provide for some
uniformity and consistency in financial reports to shareholders
and the general public.40
The accounting writers who have primarily followed
deductive process are Paton, Canning, Sweeny, MacNeal,
Alexander, Edwards and Bell, Moonitz, and Sprouse and Moonitz
(Table 3.1). These deductive theorists unanimously suggest that
users should use current cost or value information in their
economic decisions. Some deductive writers have used
mathematical, analytical representations and testing. Known as
the exiomatic method, it is found in the writings of Mattessich
and Chambers.41
Many of the deductive writers cite particular users (generally
shareholders, creditors, and managers) and occasionally suggest
the information that users would find useful. Except in the case
of Alexander, who proposes different models for different users,
each writer offers his policy recommendations as a universally
valid proposal, as if the entire hierarchy of users would be
sufficiently well served by a single set of resulting information.
It is also found that the deductive writers operated independently
of one another, rarely comparing their work with that of
predecessors or contemporaries. The logic of their analyses is
difficult to monitor, as it reflects implicit criteria and judgements.
Of their writings, it may be said that they neither proved their
points nor were disproven by others. A common point may be
found in their diverse recommendations: the implicit agreement
that users seek (or should seek) current cost information in making
economic decision. In this important respect, notwithstanding the
diversity of their recommendations, their cause was united.
An important limitation of the deductive approach is that if
any of the postulates and propositions are false, the conclusions
may also be wrong. Also, it is difficult to derive realistic and
workable principles or to provide the basis for practical rules as
deductive approach may be found far from reality. But it has been
contended that these limitations generally stem from a
misunderstanding of the purpose and meaning of deductive theory.
It is not necessary that theory be entirely practical in order to be
useful in establishing workable procedures. The main purpose of
theory is to provide a framework for the development of new
ideas and new procedures and to help in the making of choices
among alternative procedures. If these objectives are met, it is
not necessary that theory be based completely on practical
concepts or that it be restricted to the development of procedure,
that are completely workable and practical in terms of current
known technology. In fact many of the currently accepted
principles and procedures are general guides to action rather than
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Table 3.1
Summary Analysis of the Approaches of the Deductive Theories
Name Inferred User(s) Inferred Model under Recommended
Ideal Circumstances Measurement Methods
To promote efficient management,
which furthers the interests of all
equity holders; also as a report on
enterprise progress to equity holders.
“The proprietor and those
beneficially interested in
proprietorship wish chiefly to know
what net changes in power to
command future final income have
occurred within a year by reason of
the enterprise activities.” (pp. 169-
170)
All users. but primarily business
management.
“To inform the owners of a business
of all the profits and losses in which
they have an equity” (p. 299); other
parties (esp. managers and creditors)
at interest also have a right to the
same information (pp. 180-1 82).
Asserts different incomes for
different purposes where economy is
characterized by changing prices and
changing expectations of future
earning power.
To facilitate management planning
and to assist security analysts. owners
of business firms, and potential
entrepreneurs in making rational
comparisons among companies and
industries.
“Income in the broadest sense may
be conceived as including the entire
net increase in the [true economic
position of a business] after due
allowance has been made for new
investments and withdrawals” (pp.
440, 464)
Measure the annual change in capital
value by reference to the direct
valuation of the assets.
Measure changes in the real valuation
of capital by reference to changes in
its future productivity to the marginal
user.
Measure changes in “economic
value,” defined as the market prices
of the firm’s assets in a free,
competitive, broad, and active
market.
Measure the capitalized value of the
enterprise and changes therein.
Measure the subjective value and
subjective profit of the enterprise.
Include appreciation of marketable
securities and standard raw materials
in non-operating income; to
recognize appreciation on other
inventories would be more dubious;
appreciation on fixed assets and the
consequent depreciation on
appreciation might be displayed in a
supplementary statement.
Measure assets and liabilities by
discounting future cash flows, if
feasible; if not, resort to indirect
valuations (such as cost). Income is
the change in net assets.
Account for changes in replacement
cost (which are denominated as
unrealized until the assets are
exchanged); also use GPL changes.
Use market price for “marketable
assets,” appraisals or replacement
cost for ‘reproducible, non-
marketable assets,” and original cost
less amortization or depletion for
“non-reproducible, non-marketable
assets.” Would include unrealized
holding gains and losses on
merchandise inventory in net income;
other unrealized items, while
disclosed in the income statement, are
transferred to Capital Surplus.
Proposes various measures
depending on user and use. Is
skeptical of the usefulness of GPL
accounting.
Account for changes in replacement
cost, distinguishing between (1) the
excess of realized revenue over the
current replacement cost of non-
monetary assets consumed, and (2)
the unrealized changes in the
replacement cost of non-monetary
assets. The grand total is called
“business profit.” Also use GPL
changes.
Paton (1922)
Canning
(1929)
Sweeney
(1936)
MacNeal
(1939)
Alexander
(1950)
Edwards/Bell
(1961)
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To facilitate management planning
and control, and to aid owners,
creditors, and government in
evaluating management performance.
Measure the changes in enterprise
wealth, evidently being the present
value of future cash flows.
Use discounted present value (at
historical interest rates) for
receivables and payables to be settled
in cash, net realizable values for
readily salable inventories, and
replacement cost for other inventories
and for tangible fixed assets. Reject
realization as lacking “analytical
precision.”Also favour GPLchanges.
Moonitz (1961)
Sprouse/
Moonitz (1962)
Source: American Accounting Association, Statement on Accounting Theory Acceptance, AAA, 1977, p. 7.
specific rules that can be followed precisely in every applicable
case.42
Inductive Approach
Inductive reasoning examines or tests data, usually a sample
from a population, and makes inferences about the population. If
an individual were testing a pair of dice to see whether they were
loaded, he or she might throw each dice 100 times in order to
check that all sides come up approximately one sixth of the time.
Accounting researchers gather data through many methods and
sources. These include questionnaires sent to practitioners or other
appropriate parties, laboratory experiments involving individuals
in simulation exercises, numbers from published financial
statements, and prices of publicly traded securities.
In a complex environment such as the business world, a good
inductive theory must carefully specify the problem that is under
examination. The research must be based on a hypothesis that is
capable of being tested. The process includes selecting an
appropriate sample from the population under investigation,
gathering and scrutinizing the needed data, and employing the
requisite tools of statistical inference to test the hypothesis.
The inductive approach to accounting theory examines
observations first and accounting practices and then derives
principles and procedures from these observations. This approach
emphasises on drawing generalised conclusions and principles
of accounting from detailed observations and measurements of
financial information of business enterprises. The inductive
approach includes the following steps:
(i) Making observations and recording of all observations.
(ii) Analysis and classification of these observations to
determine recurring relationships, similarities, and
dissimilarities.
(iii) Derivation and formulation of generalisations and
principles of accounting from the recorded observations
that reflect recurring relationships.
(iv) Testing of generalisations and principles.
Some accounting writers have followed inductive approach
and used observations regarding accounting practice to suggest
an accounting theory, accounting principles and generalisations.
Inductive theorists include Hatfield, Littleton, Patton and Littleton,
and Ijiri.All these theorists emphasise rationalising and improving
accounting practice to draw theoretical conclusions. The inductive
approach has been forcefully supported and defended by Ijiri.
Ijiri undertakes to generalise the objectives implicit in current
accounting practice and then defends the use of historical cost
against current cost and current value. He rejects current values
because they are predicted on hypothetical actions of the entity
and, as such, are not verifiable. Ijiri concludes that accounting
practice may best be interpreted in terms of accountability, which
he defines as economic performance measurement that is not
susceptible to manipulation by interested parties. Ijiri43 explains
forthrightly his preference for inductive approach:
“This type of inductive reasoning to derive goals implicit in
the behaviour of an existing system is not intended to be
proestablishment or promote the maintenance of the status quo.
The purpose of such an exercise is to highlight where changes
are most needed and where they are feasible. Changes suggested
as a result of such a study have a much better chance of being
actually implemented. Goal assumptions in normative models or
goals advocated in policy discussions are often stated purely on
the basis of one’s conviction and preference, rather than on the
basis of inductive study of the existing system. This may perhaps
be the most crucial reason why so many normative models or
policy proposals are not implemented in the real world.”
Inductive approach has advantages as it is not necessarily
influenced by predetermined objectives, structure or model. The
investigators may make any observations they find purposeful.
After generalisations and principles are formulated, they are
verified using the deductive approach. However, this approach
has some limitations too. The investigators are likely to be
influenced by preconceived notions in studying relationships
among the accounting data The collection of data may be
influenced by the attitude of the investigators.Another limitation
is that financial data (observations) may vary from one firm to
another. The diverse nature of the data for different firms create
difficulties in drawing meaningful generalisations and principles.
It may be said that while the deductive approach begins with
general proposition and objectives, the formulation of these
propositions and objectives are often done by using inductive
approach, conditioned by the researcher’s knowledge of and
experience with accounting practice. In other words, the general
propositions are formulated through an inductive process, while
the principles and techniques are formulated by a deductive
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process. Therefore, some of the inductive writers sometimes
interpose deductive approach, and deductive writers sometimes
interpose inductive reasoning. Yu suggests that inductive logic
may presuppose deductive logic.44
EVENTS APPROACH, VALUE APPROACH
AND PREDICTIVE APPROACH
Events Approach
The events approach in accounting theory implies that the
purpose of accounting is to provide information about relevant
economic events that might be useful in a variety of possible
decision models.45 It is upto the accountant to provide information
about the events and leave to the user the task of fitting the
events to their decision models. It is upto the user to aggregate
and assign weights and values to the data generated by the event
in conformity with his own decisions The user rather than the
preparer of accounts transfers the event into accounting
information suitable to the user’s own individual decision model.
Events may be characterised by one or more basic attributes or
characteristics and these characteristics can be directly observed
with feasibility. The events approach suggests a large expansion
of the accounting data presented in financial reports.
Characteristics of an event other than just monetary values may
have to be disclosed. Under the events approach because of a
disaggregation of data provided to users, the data are expanded.
Sorter proposes the following guidelines for the preparation of
balance sheet and income statement under the events approach:
(i) A balance sheet should be so constructed as to maximise
the reconstructibility of the events to be aggregated. This
means that all aggregated figures in the balance sheet
may be disaggregated to show all the events that have
occurred since the inception of the firm.
(ii) In Income statement, each event should be described in
a manner facilitating the forecasting of that same event
in a future time period given exogenous changes.46
Johnson has emphasised upon ‘normative events theory’ to
increase the forecasting accuracy of accounting reports by
focusing on the most relevant attributes of events crucial to the
users. Johnson47 observes:
“In order for interested persons (shareholders, employees,
manager, suppliers, customers, government agencies, and
charitable institutions) to better forecast the future of social
organisations (households, business, governments, and
philanthropies), the most relevant attributes (characteristics) of
the crucial events (internal, environmental and transactional)
which affect the organisations are aggregated (temporally and
sectionally) for periodic publication free of inferential bias.”
The events approach suffers from the following limitations:
(i) Information overload may result from the attempt to
measure the relevant characteristics of all crucial events
affecting a firm. This is important as there is a limit to the
Complementary Nature of Deductive and inductive
Methods
The deductive-inductive distinction in research, although a
good concept for teaching purposes, often does not apply in
practice. Far from being either/or competitive approaches,
deduction and induction are complementary in nature and often are
used together..
Hakansson, for example, suggested that the inductive
method can be used to assess the appropriateness of the set of
originally selected premises in a primarily deductive system.
Obviously, changing the premises can change the logically derived
conclusions. The research process itself does not always follow a
precise pattern. Researchers often work backward from the
conclusions of other studies by developing new hypotheses that
appear to fit the data. They then attempt to test the new
hypotheses.
The methods used by the greatest detective in all literature,
Sherlock Holmes, renowned for his extraordinary powers of
deductive reasoning, provide an excellent example of the
complementary nature of deductive and inductive reasoning. In
one of Holmes’s cases, Silver Blaze, a famous racehorse,
mysteriously disappeared when its trainer was murdered. One
element of the case was that the watchdog did not bark when the
horse disappeared. Dr. Watson, Holmes’s somewhat slow witted
sidekick, saw nothing unusual about the dog not barking. Holmes,
however, immediately deduced that the horse was taken from the
stable by someone from the household rather than by an outsider.
Thus, his list of suspects was immediately narrowed. Holmes was
also keenly aware of induction: He systematically observed
elements that would increase his knowledge and perceptions.
Extensive studies of such diverse items as cigar ashes, the influence
of various trades on the form of the hand, and the uses of plaster of
Paris for preserving hand and footprints added considerable depth
to his deductive abilities.
In a not dissimilar fashion, inductive research in accounting
can help to shed light on relationships and phenomena existing in
the business environment. This research, in turn, can be useful in
the policymaking process in which deductive reasoning helps to
determine rules that are to be prescribed. Hence, it should be clear
that inductive and deductive methods can be used together and are
not mutually exclusive approaches, despite the impossibility of
keeping inductive research value free.
Source: Harry I. Wolk, James L. Dodd and John J. Rozycki,
Accounting Theory, Conceptual Issues in a Political and Economic
Environment, VIIIth Edition, Sage Publications, 2013, pp. 38-39.
amount of information an individual can efficiently
handle at one time.
(ii) Measuring all the characteristics of an event may prove
to be difficult, given the state of the art in accounting.
(iii) The criterion for selecting what information (events)
should be presented is very vague, and therefore, it does
not lead to a fully developed theory of accounting. Yet,
an adequate criterion for the choice of the crucial events
has not been developed.
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Value Approach
Value approach in accounting is traditional approach which
assumes that “users needs are known and sufficiently well
specified so that accounting theory can deductively arrive at and
produce, optimal input values for user and useful decision
models.” However, it is accepted that input values cannot be
optimal for all uses and users. In the value approach, the balance
sheet is regarded as an indicator of the financial position of a
business enterprise at a given point in time. On the contrary, in
the events approach, the balance sheet is regarded as an indirect
communication of all accounting events, relevant to the firm since
its inception. Similarly, in the value approach, the income
statement is perceived as an indicator of the financial performance
of the business firm for a given period. In the events approach, it
is perceived as a direct communication of the operating events
occurring during period. In the value approach, the funds flow
statement is perceived as an expression of the changes in working
capital. In the events approach, however, it is better perceived as
an expression of financial and investment events. In other words,
an event’s relevance rather than its impact on the working capital
determines the reporting of an event in the funds flow statement.
Events approach assumes the existence of many and diverse
users and therefore financial reporting in this approach is not
directed towards specific users. It also assumes that the user
should be able to select the desired information from a broader
list and also to decide the amount of aggregation. A user can
generally aggregate accounting data with sufficient detail, but
cannot disaggregate data without the detail.
Which approach—event approach or value approach—
should be followed, depends on many factors such as decision
models, users’ informational requirements, the need to predict
specific events, etc. Benbasat and Dexter48 conclude that the
psychological type of the decision maker is an important factor in
determining what type of information system to provide.
Structured/Aggregate reports are preferable for high analytical
decision makers, and events approach is preferable for low
capability decision makers. In addition to psychological type, the
information provider needs to consider the users decision
environment as a contributing factor in the design process. As
the uncertainty in the decision environment decreases, the “value”
approach seems preferable. On the other hand, as uncertainty
about the environment increases or if the decision making process
is not well understood, the event approach may be more suitable.
Predictive Approach
Predictive approach in accounting theory basically deals with
deciding different accounting alternatives and measurement
methods. This approach signifies that particular accounting
method should be followed which has predictive ability, i.e., which
can predict events that are useful in decision making and in which
users are interested. In this way, an accounting measure or option
having the highest predictive ability or power with regard to a
specific situation or event will be preferred by the preparers of
accounting reports as it will be useful to users in predicting the
decision making variables.
Predictive approach in accounting theory is based on the
concept of relevant information. The assumption is that the
relevant information, if communicated, commands greater
predictive ability in predicting the future events about a business
enterprise. The predictive approach is useful in evaluating the
current accounting practices, evaluating alternative methods of
accounting, choosing competing accounting measures and
hypotheses. It facilitates the testing and evaluation of accounting
choices empirically and the ultimate decision making. Predictive
ability is a purposeful criterion which is linked with the decision-
making purpose of accounting information and within this goal
this approach helps in selecting relevant information for the users.
Prediction is a prerequisite to making decision, i.e., decisions are
usually not made without the prediction. However, prediction
may not necessarily end into decision making, i.e., prediction
may be made without the goal of decision.
Predictive approach may not be successfully used due to some
inherent difficulties such as difficulty in identifying the decision
models of different users, difficulty in identifying the events and
items which are of interest to users, difficulty in establishing
predictive and explanatory relationship between accounting events
and information on the one hand and accounting methods and
measures on the other hand.
METHODOLOGY IN ACCOUNTING
THEORY
A methodology is required for the formulation of an
accounting theory. In accounting it is true that many theories,
approaches, opinions, have been proposed and supported. These
theories and approaches have led to the use of two methodologies:
(1) Positive Accounting Theory
(2) Normative Accounting Theory
Positive Accounting Theory
Positive methodology, is often known as Descriptive
Methodology, Positive Accounting Theory or “the Rochester
School of Accounting”. The basic message in positive theory of
accounting is that most accounting theories are unscientific
because they are normative and should be replaced by positive
theories that explain actual accounting practices in terms of
management’s voluntary choice of accounting procedures and
how the regulated standards have changed over time. It attempts
to set forth and explain what and how financial information is
presented and communicated to users of accounting data. Positive
theory yields no prescriptions and norms for accounting practices.
It is concerned with explaining accounting practice. Positivism
or empiricism means testing or relating accounting hypotheses
or theories back to experiences or facts of the real world. It is
designed to explain and predict which firms will and which firms
will not use a particular method of valuing assets, but it says
nothing as to which method a firm should use.
The concept of positive theory was introduced into the
accounting literature relatively recently during 1960s. The best
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defence of positive accounting theory has been provided by Watts
and Zimmerman through their various writings, the most recently
being Positive Accounting Theory (1986).49
Watts and Zimmerman asserted:
“The objective of [positive] accounting theory is to explain
and predict accounting practice ... Explanation means providing
reasons for observed practice. For example, positive accounting
theory seeks to explain why firms continue to use historical cost
accounting and why certain firms switch between a number of
accounting techniques. Prediction of accounting practice means
that the theory predicts unobserved phenomena.”
Unobserved phenomena are not necessarily future
phenomena; they include phenomena that have occurred, but on
which systematic evidence has not been collected. For example,
positive theory research seeks to obtain empirical evidence about
the attributes of firms that continue to use the same accounting
techniques from year to year versus the attributes of firms that
continually switch accounting techniques. We might also be
interested in predicting the reaction of firms to a proposed
accounting standard, together with an explanation of why firms
would lobby for and against such a standard, even though the
standard has already been released. Testing these theories provides
evidence that can be used to predict the impact of accounting
regulations before they are implemented.
Positive accounting theories are based on assumptions about
the behaviour of individuals:
Managers, investors, lenders and other individuals are
assumed to be rational, evaluative utility maximisers
(REMs).
Managers have discretion to choose accounting policies
that directly maximise their utility (self-interest) or to
alter the firm’s financing, investment and production
policies to indirectly maximise their self-interest.
Managers take actions that maximise the value of the
firm.
Watts and Zimmerman find that prescriptions and proposed
accounting objectives and methodologies in the form of ‘should
be’ fail to satisfy all and not accepted generally by all standard
setting bodies. Prescriptions require the specification of an
objective and an objective function. For example, to argue that
current cost values should be the method of valuing assets, one
might adopt the objective of operating capability and specify
how certain variables affect operating capability (the objective
functions). Then one could use a theory to argue that adoption
of current cost values will increase operating capacity. However,
a theory (which suggest the specification of objective) does not
provide a means for assessing the appropriateness of the
objective(s) which frequently differ among writers and
researchers. The decisions on the objective is subjective and there
is no method for resolving differences in individual decisions.
The differences in objectives are reflected in many statements on
accounting theory. For example, Chambers (Accounting,
Evaluation and Economic Behaviour, Prentice Hall 1966,
Chapters 911) apparently adopts economic efficiency as an
objective while the American Institute of Certified Public
Accountants (AICPA) Study Groups on the Objectives of
Financial Statements (1973, p. l7) decided that “financial
statements should meet the needs of those with the least ability
to obtain information....” Not only are the researchers unable to
agree on the objectives of financial statements, but they also
disagree over the methods of deriving prescriptions from the
objectives. Thus, choosing an objective amounts to choosing
among individuals and, therefore, necessarily entails a subjective
value judgement.
Belkaoui50
observes
“The major thrust of the positive approach to accounting is
to explain and predict management’s choice of standards by
analyzing the costs and benefits of particular financial disclosures
in relation to various individuals and to the allocation of resources
within the economy. The positive theory is based on the
propositions that managers, shareholders, and regulators/
politicians are rational and that they attempt to maximize their
utility, which is directly related to their compensation and, hence,
to their wealth. The choice of an accounting policy by any of
these groups rests on a comparison of the relative costs and
benefits of alternative accounting procedures in such a way as to
maximize their utility. For example, it is hypothesized that
management considers the effects of the reported accounting of
numbers on tax regulation, political costs, management
compensation, information production costs, and restrictions
found in bond-indenture provisions. Similar hypotheses may be
related to standard setters, academicians, auditors and others. In
fact, the central ideal of the positive approach is to develop
hypotheses about factors that influence the world of accounting
practices and to test the validity of these hypotheses empirically:
(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 number in general and the reduction of systematic risk
in particular by reducing the covariances of the firm’s returns
with the market returns.”
Evaluation of the Positive Approach
Positive methodology or theory is important because it can
provide those who must make decisions on accounting policy
(corporate managers, auditors, investors, creditors, loan officers,
financial analysts, company law authorities) with explanations
and predictions of the consequences of their decisions. An
important test of the value of an accounting theory is how useful
it is. For example, a user will use the accounting theory that
increases his welfare the most,51 through making decisions.
Therefore, all users are interested in predicting the effects of
decisions.
Positive accounting theory attempts to make good
predictions of real-world events. This theory is concerned with
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predicting such actions as the choice of accounting policies by
firms and how firms will respond to proposed new accounting
standards. It should be noted that this theory does not go far as
to suggest that firms (and standard setters) should completely
specify the accounting policies they will use. This would be too
costly. It is desirable to give managers some flexibility to choose
accounting policies so that they can adopt to new or unforeseen
circumstances.
However, giving management flexibility to choose from a set
of accounting policies opens up the possibility of opportunistic
behaviour. That is, this theory assumes that managers are rational
(like investors) and will choose accounting policies in their own
best interests if able to do so.52
The positive approach looks into “why” accounting practices
and/or theories have developed in the way they have in order to
explain and/or predict accounting events. As such, the positive
approach seeks to determine the various factors that may influence
rational factors in the accounting field. It basically attempts to
determine a theory that explains observed phenomena. The
positive approach is generally differentiated from the normative
approach, which seeks to determine a theory that explains “what
should be” rather than “what is”. The positive approach seemed
to generate considerable optimism among its advocates and
supporters.
Christenson53
has pointed out the following limitations of
positive theory of accountings:
The Rochester School’s assertion that the kind of
“positive” research they are undertaking is a prerequisite
for normative accounting theory is based on a confusion
of phenomenal domains at the different levels
(accounting entities versus accountants), and is
mistaken.
The concept of “positive theory” is drawn from an
obsolete philosophy of science and is, in any case, a
misnomer, because the theories of empirical science
make no positive statement of “what is”.
Although a theory may be used merely for prediction
even if it is known to be false, an explanatory theory of
the type sought by the Rochester School, or one that is
to be used to test normative proposals, ought not to be
known to be false. The method of analysis, which
reasons backward from the phenomena to the premises
which are acceptable on the basis of independent
evidence, is the appropriate method for constructing
explanatory theories.
Contrary to the empirical method of subjecting theories
to severe attempts to falsify them, the Rochester School
introduces ad hoc arguments to excuse the failure of
their theories.
Another criticism is based on the argument that positive or
“empirical” theories are also normative and value-laden because
they usually mark a conservative ideology in their accounting-
policy implications.54
Normative Accounting Theory
The 1950s and 1960s saw what has been described as the
‘golden age’ of normative accounting research. During this period,
accounting researchers became more concerned with policy
recommendations and with what should be done, rather than with
analysing and explaining what was currently accepted practice.
Normative theories in this period concentrated either on deriving
the ‘true income’ (profit) for an accounting period or on discussing
the type of accounting, information which would be useful in
making economic decisions.
Normative accounting theory, popularly known as normative
methodology also, attempts to prescribe what data ought to be
communicated. and how they ought to be presented; that is, they
attempt to explain ‘what should be’ rather than ‘what is.’ Financial
accounting theory is predominantly normative (prescriptive).
Most writers are concerned with what the contents of published
financial statements should be; that is, how firms should account.
Normative methodology and accounting, with more than half a
century of research in its area, has got support from many writers
and accounting bodies, notably Moonitz, Sprouse and Moonitz,
AAA’s Statement of BasicAccounting Theory, Edwards and Bell,
Chambers. It has been found that government regulations relating
to accounting and reporting has acted as a major force in creating
a demand for normative accounting theories employing public
interest arguments, that is, for theories purporting to demonstrate
that certain accounting procedures should be used, because they
lead to better decisions by investors, more efficient capital market,
etc. Further, the demand is not for one (normative) theory, but
rather for diverse prescriptions and suggestions.
Normative researchers labelled their approach to theory
formulation as scientific and, in general, based their theory on
both analytic (syntactic) and empirical (inductive) propositions.
Conceptually, the normative theories of the 1950s and 1960s began
with a statement of the domain (scope) and objectives of
accounting, the assumptions underlying the system and definitions
of all the key concepts. The normative theorists also made
assumptions about the nature of firm’s operations based on their
observations. Detailed and precise accounting principles and rules
and a logical explanation of the accounting outputs were outlined.
The deductive framework was to be rigorous and consistent in its
analytic concepts.
According to Scott:
“Whether or not normative theories have good predictive
abilities depends on the extent to which individuals actually make
decisions as those theories prescribe. Certainly, some normative
theories have predictive ability—we do observe individuals
diversifying their portfolio investments. However, we can still
have a good normative theory even though it may not make good
predictions. One reason is that it may take time for people to
figure out theory.
Individuals may not follow a normative theory because they
do not understand it, because they prefer some other theory or
simply because of inertia. For example, investors may not follow
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a diversified investment strategy because they believe in technical
analysis, and may concentrate their investments in firms that
technical analysts recommend. But, if a normative theory is a
good one, we should see it being increasingly adopted over time
as people learn about it. However, unlike a positive theory,
predictiveability is not the main criterion by which a normative
theory should be judged. Rather it is judged by its logical
consistency with underlying assumptions of how rational
individuals should behave.”55
COMPARISON BETWEEN POSITIVE
THEORY AND NORMATIVE THEORY
The main difference between normative and positive theories
is that normative theories are prescriptive, whereas positive
theories are descriptive, explanatory or predictive. Normative
theories prescribe how people such as accountants should behave
to achieve an outcome that is judged to be right, moral, just, or
otherwise a ‘good’ outcome. Positive theories do not prescribe
how people (e.g., accountants) should behave to achieve an
outcome that is judged to be ‘good’. Rather, they avoid making
value_laden prescriptions. Instead, they describe how people do
behave (regardless of whether it is ‘right’); they explain why
people behave in a certain manner, for example to achieve some
objective such as maximising share values or their personal wealth
(regardless of whether that is, right’); or they predict what people
have done or will do (again, regardless of whether that is ‘right’
or ‘best behaviour’).
Normative theories employ a value judgment: Contained
within them is at least one premise saying that this is the way
things should be. For example, a premise stating that accounting
reports should be based on net realizable value measurements of
assets indicates a normative system. By contrast, descriptive
theories attempt to find relationships that actually exist. The Watts
and Zimmerman study is an excellent example of a descriptive
theory applied to a particular situation.
The positive theory is a predictive model whose validity is
independent of the acceptance of any goal structure. Though
assumed goals may be part of such a model, research relating to
a theory or model of accounting does not require acceptance of
the assumed goals as necessarily desirable or undesirable. On the
other hand, accounting policies as made in normative theory,
requires a commitment to goals and, therefore, requires a policy-
maker to make value judgements. Policy decisions presumably
are based on both an understanding of accounting theories and
acceptance of a set of goals.56 In spite of the existence of positive
and normative methodologies in accounting theory, theorists and
writers have to be very careful in discriminating between positive
and normative propositions. Positive theories are concerned with
how the world works. For example, the following is a propositions
made in positive accounting: “if a business enterprise changes
from FIFO to LIFO and the share market has not anticipated the
change, the share price will rise.” This statement is a prediction
that can be refuted by evidence. Normative theories are concerned
with prescriptions, goal setting. For example, “given the set of
conditions A, alternative D should be selected,” is a normative
proposition. The other normative proposition can be, “since prices
are rising, LIFO should be adopted.” These (normative)
propositions are not refutable. Given an objective, it can be made
refutable. For example, the statement, “if prices are rising,
choosing LIFO will maximise the value of the firm,” is refutable by
evidence. Thus, given an objective, a researcher can turn a
prescription into a conditional prediction and assess the empirical
validity. However, the choice of the objective is not made by the
theorists, but by the users of theory.
It is difficult to say which methodology—positive or
normative—should be used in the formulation and construction
of accounting theory. It is argued that, given the complex nature
of accounting, accounting environment, issues and constraints,
both methodologies may be needed for the formulation of an
accounting theory. Positive theory may be used in justifying some
accounting practices. At the same time, normative theory may be
useful in determining the suitability of some accounting practices
which ought to be followed in terms of normative theories. Watts
and Zimmerman57 observe:
“We emphasise that positive theory does not make normative
propositions unimportant. The demand for theory arises from the
users’ demands for prescriptions, for normative propositions.
However, theory only supplies one of the two necessary
ingredients for a prescription: the effect of certain actions on
various variables. The user supplies the other ingredient: the
objective and the function that provides the effect of variables on
that objective (the objective function).”
Similarly, Scott58 comment:
“....it is sufficient to recognise that both normative and positive
approaches to theory development and testing are valuable.
To the extent that decision makers proceed normatively, both
positive and normative theories will make similar predictions.
By insisting on empirical testing of these predictions, positive
theory helps to keep the normative predictions on track. In
effect, the two approaches complement each other.”
Many positive theory researchers are largely dismissive of
normative viewpoints. Similarly, many normative theorists do not
accept the value of positive accounting research. In fact, the
theories can coexist, and can complement each other. Positive
accounting theory can 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.59
OTHER APPROACHES IN ACCOUNTING
THEORY
In the previous section, many theories (approaches) of
accounting have been discussed. It is also clear that there is no
single comprehensive theory of accounting. Besides the theories
discussed earlier, some more traditional approaches to formulation
of an accounting theory are found. They are listed as follows:
(1) PragmaticApproach
(2) Authoritarian Approach
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(3) Ethical Approach
(4) Sociological Approach
(5) EconomicApproach
(6) Eclectic Approach
1. Pragmatic Approach
The pragmatic approach aims to construct a theory
characterized by its conformity to real world practices and that is
useful in terms of suggesting practical solutions. According to
this approach, accounting techniques and principles should be
chosen because of their usefulness to users of accounting
information and their relevance to decision making processes.
Usefulness, or utility, means that attribute which fits something
to serve or to facilitate its intended purpose.
2. Authoritarian Approach
The authoritarian approach to the formulation of an
accounting theory, which is used mostly by professional
organizations, consists of issuing pronouncements for the
regulation of accounting practices.
Because the authoritarian approach also attempts to provide
practical solutions, it is easily identified with the pragmatic
approach. Both approaches assume that accounting theory and
the resulting accounting techniques must be predicted on the
ultimate uses of financial reports if accounting is to have a useful
function. In other words, a theory without practical consequences
is a bad theory.
3. Ethical Approach
The several approaches to accounting theory are not
independent of each other. This is particularly true of the ethical
approach; defining it as a separate approach does not necessarily
imply that other approaches do not have ethical content, nor does
it imply that ethical theories necessarily ignore all other concepts.
The ethical approach to accounting theory places emphasis on
the concepts of justice, truth and fairness. Fairness, justice, and
impartiality signify that accounting reports and statements are
not subject to undue influence or bias. They should not be prepared
with the objective of serving any particular individual or group
to the detriment of others. The interests of all parties should be
taken into consideration in proper balance, particularly without
any preference for the rights of the management or owners of the
firm, who may have greater influence over the choice of
accounting procedures. Justice frequently refers to a conformity
to a standard established formally or informally as a guide to
equitable treatment.
Truth, as it relates to accounting, is probably more difficult
to define and apply. Many seem to use the term to mean “in
accordance with the facts.” However, not all who refer to truth in
accounting have in mind the same definition of facts. Some refer
to accounting facts as data that are objective and varifiable. Thus,
historical costs may represent accounting facts. On the other
hand, the term truth is used to refer to the valuation of assets and
expenses in current economic terms. For example, MacNeal stated
that financial statements display the truth only when they disclose
the current value of assets and the profits and losses accruing
from changes in values, although the increases in values should
be designated as realized or unrealized.
Truth is also used to refer to propositions or statements that
are generally considered to be established principles For example,
the recognition of a gain at the time of the sale of an asset is
generally considered to be a reporting of true conditions, while
the reporting of an appraisal increase in the value of an asset
prior to sale as ordinary income is generally thought to lack
truthfulness. Thus, the established rule regarding revenue
realization is the guide. But the truthfulness of the financial reports
depends on the fundamental validity of the accepted rules and
principles on which the statements are based. Established rules
and procedures provide an inadequate foundation for measuring
truthfulness.
Probably the greatest disadvantage of ethical approach to
accounting theory is that it fails to provide a sound basis for the
development of accounting principles or for the evaluation of
currently accepted principles. Principles are evaluated on the basis
of subjective judgement; or, as generally found, currently accepted
practices become accepted without evaluation because it is
expedient and easier to do so.
4. Sociological Approach
The Sociological approach to the formulation of an
accounting theory emphasizes the social effects of accounting
techniques. It is an ethical approach that centers on a broader
concept of fairness, that is, social welfare. According to the
sociological approach, a given accounting principle or technique
will be evaluated for acceptance on the basis of its reporting effects
on all groups in society. Also implicit in this approach is the
expectation that accounting data will be useful for social welfare
judgements. To accomplish its objectives, the sociological
approach assume the existence of “established social values”
that may be used as criteria for the determination of accounting
theory. A strict application of the sociological approach to
accounting theory construction may be difficult to find because
of the difficulties associated with both determining acceptable
“social values” to all people and identifying the information needs
of those who make welfare judgements.
The sociological approach to the formulation of an
accounting theory has contributed to the evolution of a new
accounting subdiscipline — social responsibility accounting. The
main objective of social responsibility accounting is to encourage
the business entities functioning in a free market system to
account for the impact of their private production activities on
the social environment through measurement, internalization,
and disclosure in their financial statements. Over the years, interest
in this subdiscipline has increased as a result of the social
responsibility trend espoused by organizations, the government,
and the public. Socialvalueoriented accounting, with its emphasis
on “social measurement,” its dependence on “social values,” and
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its compliance to a “social welfare criterion,” will probably play a
major role in the future formulation of accounting theory.
5. Economic Approach
The economic approach to the formulation of an accounting
theory emphasizes controlling the behaviour of macroeconomics
indicators that result from the adoption of various accounting
techniques. While the ethical approach focuses on a concept of
“fairness” and the sociological approach on a concept of “social
welfare,” the economic approach focuses on a concept of “general
economic welfare.” According to this approach, the choice of
different accounting techniques depends on their impact on the
national economic good. Sweden is the usual example of a country
that aligns its accounting policies to other macroeconomic
policies. More explicitly, the choice of accounting techniques will
depend on the particular economic situation. For example, last in
first out (LIFO) will be a more attractive accounting technique in
a period of continuing inflation. During inflationary periods, LIFO
is assumed to produce a lower annual net income by assuming
higher, more inflated costs for the goods sold than under the first
in, first out (FIFO) or average cost methods.
The general criteria used by the macroeconomic approach
are (1) accounting policies and techniques should reflect
“economic reality,” and (2) the choice of accounting techniques
should depend on “economic consequences.” “Economic reality”
and “economic consequences” are the precise terms being used
to argue in favour of the macroeconomic approach.
Until the setting of standards setting bodies in different
countries, the economic approach and the concept of “economic
consequences of accounting choices” were not much in use in
accounting. The professional bodies were encouraged to resolve
any standardsetting controversies within the context of traditional
accounting. Few people were concerned with the economic
consequences of accounting policies. However. at present, the
economic approach and the concepts of economic consequences
and economic reality are being applied while framing accounting
standards. Some examples where economic approach has got
major consideration are accounting for research and development,
foreign currency fluctuations, leases, inflation accounting. In
setting accounting standards, therefore, the considerations implied
by the economic approach are more economic than operational.
While in the past, reliance has been on technical accounting
considerations, the tenor of the times suggests that standard setting
encompasses social and economic concerns.
6. Eclectic Approach
The eclectic approach is basically the result of numerous
attempts by individual writers and researchers, professional
organisations, government authorities in the establishment of
accounting theory and principles and concepts therein. Therefore,
eclectic approach comprises a combination of approaches. For
example, in USA, many public accounting firms (like Arthur
Anderson and Company; Arthur Young and Company; Coopers
and Lybrand; Ernst and Whinney; Price Water House Co.; Peat,
Marwick, Mitchell and Co.; Touche Ross and Co.; Deloitte Haskins
and Sells), TheAmerican Institute of Certified PublicAccountants
(AICPA), American Accounting Association (AAA), Financial
Accounting Standards Board (FASB), Securities and Exchange
Commission (SEC), and other professional organisations are
involved in the development of accounting theory. In other
countries also including India, many efforts have, although on a
lesser degree, been made by individual accounting organisations
and government authorities to establish accounting principles
and concepts.
REFERENCES
1. American Accounting Association, A Statement of Basic
Accounting Theory, Sarsota: AAA, 1966, p. 1.
2. Kenneth S. Most, Accounting Theory, Ohio: Grid Inc. 1982,
p. 11.
3. Frederick D.S. Choi and G. Mueller, International Accounting,
Englewood Cliffs: Prentice Hall, 1984, p. 28 4. Eldon S.
Hendriksen, Accounting Theory, Homewood: Richard D.
Irwin, 1982, p. l.
4. Eldon S. Hendriksen, Accounting Theory, Irwin, 1982, p. 1.
5. Kenneth S. Most, Accounting Theory, Ibid.
6. Ross L. Watts and Jerold L. Zimmerman, Positive Accounting
Theory, Englewood Cliffs: Prentice Hall, 1986, p. 2.
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Construction and Verification, Accounting Review
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10. Yuji Ijiri, Theory of Accounting Measurement, American
Accounting Association, 1975.
11. Eldon S. Hendriksen, Accounting Theory, Ibid., p. 3.
12. Eldon S. Hendriksen, Accounting Theory, Ibid., p. 4.
13. American Institute of Certified PublicAccountants, Objectives
of Financial Statements, New York: AICPA, 1973, p. 13.
14. Financial Accounting Standards Board, Concept No. l,
Objectives of Financial Reporting by Business Enterprises,
FASB, 1978.
15. American Accounting Association, Accounting Principles
Underlying Accounting Financial Statement, The Accounting
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16. W.A. Paton and A.C. Littleton, An Introduction to Corporate
Accounting Standards, American Accounting Association,
1940, p. 1.
17. R.J. Chambers, “Blue Print for a Theory of Accounting,”
Accounting Research, No. 6, (January 1955) p. 25.
18. C.J. Staubus, A Theory of Accounting to Investors, Berkeley:
University of California Press, 1961, p. 8.
19. C.T Devine ‘Research Methodology and Accounting Theory
Formation,” The Accounting Review (July 1960), p. 394
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20. C.T. Horngreem, “Depreciation, Flow of Funds, and the Price
Levels,” Financial Analysts Journal (August 1957), pp. 45-
47.
21. R.D. Bradish, Corporate Reporting and the FinancialAnalyst,”
The Accounting Review (October 1965), pp. 757766.
22. In this category, many studies have been conducted abroad
and few in India; e.g. (a) S.S. Singhvi and Harsh B. Desai,
“An EmpiricalAnalysis of the Quality of Corporate Financial
Disclosure,” The Accounting Review (January 1971), pp.
129138. (b) S.L. Buzby, “Selected Stems of Information and
Their Disclosure inAnnual Reports,” The Accounting Review,
(July 1974), pp. 423435. (c) Jawahar Lal, Corporate Annual
Reports, Theory and Practice, New Delhi: Sterling Publishers
Private Ltd., 1985.
23. (a) H.K. Baker Haslem, “Information Needs of Individual
Investors,” The Journal of Accountancy (November 1983),
pp. 64-69. (b) Gyan Chandra, “ A Study of the Consensus on
DisclosureAmong PublicAccountants and SecurityAnalysts,”
24. (a) H. Falk and 1. Ophir, “The Effect of Risk on the Use of
Financial Statements by Investment Decision Makers: ACase
Study,” The Accounting Review (April 1973), pp. 32338, and
“The Influences of Differences in Accounting Policies on
Investment Decisions,” The Journal of Accounting Research
(Spring 1973), pp. l0816. (b) R. Libley, “The use of Simulated
Decision Makers in Information Evolution,” The Accounting
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358-62. (b) J.E. Smith and N.P. Smith, ‘Readability: A
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1973), pp. 117142.
26. (a) K. Nelson and R.H. Strawser, “A Note on APB Opinion
No. 76” Journal of Accounting Research (Autumn 1970), pp.
28489. (b) V. Brewner and R. Shvey, “An Empirical Study of
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Research (Spring 1972), pp. 200208.
27. (a) R.M. Copeland,A.J. Francia, and R.H. Strawser, “Students
as Subjects in Behavioural Business Research”, The
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“CPAand User Opinions on Increased Corporate Disclosure”,
The CPA Journal (July 1975), pp. 3135.
28. (a) S.M. Woolsey, “Materiality Survey,” The Journal of
Accountancy (September 1973), pp. 9192. (b) J.A. Boatsman
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Judgements”, The Accounting Review (April 1974), pp.
342352. (c) J.W. Pattilo, “Materiality: The (Formerly) Elusive
Standard”, Financial Executive (August 1975), pp. 2027.
29. (a) J. Rose et al.: “Toward an Empirical Measure of
Materiality”, Journal of Accounting Research, Supplement
to Vol. 8 (1970), pp. l38156. (b) J.W. Dickhaut and I.R.C.
Eggleton, “An Examination of the Processes Underlying
Comparative Judgements of Numerical Stimuli,” Journal of
Accounting Research (Spring 1975), pp. 3872.
30. Some such studies are: (a) A. Belkaoui and A. Cousineau,
“Accounting Information, NonAccounting Information and
Common Stock Perception,” Journal of Business (July 1977),
pp. 33442. (b) T.R. Dyckman, “On the Investment Decisions,’
The Accounting Review (April 1976), pp. 258295. (c) N.
Dopuch and J. Ronen, “The Effects of Alliterative Inventory
Valuation Methods: An Experimental Study” Journal of
Accounting Research (Autumn 1973) pp. 191211. (d) R.F.
Ortman, “The Effect of Investment Analysis of Alternative
Reporting Procedure for Diversified Firms,” Accounting
Review (April 1974), pp. 298304.
31. Ahmed Riahi Belkaoui, Accounting Theory, New York:
Harcourt Brace Jovanovica, 1981, p. 43.
32. R.A.Abdel Khalik, “On the Efficiency of Subject Surrogation
in Accounting Research,” The Accounting Review (October
1974), pp 443450.
33. (a) N.J. Gonedes, “Efficient Capital Markets and External
Accounting,” The Accounting Review (January 1972). pp.
1121. (b) N.J. Gonedes and N. Dopuch, “Capital Market
Equilibrium, Information Production, and Selecting
Accounting Techniques; Theoretical Framework and Review
of Empirical Work,” Journal of Accounting Research
(Supplement 1974), pp. 48129.
34. S.J. Grossman and J.E. Stiglitz, ‘Information and Competitive
Price Systems”, The American Economic Review (May 1970),
pp. 246253.
35. R.J. Ball and P. Brown, “An Empirical Evaluation of
Accounting Income Numbers”, Journal of Accounting
Research (Autumn 1968), pp. 159-177.
36. W. Beaver, “The Behaviour of Security Prices and Its
Implications for Accounting Research (Methods)”, The
Accounting Review Supplement (1972), p 408.
37. N.J. Gonedes “Capital Market Equilibrium and Annual
Accounting Numbers: Empirical Evidence”, Journal of
Accounting ‘Research (Spring 1974), pp. 2662.
38. R.G. May, “The Influence of Quarterly Earnings
Announcements on Investor Decisions as Reflected in
Common Stock Price Changes”, Journal of Accounting
Research (Spring 1971) pp. 119163.
Theory, Ibid, p. l0.
40. Eldon S. Hendriksen, Accounting Theory, Ibid, p. 8.
41. (a) R. Mattessich, Accounting and Analytical Methods,
Homewood: Richard D. Irwin, 1964. (b) R.J. Chambers,
Accounting, Evaluation and Economic Behaviour, Englewood
Cliffs: Prentice Hall, 1966.
42. Eldon S. Hendriksen, Accounting Theory, Ibid, p. 9.
43. Y. Ijiri, Theory of Accounting Measurement, Studies in
Accounting Research 10, AAA, 1975, p. 28.
44. S.C. Yu, The Structure of Accounting Theory, Gainesville: The
University Press of Florida, 1976, p. 20.
45. G.H. Sorter, “An Events Approach to Basic Accounting
Theory,” The Accounting Review (January 1969), pp. 12-19.
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46. G.H. Sorter, “An Events Approach to Basic Accounting
Theory,” Ibid, pp. l516.
47. O. Johnson, “Toward An Events Theory of Accounting,” The
Accounting Review (October, 1970), pp. 641-653.
48. Izak Benbasat and Albert S. Dexter, “Value and Events
Approaches to Accounting: An Experimental Evaluations,”
49. (a) Ross L. Warts and Jerold L. Zimmerman, “Towards a
Positive Theory of the Determination of Accounting
Standards,” The Accounting Review (January 1978), pp.
112-134.
(b) Ross L. Watts, and Jerold L. Zimmerman, ‘The Demand
for and Supply of Accounting Theories: The Market for
Excuses,” The Accounting Review (April 1979), pp.
273305.
(c) Ross L. Watts and Jerold L. Zimmerman, “Agency
Problems, Auditing and the Theory of the Firm: Some
Evidence,” Journal of Law and Economics (October
1983), pp. 613634.
(d) Ross L. Watts and Jerold L. Zimmerman, Positive
Accounting Theory, Englewood Cliffs: Prentice Hall,
Inc., 1986.
50. Ahmed Riahi – Belkaoui, Accounting Theory, Thomson
Learning, 2000, pp. 369-370.
51. Ross L Watts and Jerold L. Zimmerman, Positive Accounting
Theory, Ibid, p. 14.
52. William R. Scott, Financial Accounting Theory, Prentice Hall,
1997, p. 220.
53. C-Christenson, “The Methodology of Positive Accounting”,
The Accounting Review (January, 1983), pp. 1-22.
54. A.M. Tinker, B.D. Merino and M.D. Neimark, “The Normative
Origins of Positive Theories: Ideology and Accounting
Thought”, Accounting, Organizations and Society (May 1982),
pp. 167-200.
55. William R. Scott, Ibid.
56. Robert G. May and Gary L. Sundem, “Research forAccounting
Policy:An Overview,” The Accounting Review (October 1976),
pp. 747763.
Theory, Ibid., p. 9.
58. William R. Scott, Ibid, p. 221.
59. Jayne Godfrey,Allan Hodgson, Scott Holmes and Ann Tarca,
Accounting Theory, John Wilay and SonsAustralia Ltd., 2006,
p. 55.
QUESTIONS
1. Explain the terms ‘theory’ and ‘accounting theory.’
2. How does accounting theory influence accounting practices
and accounting issues? (M.Com., Delhi, 2011)
3. Discuss the descriptive approach in financial accounting
theory. What are the limitations of this approach?
4. “Decision-usefulness approach focuses on the relevance of
information being communicated.” Explain this statement.
5. Discuss the main characteristics of decision-usefulness
approach in financial accounting.
6. Behavioural approach to accounting theory studies human
behaviour as it relates to accounting information.” Discuss
this statement and also examine studies conducted in this area.
7. In what way ‘aggregate market behaviour research’ can
contribute to the development of accounting theory?
8. Compare normative deductive and inductive approaches to
theory formulation. Which approach is more useful in theory
construction? (M.Com., Delhi, 2013)
9. “No single approach is accounting theory is universally
recognised.” In the light of this statement discuss the factors
responsible for it?
10. “Accounting is what accountants do; therefore, a theory of
accounting may be extracted from the practices of
accountants.” Do you agree?
In the light of the above statement, discuss the nature of
accounting theory. (M.Com., Delhi, 1990)
11. (a) Define ‘accounting theory.’
(b) Although there are several ways of classifying accounting
theories, a useful frame of reference is to classify theories
according to prediction levels.” Explain clearly.
(M.Com., Delhi)
12. “A single universally accepted basic accounting theory does
not exist at this time. Instead a multiplicity of theories has
been proposed.” Elaborate in brief.
(M.Com., Delhi)
13. What is the difference between traditional and new approaches
to accounting theory formulation? Explain briefly the
traditional approaches. (M.Com., Delhi)
14. “....At the present time, no comprehensive theory of
accounting exists. Instead, different theories have been and
continue to be proposed.” What are the reasons for so many
theories (of middle range) being proposed from time to time?
Have some attempts been recently made in the direction of
formulating a universally acceptable accounting theory?
Explain in brief. (M.Com., Delhi, 1991)
15. Distinguish between deductive and inducting reasoning.
(M.Com., Delhi)
16. Contrast the descriptive and general normative approaches to
theory construction. (M.Com., Delhi)
17. “....The ability to predict is not the only consideration in the
development of theories in accounting” (E.S. Hendriksen).
Do you agree with the above statement? Also state any other
considerations which you consider to be relevant in this
context. (M.Com., Delhi, 1994)
18. Explain briefly how the welfare approach to accounting theory
differs from other approaches. (M.Com., Delhi, 1994)
19. Explain the primary purpose of accounting theory.
(M.Com., Delhi 1992)
20. Define accounting theory. What is the primary purpose of
accounting theory? (M.Com., Delhi, 1991)
21. Discuss the salient features of the ‘ethical approach’ to
accounting theory. What are its limitations? Can exclusive
reliance on this approach lead to development of sound
accounting principles. (M.Com., Delhi)
22. “In the formulation of accounting theory, a hypothesis has
been widely accepted that relates the user of accounting
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information, the relevance of accounting information to
decision making, the decision maker’s conception of accounting
and other available information to the effect of accounting
information on decisions.”
Which accounting theory(s), in your opinion, accomplishes
the hypothesis contained in the above statement? Explain,
giving reasons. (M.Com., Delhi, 1995, 2008, 2012)
23. Mr. Raghavan, a practising accountant for over twenty years
made the following statement:
“In other fields of study, there is no overall theory, so why do
so many accounting theorists want to construct a general
theory of accounting. Attempts to formulate a general theory
is futile and is of no value. After all, we have gotten along
these many years without one, so why do we need one now.”
Comment on Mr. Raghavan’s statement, giving appropriate
explanation. (M.Com., Delhi, 1995, 2007, 2010)
24. “Accounting theory has great utility for improving accounting
practices and resolving complex accounting issues.” Discuss
this statement. (M.Com, Delhi, 1996)
25. “A single general theory of accounting may be desirable, but
accounting as a logical and empirical science is still in too
primitive a stage for such a development.” Hendriksen, Do
you agree with this statement? Explain briefly.
26. What do you understand by the term ‘syntactical theories.’?
Can such theories be tested?
27. Discuss briefly the need for ‘Behavioural theories,’ in
accounting. (M.Com., Delhi, 1997)
28. Explain the main objectives of Accounting Theory. Does it
precede or follow Accounting practice.
(M.Com., Delhi, 1998)
29. Explain decision-usefulness approach. How does it differ from
welfare approach? (M.Com, Delhi, 1999)
30. Hendriksen has classified accounting theories at three main
levels. Discuss them with the help of suitable examples.
31. What do you understand by the term Interpretational theories?
Discuss briefly the role of such theories in the development
of accounting theory. (M.Com., Delhi, 2000)
32. Discuss briefly the major objective of corporate social
accounting approach. What is its relevance in the present day
context? (M.Com., Delhi, 2000)
33. Which method of reasoning would you suggest for the
development of accounting theory? Is it possible to develop
a sound theory of accounting based on any particular method
of reasoning? Explain. (M.Com., Delhi, 2000, 2011)
34. Define accounting theory. What is the primary purpose of
accounting theory? (M.Com., Delhi, 2008, 2012)
35. Discuss decision-usefulness theory in the formulation of
accounting theory. Explain the relevance of ‘Individual User
Behaviour’ and ‘Aggregate Market Behaviour’ in decision-
usefulness theory. (M.Com., Delhi, 2007, 2010)
36. “The ethical approach to accounting theory places emphasis
on the concepts of justice, truth and fairness.” Comment.
37. Distinguish between deductive and inductive reasoning.
38. Explain positive and normative theory. Which theory is
appropriate for formulating accounting theory.
39. Can a positive theory make good predications even though it
may not capture exactly the underlying decision processes
by which individuals make decisions? Explain.
40. Explain methods of reasoning for the development of
accounting theory. Is it possible to develop a sound theory of
accounting based on any particular method of reasoning? Why
or why not? (M.Com., Delhi, 2011)

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