Free Essay

Accounting Theory

In: Business and Management

Submitted By akpa
Words 4446
Pages 18
FORMULATION OF ACCOUNTING THEORY: PURPOSE AND APPROACHES

A TERM PAPER (2)
ON
ADVANCED ACCOUNTING THEORY (ACC 821)
PRESENTED BY

EKERIA, Victor
IKYUME, Chiahemba James
OGBOLE, Philip Osemudiamen

SUBMITTED TO
PROFESSOR A.E. OKOYE

DEPARTMENT OF ACCOUNTING
COLLEGE OF BUSINESS AND MANAGEMEN SUDIES
IGBINEDION UNIVERSITY, OKADA

MARCH, 2015

Abstract
As tasks of accounting became more difficult and focus shifted to users’ needs, a theory became necessary. Existence of a need for information for decision making (decision usefulness) in face of information asymmetry led to development of means, tools and techniques for satisfying decision making needs (formulation of accounting theories)
This paper briefly discusses the purpose/importance for accounting theory and various approaches to the formulation of an accounting theory under two headings, namely: (1) traditional approaches, and (2) new approaches. The paper finally highlights the critiques of the accounting theory approaches

Table of Content 1.0.0. Introduction……………………………………………………………………………… 1 2.0.0. Meaning of Accounting Theory………………………………………………………… 2 2.1.0. Needs and Purpose for Accounting Theory…………………………………………….. 3
3.0.0. Early Attempts at Accounting Theory……………………………………………………...3 4.0.0. Approaches to the for Formulation of Accounting Theory……………………………….5 4.1.0. 4.1.0. The Traditional Approaches………………………………………………………..5 4.1.1. Non – Theoretical, Practical, or Pragmatic (Informal) Approaches……............................5 4.1.2. Theoretical Approaches…………………………………………………...........................6
4.1.21. Deductive Approach………………………………………………………………………6 4.1.22. Inductive Approach ……………………………………………………………………….6 4.1.23. Ethical Approach…………………………………………………………….....................7 4.1.24. Sociological Approach…………………………………………………………………….7 4.1.25. Economic Approach……………………………………………………………………….8 4.2.0. New Approaches……………………………………….………………………………….8 4.3.1. The Events Approach……………………………………………………………………...8 4.3.2. The Bahavioural Approach………………………………………………………………..9 4.3.3. The Bahavioural Approach………………………………………………………………..9 4.3.4. The Predictive Approach………………………………………………………………….9 4.3.5. The Positive Approach…………………………………………………...........................10 4.3.0. Critiques of the Accounting Theory Approaches……………………………………….10 5.0.0. Summary/Conclusion…………………………………………………………………….13
References………………………………………………………………………………..14

1.0.0. Introduction

Accountants draw on different images of the accounting process to elaborate different theories of accounting (Al-Aqeel & Fouda). This is clearly evident from some of the images presented below: (i) Accounting as an ideology: Accounting has been perceived as an ideological phenomena –as a mean of sustaining and legitimizing the current social, economic, and political arrangements. (ii) Accounting as a language: Accounting has been perceived as the language of business. It is one means of communicating information about a business. (iii) Accounting as a historical record: Accounting has been viewed as a means of providing the history of an organization and its transactions with its environment (iv) Accounting as current economic reality: The central thesis of advocates of this view is that both balance sheets and income statements should be based on a valuation basis that is more reflective of economic reality than historical costs. (v) Accounting as an information system: Accounting has always been viewed as an information system. It is assumed to be a process that links an information sources or transmitter (usually the accountant), a channel of communication, and a set of receivers (external users). (vi) Accounting as a commodity: Accounting is also viewed as a commodity that results from an economic activity. It exists because specialized information is in demand and accountants are willing and capable of producing it.
Arowoshegbe (2012) views accounting as a service activity, as its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making informed decisions among alternative courses of action.
The primary objective of accounting theory is to provide a basis for the prediction and explanation of accounting behaviour and events. Different approaches have been adopted by accounting researchers and academics to the formulation of accounting theory which is the main thrust of this paper

2.2.0. Meaning of Accounting Theory

A theory is an interrelated set of concepts, definitions and propositions that present a systematic view of some phenomenon (Kerlinger, 1973) as cited Arowoshegbe (2012). According to Baker & Spear (1988: 31) it is "a framework of explanation involving demonstrated hypothesis containing the facts of a unified system purporting to explain natural phenomena." A theory is a systematically organized knowledge applicable in a relatively wide variety of circumstances, especially a system of assumptions accepted as principles and rules of procedure devise to analyze, predict or otherwise explain the nature or behaviour of a specified set of phenomena. Accounting theory, therefore, should be the result of both a process of theory construction and a process of theory verification (Belkaoui, 1992).
Hendriksen (1982) defines accounting theory as a set of broad principles that: (i). provides a general frame of reference by which accounting practice can be evaluated, and (ii). guides the development of new practices and procedures.
This definition allows us to perceive accounting theory, in the views of Belkaoui (1992) as a basis of explanation and prediction. No comprehensive accounting theory exists at the present time. Instead, different theories have been and continue to be proposed in the literature. There are different approaches to the formulation accounting theory and one of them is the regulatory approach. The regulatory approach is an embodiment of accounting

2.1. 0. Needs and Purpose for Accounting Theory
The primary objective of accounting theory is to provide a basis for the prediction and explanation of accounting behavior and events. We assume, as an article of faith, that an accounting theory is possible. A theory is define as a set of interrelated constructs ( concepts ) , definitions , and propositions that present a systematic view of phenomena by specifying relations among variables with the purpose of explaining and predicting the phenomena (Porwal 2012).
To be absolutely able to solve any real world accounting problem, an accountant should have sufficient practical experience helped by adequate theoretical knowledge. Generally accepted accounting principles (GAAP), widely used customs, conventions, doctrines, procedures and postulates constitute accounting theories.
Alan (2015) opines that, accounting theories and rules based are useful because their creation and implementation ensure that these factors are promoted in accounting methods and practices which enhance to provide accurate and consistent information for financial decisions. Al-Jabali (2013) views that, accounting comes from theoretical application in addition to being logically consistent and proportionate importance appears in the following: A. Accounting as a science in desperate need of a framework for a general theory after long practice in the absence of such a theory. B. The existence of these Theoretical assumptions contained therein, including scientific principles and leads to the availability of significant accounting entity, and put it in the ranks of the advanced social sciences. C. The theory Provides assumptions and principles of the foundation upon the selection between alternative systems that can be used in practice. D. Theory contributes to an increase in understanding of the content of users of accounting information and then provides confidence in it. E. Theory contributes to make comparisons when judging the significance of the financial statements. It is the language in which they will be addressed in such a way gives one meaning when used since all concepts used in the field of accounting in general and accounting theory in particular, the concepts agreed upon scientific and must be uniform and free of confusion and ambiguity From the above, we can agree that a theory can be applied into practical areas of interest. An accounting theory makes it easier to understand accounting in a professional way

3.0.0. Early Attempts at Accounting Theory

Historically, there have been three basic approaches to the development of accounting theory. Attention was first directed to the account itself, and attempts were made to construct rules for the operation of accounts. This led to the celebrated personification theories in which the account was ascribed the qualities of a person who received and gave. But an account is not a person, and recognition of this fact directed attention to the transactions and events which are in great part the subject-matter of accounts. This led to attempts to formulate rules and standards designed to ensure that objective economic facts were recorded and reported. It then became clear that accounts contained values other than those represented by transactions and events, and that the very concept of value was subjective. Attention is now directed to the user of accounting, and contemporary accounting research is heavily influenced by such questions as: is it useful? to whom ? is it used ?
The transfer of accounting knowledge from one age to another, and from one part of the world to another was accomplished by writing, teaching, and example. Until the twentieth century however, very little of this involved theoretical explanation separate and distinct from practical instruction. In the absence of an accounting theory, early writers had great difficulty in expressing their objectives, models, and systems. They resorted in most cases to precept and admonition, frequently bolstered by appeals to the deity.
A few writers attempted generalizations which would avoid the necessity to memorize many rules and procedures. One of the earliest devices was the personification theory of accounts. This device imputed personalities to accounts for things, so that they were treated as living persons. Personification permitted the formulation of general rules, such as .debit him that receives; credit him that gives, which appear to have explanatory qualities. Personification took three forms; the attribution of human qualities to inanimate objects, the fiction that each account was a branch of the owner’s personality (e.g. James Smith his goods.) and the construction that the account represented a clerk, who received and gave up value for the proprietor of the business. Of these, the most useful was the second, for it permitted the accounts of a business to be classified into personal accounts, or accounts of persons outside the business (e.g. debtors, creditors) and impersonal or real accounts, or accounts for objects owned by the owner. The former, of course, would be equal and opposite to the personal accounts kept by others, and must therefore conform to general rules. The latter, being peculiar to the particular business, could be handled in different ways.
The rise of the income statement, or profit and loss account, was accompanied by the development of a third class of nominal accounts for revenues and expenses. At this point personification came under severe strain. How does one personify, for example, discounts received or discounts allowed? This, coupled with a growing realization of the artificial nature of the device, led to its abandonment. By the latter part of the nineteenth century explanations were being phrased in terms of transactions. The second generation of theorists was concerned with images of form and structure, and they attempted to explain accounting by demonstrating the effect of accounting entries on these images. 4.2.0. Approaches to the for Formulation of Accounting Theory
Attempts to formulate a generally accepted accounting theory have not succeeded so far because of different assumptions, methodologies and users.
This paper discusses in brief the different approaches to the formulation of an accounting theory under two headings: (1) traditional approaches, and (2) new approaches. It should, however, be understood clearly that these approaches are not independent of one another. Generally, more than one approach, is used in the development of accounting principles 4.3.0. The Traditional Approaches
The traditional approaches includes among others (Oseni, Ireghah & Ali-Momoh, 2011): a. Non – theoretical, practical, or pragmatic (informal) b. Theoretical : i. The Deductive Approach. ii. The Inductive Approach. iii. The Ethical Approach. iv. The Sociological Approach. v. The Economic Approach. vi. The Electronic approach.

4.4.1. Non – Theoretical, Practical, or Pragmatic (Informal) Approaches
The non – theoretical approaches are a pragmatic (or practical) approach and an authoritarian approach. The pragmatic approach consists of construction of a theory characterized by its conformity to real-world practices that is useful in terms of suggesting practical solution. According to this approach, accounting techniques and principles should be chosen on the base of their usefulness to users of accounting information and their relevance to decision making process. Usefulness, or utility, means “that property which fits something to serve or to facilitate its intended purpose”.
The authoritarian approach to the formulation of an accounting theory, which is employed primarily by professional organization, consists of issuing pronouncements for the regulation of accounting practices. Because the authoritarian approach also attempts to provide practical solution, it is easily identified with the pragmatic approach. Both approaches assume that accounting theory and the resulting accounting techniques must be predicted on the basis of 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.

4.4.2. Theoretical Approaches 4.1.21. Deductive Approach
In accounting, this approach begins with basis accounting propositions (Assumptions) and proceeds to derive by logical means the accounting principles. In this approach we go from general to particular. It emphasizes on “what ought to be”. If we assume at this point that the basic propositions about the accounting environment consist of both objectives and postulates, the steps used to derive the deductive approach according to Porwal (2001) will include: i. Specifying the objectives of financial statements ii. Selecting the “postulates” of accounting iii. Deriving the “principles” of accounting iv. Developing the “techniques” of accounting
In a deductively derived accounting theory, therefore, the techniques are related to the principles, postulate, and objectives in such a way that if they are true, the techniques must also be true. 4.1.22. Inductive Approach
In this approach we go from particular to general. On the basis of particular observation and measurement, generalized conclusions are drawn. Applied to accounting, the inductive approach beings with observation about the financial information of business enterprises and proceeds to construct generalization and principles of accounting from these observations on the basis of recurring relationships. It is based on “what is”. Inductive arguments are said to lead from the particular (accounting information depicting recurring relationships) to the general (postulates and principles of accounting). The inductive approach to a theory according to Porwal (2001) involves four stages: i. Reducing all observation. ii. Analysis and classification of these observations to detect recurring relationship (“like” and “similarities”). iii. Inductive derivation of generalization and principles of accounting from observations that depict recurring relationships. iv. Testing the generalizations.
Unlike the deductive approach, the truth or falsity of the propositions does not depend on the propositions, but must be empirically verified. 4.1.23. Ethical Approach

The basic core of the ethical approach consists of the concepts of fairness, justice, equity and truth. Accountants equate “justice” with equitable treatment of all interested parties, “truth” with true and accurate accounting statements without misrepresentation, and “fairness” with fair, unbiased, and impartial presentation. The “fairness” concept implies that accounting statements have not been subject to undue influence or bias. “Fairness” generally implies that the preparers of accounting information have acted in good faith and employed ethical business practices and sound accounting judgment. “Fairness” is a value statement that is variously applied in accounting. “Fairness” is ranked as a basic standard to be used in the evaluation of other standards, because it is the only standard that implies “ethical considerations”. Fairness is a desirable objective in the construction of an accounting theory if whatever is asserted on its basis is logically or empirically verified and it is made operational by an adequate definition and identification of its properties. 4.1.24. Sociological Approach
The sociological approach to the formulation of an accounting theory emphasizes the social effects of accounting techniques. It is ethical approach that centers on a broader concept of fairness-social welfare. Accounting to sociological approach, a given accounting principles or techniques is 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 in making social-welfare judgments. To accomplish its objectives, the sociological approach assumes the existence of “established social values” that may be used as criteria for the determination of accounting theory.

4.1.25. Economic Approach
The economic approach to the formulation of an accounting theory emphasizes controlling the behaviour of macroeconomic 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 “social welfare”, the economic approach focuses on a concept “general economic welfare”. According to this approach the choice of different accounting techniques depends on their impact on the national economic goals. More explicitly, the choice of accounting techniques will depend on the particular economic situation. The general criteria employed in the macroeconomic approach are firstly, that accounting policies and techniques should reflect “economic reality” and secondly that 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.
4.2.0. New Approaches
New approaches have been developed or revised recently, the aims of which are not yet generally accepted by the various interest groups or by the accounting profession in particular. They represent new streams of accounting research that use both conceptual and empirical reasoning to formulate and verify a conceptual accounting framework. (Belkaoui, 1992).
The new approaches include the following; a. Events approach b. Behavioural approach c. Human information processing approach d. Predictive approach e. Positive approach
4.2.1. The Events Approach
The events approach was first explicitly stated after a divergence of opinion among the members of the committee of the American Accounting Association, which issued A Statement of Basic Theory in 1966. The majority to the Committee members favoured the value approach to accounting. Only one member, George Sorter, favoured the events approach.
The value school, also called the user-need school, considers that needs of users to be known sufficiently to allow the deduction of an accounting theory that provides optimal input to the specified decision models. The events approach, on the contrary, suggests that the purpose of accounting is “to provide information about relevant economic events that might be useful in a variety of decision models”. It is up to 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 up to the user to aggregate and assign weights and values to data generated by the event in conformity with his or her own utility function.
4.2.2. The Bahavioural Approach
Most traditional approaches to the construction of an accounting theory have failed to take into consideration user behaviour in particular and behavioral assumptions in general. The behavioral approach to the formulation of an accounting theory is concerned with human behavioural, as it relates to accounting information and problems. In this context, the choice of an accounting technique must be evaluated with references of the objectives and behavior of the users of financial information.
4.2.3. The Bahavioural Approach

Interest in the human information processing approach arose from a desire to improve both the information set presented to users of financial data and the ability of users to use the information. Theories and models from human information processing in psychology provide a tool for transforming accounting issues into generic information processing issues. There are three main components of information processing model-inputs, process, and output.

4.2.4. The Predictive Approach

The predictive approach arose from the need to solve difficult problem of evaluating alternative methods of accounting measurement and from the search for a criterion on which to base the choice between measurement alternatives. Specifically, “the measure with the greatest predictive power with respect to a given event is considered to be the “best method for that particular purpose”.

4.2.5. The Positive Approach
The positive approach to accounting is generally drawn from a well-known essay in which Friedman argues “for distinguishing positive economics sharply from normative economics”. In fact, Friedman credits his distinction between “positive” and “normative” science to Keynes. Positive science may be defined as a body of systematized knowledge concerning what is; a normative or regulative sciences as a body of systematized knowledge relating to criteria of what ought to be, and concerned, therefore with the ideal as distinguished from the actual.
The development of a positive theory accounting will help to explain why accounting is what it is, why accountants do what they do, and what effects these phenomena have on people and resource utilization”. 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 relations to various individuals and to the allocation of resources within the economy.

4.3.0 Critiques of the Accounting Theory Approaches
Looking at Eric (1963) and Hendriksen (1982) definition of accounting theory, two parts of this definition must be qualified with respect to accounting theory. First, theory does not explain all accounting practice. Theory is base on logic, and not all practice is logically conceived. But if the emphasis is placed on the explanation of concepts and results rather than on technique, the definition is generally correct. Secondly, the body of fact being explained by accounting theory can be assumed to be either (1) financial facts as represented in accounting statements, (2) concepts implied in the presentation of accounting data, or (3) economic relationships of firms with other firms, individuals and the economy as a whole as measured and summarized in accounting statement. Of these three, the first- the explanation of financial facts presented by accounts – is not the function of theory.
The events approach offers certain advantages and certain limitations. The advantages predominantly take the form of effects to provide information about relevant economic events that might be useful to a variety of decision models.
The usefulness of events approach may depend, however, on one or more of the following arguments: a. The usefulness of the events approach may depend on the psychological type of the decision maker. It has been shown, for example that structured/aggregate reports are preferable for high-analytic decision makers, but that data-base inquiry systems (the events approach) are preferable for low-analytic decision makers. b. An adequate criterion of the choice of the crucial events has not be developed. c. Measuring all the characteristics of an events approach may prove difficult, given the state of the art in accounting.
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 inference rational factors in the accounting filed. 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”.
One striking criticism of the positive approach was based on following points. a. 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”. b. Contrary to the empirical method of subjecting theories to sever 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 because they usually mark a conservative ideology in their accounting policy implications. The most striking critics of positive accounting theory come from sterling, with his comments that: (i) The two pillars of value-free study and accounting practices are insubstantial, (ii) The economic and scientific support of the theory is mistaken and (iii) The accomplishments have been nil.
Most of the behavioral accounting research discussed in the preceding sections has attempted to establish generalization about human behaviour in relation to accounting information. The implicit objective of all these studies is to develop and verify the behavioural hypothesis relevant to accounting theory hypotheses on the corporate reporting practices, materiality judgments, the decision effects of alternative accounting procedures, and the components of an information processing model (input, process, and output). This implicit objective has not yet been reached.

4. Summary/Conclusion
As tasks of accounting became more difficult and focus shifted to users’ needs, a theory became necessary. Existence of a need for information for decision making (decision usefulness) in face of information asymmetry led to development of means, tools and techniques for satisfying decision making needs (formulation of accounting theories).
Accounting theory goal provides a coherent set of logical principles that form the general frame of reference for evaluation and development of some accounting practice.
Once the objectives of accounting are determined, one or more several approaches to accounting theory must be selected in order to derive logically conceived accounting principles. These objectives however, may be modified with the development of theory but a change in the basic objective might require a reformulation of the entire theoretical structure.
For the sake of clarity this paper briefly discussed the different approaches to the formulation of an accounting theory under two heads: (1) the traditional approaches, and (2) the new approaches and the importance as well as need for accounting theory in practical areas of interest
Conclusively, it is note while to mention that, these approaches are not independent of one another. Generally, more than one approach, is used in the development of accounting principles

References
Alan, A. (2015). Usefulness of accounting theory. Available at www.smallbussiness.chron.com accessed on 26/02/2015
Al-Aqeel, E. & Fouda, A. (nd). The traditional approaches to the formulation of accounting theory: 2nd Semester, 1426-1427 King Saud University College of Administrative Science Department of Accounting
Al-Jabali ,M.A. (2013). Framing accounting theory: Theory theoretical and practical. European Journal of Economics, Finance and Administrative Sciences. ISSN 1450-2275 Issue 57, 2013. Http://www.eurojournals.com/EJEFAS.htm
Arowoshegbe, A.O. (2012). The Regulatory approach to the formulation of accounting theory: The place of the Nigeria Accounting Standard Board. Knowledge Review 25 (1) (Nov. 2013)
Baker, T.B. & Spear, P.D. (1988). Psychology: Perspective on Behavior. New York: John Willey.
Belkaoui, A. R. (1992). Accounting theory. (4th ed), London: Thomson Learning.
Hendriksen, E.S. (1982). Accounting theory. (4th ed), Homewood, Illinois: Richard D. Irwin Inc.
Oseni, A.I., Ireghah, M.M. & Ali-Momoh, B.(2011). Accounting theory formulation as a tool for enhancing international harmonization of accounting standards: Journal of Innovative Research in Management and Humanities, 2(1).
Porwal, L. S.(2001). Accounting Theory: An Introduction, (3th ed). New Delhi Tata M. Graw-Hall Publishing Company Limited.

Similar Documents

Free Essay

Accounting Theory

...How would critical theorists assess research based on the Positive Accounting Theory? Accounting researchers tend to accept current accounting systems. Rather than focusing on why accounting systems favour certain classes of society, research is mainly carried out to such things as what accounting methods are most appropriate in certain circumstances, what motivates managers to use one accounting method over another and disclosure. By looking at accounting with a critical perspective is to recognise the way in which people are in control of capital. The Positive Accounting Theory (PAT) and Legitimacy Theory can be analysed critically for their bias approach of a political and economic perspective disregarding those people without wealth. A critical perspective of accounting is a perspective that critically evaluates the role of accounting in society. It does not consider issues such as what accounting methods should be used in which situations and often views accounting as a major contributor to perceived social problems and inequalities (Deegan, 2001). Critical theorists are those that ignore the whole world of accounting, favouring the interests of those people with wealth of power. However, they focus on the problems in and of society, not debate which methods of accounting should be employed. Accounting to Watts & Zimmerman (1990, page 7) Positive Accounting Theory is concerned with explaining accounting practice. It is designed to explain and predict which firms will...

Words: 454 - Pages: 2

Premium Essay

Accounting Theory

...favor of what the accountant is able to measure and chooses to measure…” (p. 480). Required: Discuss the extent to which the “scientific” world-view of mainstream accounting researchers, is grounded on a belief that “reality” exists independently of thee human subject and the possible implications this has for accounting theory development. Introduction Accounting is a subject that is guided with principles and regulations. Thus, it is often regarded as a rigid, rigorous, and highly analytical discipline with very precise interpretations. However, this is far from the truth. For instance, two organizations that are otherwise homogeneous can apply different valuation methods giving entirely distinct but equally correct answers. One may argue that a choice between accounting schemes is merely an “accounting construct” the sorts of “games” accountants play that are exclusively of relevance to them but have no pertinent in the “real world.” Once again this is entirely false. For example, valuation of inventory using either LIFO (Last-in-last-out) or FIFO (First-in-first-out) has an impact on income tax, especially in the US. Therefore an accounting construct possesses an essential “social reality” i.e. the amount of income tax that is paid. Income tax payments are not the only social reality that accounting numbers affect. Income numbers also influence dividend payments, price of a firm’s stock, the cost of capital as well as salaries and bonuses since it can be used as an...

Words: 1609 - Pages: 7

Premium Essay

Accounting Theory

...Accounting theory without a doubt, has transformed rapidly throughout the years due to changes in society, environment, globalization, and the expansion of various industries, which ties in with the needs for new accounting standards. However, some basic aspects remain the same, for example, the double entry system. These drastic changes throughout the years call for a change in the accounting standards and in order for accounting standards to be fair, efficient, reliable and reflect modern practices researchers require several methods to gain more perspective and a better vantage point on the situation to ensure the best possible accounting standards are created to suit each particular accounting phenomenon. These include the descriptive and prescriptive methods, which are almost exact opposites in theory. Theorists seek to explain phenomena such as asset valuation, the demand and supply of accounting information, and what sort of accounting information should be provided to particular users through these two methods. The aforementioned theories can never be proven so researchers aim to create the best possible standards and answer to these phenomena by shuffling back and forth between methods and provide different perspectives on one subject. Other researchers including Grady, Watts and Zimmerman, Paton, etc. have laid the necessary groundwork and this allows modern researchers to theorize and apply past theories to modern accounting phenomena. Descriptive methods of...

Words: 2133 - Pages: 9

Free Essay

Positive Accounting Theory

...Positive Accounting Theory: A Ten Year Perspective Ross L. Watts and Jerold L. Zimmerman University of Rochester ABSTRACT: This paper reviews and critiques the positive accounting literature following publication of Watts and Zimmerman (1978, 1979). The 1978 paper helped generate the positive accounting literature which offers an explanation of accounting practice, suggests the importance of contracting costs, and has led to the discovery of some previously unknown empirical regularities. The 1979 paper produced a methodological debate that has not been very productive. This paper attempts to remove some common misconceptions about methodology that surfaced in the debate. It also suggests ways to improve positive research in accounting choice. The most important of these improvements is tighter links between the theory and the empirical tests. A second suggested improvement is the development of models that recognize the endogeneity among the variables in the regressions. A third improvement is reduction in measurement errors in both the dependent and independent variables in the regressions. I T is more than a decade since our two papers, "Towards a Positive Theory of the Determination of Accounting Standards" and "The Demand for and Supply of Accounting Theories: The Market for Excuses" were published in The Accounting Review. The intervening time allows us to look back on these papers and the ensuing literature with some perspective. The two papers were...

Words: 273 - Pages: 2

Premium Essay

Positive Accounting Theory

...discussed contributors to the accounting literature of the past decade" (1989, p. 327). They are also the joint founder-editors of The Journal of Accounting and Economics, a journal devoted to positive accounting research, which has achieved an international reputation. So their story, while admittedly controversial, has achieved credibility among a significant number of accounting researchers. But what accounts for that credibility? According to Watts and Zimmerman's (1986) view of science, a theory's credibility will ultimately be a function of explanatory power and predictive capability: "Ultimately the users, who assess alternative explanations' intuitive appeal and bear the costs and benefits of theories' predictions, will determine the success of the theory outlined in this book" (p. 355). And a theory, in their conception, consists of: the assumptions, including the definitions of variables and the logic that relates them, and the set of substantive hypotheses" (1986, p. 9). And since the hypotheses of a theory bear the brunt of empirical testing, the primary concern of the empirical testing of PAT is whether or not the hypotheses can predict accounting practice. Prediction of accounting practice means that the theory predicts unobserved accounting phenomena" (1986, p. 2). More concretely, they mean that PAT can be used to predict which accounting procedures will be chosen by management when management faces a "portfolio" of accepted accounting procedures from which to choose...

Words: 1189 - Pages: 5

Premium Essay

Postive Accounting Theory

...Positive accounting is the branch of academic research in accounting that seeks to explain and predict actual accounting practices. This contrasts with normative accounting, that seeks to derive and prescribe "optimal" accounting standards. The branch of academic research in accounting that seeks to explain and predict actual accounting practices. Positive accounting can be associated with the contractual view of the firm.[1][2] The firm is viewed as “a nexus of contracts” and accounting one tool to facilitate the formation and performance of contracts. Under this view, accounting practices evolve to mitigate contracting costs by establishing ex ante agreement among varying parties. For example, positive accounting postulates that conservatism in accounting –in this sense defined conditionally as requiring lower (higher) standards of verifiability to recognize losses (gains)– has origins in contract markets, including managerial compensation contracts and lender debt contracts. As an example, absent conservatism, managerial compensation agreements may reward managers based on current reports that later evidence indicate were unwarranted. The contractual view of positive accounting puts it in tension with value relevance studies in accounting: the latter contend that accounting’s primary role is to value the firm, and thus practices like conservatism are sub-optimal.[3] The value relevance school emphasizes the usefulness of accounting information to equity investors in contrast...

Words: 700 - Pages: 3

Premium Essay

Positive Theory of Accounting

...Synopsis Positive accounting theory is perceived as a hypothetical study in accounting which helps in clarifying and foreseeing tangible accounting procedures. These theories have a tendency to rationalize why a number of accounting practices are accepted than others. Positive accounting theory was introduced to better apprehend exactly how practices in accounting must be effectively managed. Introduction Modern positive accounting research began flourishing in the 1960’s and other introduce empirical finance method to financial accounting. The subsequent literature adopted the assumption that accounting number supply information for security market investment decision and used the information perspective to investigate the relation between accounting number and stack prices. The information perspective has taught us much about the market’s use of accounting numbers. It was structured as an educational thought of discipline by the efforts of Ross Watts and Jerold Zimmerman which when made known were received with extensive criticism. Summary of the Article Positive accounting can be related with the predetermined opinion of a firm. A firm is regarded as a conception initiative put forth by a number of economists and legal commentators which stresses that corporations are nothing more than a compilation of agreements concerning different parties – mostly shareholders, directors, employees, suppliers, customers and accounting – one tool to expedite the materialization...

Words: 1357 - Pages: 6

Free Essay

Financial Accounting Theory

...number of normative theories of accounting. In doing so we examined conceptual framework projects which prescribe guidelines for how accounting should be done. We then examined a number of normative theories relating to how profit and the elements of our financial statements should be measured. This week we abandon our normative theories and begin looking at positive theories. In particular we examine a positive theory that we have made mention of a number of times, Positive Accounting Theory or PAT. Upon completion of this module you should have: A clear understanding of how a positive theory differs from a normative theory, The origins of Positive Accounting Theory (PAT) The perceived role of accounting in minimizing the transaction costs of an organisation You should understand: How accounting can be used to reduce the costs associated with various political processes How particular accounting-based agreements with parties such as debtholders and managers can provide incentives for managers to manipulate accounting numbers And some of the criticisms of PAT Before we begin our discussion of specific positive theories we should recap on what a positive theory is and how it differs from the normative theories we have examined in the previous two modules. You will recall from module one and the previous two modules that normative theories prescribe how a particular practice should be undertaken. As was evident in our study of current cost accounting and general price...

Words: 455 - Pages: 2

Premium Essay

Positive Accounting Theory

...136 Positive Accounting Theory and Science JCC Journal of CENTRUM Cathedra ™ Positive Accounting Theory and Science by M. Humayun Kabir Senior Lecturer, Faculty of Business Auckland University of Technology, Auckland, New Zealand Abstract This paper examines the development of positive accounting theory (PAT) and compares it with three standard accounts of science: Popper (1959), Kuhn (1996), and Lakatos (1970). PAT has been one of the most influential accounting research programs during the last four decades. One important reason which Watts & Zimmerman (1986) have used to popularize and legitimize their approach is that their view of accounting theory is the same as that used in science. Thus, it is important to examine how far accounting has been successful in imitating natural science and how the development of PAT compares with the three standard accounts of science. This paper shows that accounting could not emulate the success of natural science. Further, the methodological positions of PAT conform to none of the standard accounts of science. Rather, PAT contains elements of all three. Finally, this paper identifies some methodological gaps in PAT. Keywords: Positive Accounting Theory, Philosophy of Science, Methodological Controversies Acknowledgements I would like to thank two anonymous reviewers of the journal for their helpful comments. Earlier versions of this paper benefited from comments from Lee Parker of the University of South Australia, Keith...

Words: 9637 - Pages: 39

Premium Essay

Postive Accounting Theory

...examines the development of positive accounting theory (PAT) and compares it with three standard accounts of science. There is some confusion about what PAT is. If the definition of accounting theory (i.e., accounting theory seeks to explain and predict accounting and auditing practice) given in Watts and Zimmerman’s 1986 book is taken to mean PAT, studies of accounting choices and auditing practices constitute PAT. At the same time, they also seek to explain the economics-based empirical literature in accounting and they describe, in addition to accounting choice studies, capital market-based accounting research. They point out that Ball and Brown (1968) initially popularized positive research in accounting, suggesting that PAT includes both capital market-based accounting research and research in accounting choices. This paper takes PAT to include both research programs. This usage is consistent with Watts and Zimmerman’s (1986) assertion that when they use the term “positive” to differentiate it from “prescriptive” theory. Positive Accounting Theory and Science by M. Humayun Kabir Senior Lecturer, Faculty of Business Auckland University of Technology, Auckland, New Zealand Abstract This paper examines the development of positive accounting theory (PAT) and compares it with three standard accounts of science: Popper (1959), Kuhn (1996), and Lakatos (1970). PAT has been one of the most influential accounting research programs during the last four...

Words: 6941 - Pages: 28

Premium Essay

Accounting Theory

...Contemporary issues in Accounting Unit Code: ACCOO106 Assignment -1 Subject: Normative accounting theory To: Mr Khalid Mahmood Name: Muhammad Mehedi Alam ID: 21562675 Word count: 1145(reference excluded) Date of Submission-07/12/09 Normative accounting theories CPPA- current/constant purchasing power accounting CCA- current cost accounting CoCoA- continuous contemporary accounting Current purchasing power accounting a form of accounting that measures profit after allowing for the maintenance of the purchasing power of the shareholders' capital. ‘There are various prescriptive theories of accounting that were advanced by various people on the basis that historical cost accounting has too many shortcomings, particularly in times of rising prices’ (Page 83 Chapter 4). | Theory and Purpose of |CPPA |Maintain purchasing power |Adjustments to income | |accounting | | | | |Measure of non-monetary |HC (historical cost) |historical cost accounts adjusted for |Holding gain/loss on net monetary | |assets’ value | |changes in the purchasing power of the |assets/liabilities only recognised in | | | |dollar (not recognise in PNL) |PNL ...

Words: 1299 - Pages: 6

Premium Essay

Positive Accounting Theory

...The Positive Theory of Accounting Outline In the text, Scott defines Positive accounting theory (PAT) as: “concerned with predicting such actions as the choices of accounting policies by firms and how firms will respond to proposed new accounting standards.” (263) PAT uses theory to predict the choices that management will make regarding their choice of accounting policies. This theory is introduced as a way to merge efficient securities markets with economic consequences. PAT takes the view that firms will conduct themselves in the way that maximizes their own best interests. Managers do not always do what is best for shareholders, but what will be the most beneficial to their organization. The choices that an organization makes are dependent on what industry they are in, and the factors within that industry An organization can be portrayed by the contracts it enters into. A firm’s contracts with employees, suppliers, lenders, and shareholders are central to its operations. The organization is inclined to keep these contract costs as low as possible. PAT emphasizes that an organization’s choice of accounting policies is motivated by keeping contract costs down. PAT does not propose that organizations completely identify what accounting policies they will use. Such specification is costly to commit to, and does not give management the opportunity to respond to unforeseen circumstances. Managers have flexibility to choose from a set of accounting policies, and...

Words: 1003 - Pages: 5

Premium Essay

Accounting Theory Is Useful

...usefulness of accounting theory is evident at various levels within the accounting profession and society in general including, standard setters, accounting professionals and users of accounting information. This essay will address two key areas, firstly, a personal reflection on this course and why studying theory is essential for practicing accountants. The second part is a critical evaluation of the conceptual framework and why it is an essential part of accounting literature. Areas evaluated include the purpose and benefits of a conceptual framework, a brief history of it in Australia, principle based versus rules based standards and some criticisms of it are discussed. Personal reflection I must admit, when scrolling through the list of courses I have left to complete my degree Accounting Theory did not jump out as one I was eager to enrol in. This is in no small part due to my lack of appreciation of how knowledge of the development of theory can give context and power to understanding changes. Whereas before I was more about practice and ‘getting it done’, it has become apparent that theory generally is an intrinsic element in advancing our understanding of our environment, culminating in improvements in practice. It is not a means of simply explaining or predicting behaviour, nor is it there only to serve as a framework for further inquiry (although these are important benefits of theory). Theory has a much more significant and elegant role to play in accounting than simply...

Words: 3910 - Pages: 16

Premium Essay

Accounting Theory

...From Sheet of Accounting Theory Difficulties in Segment Reporting * Base of Segmentation: in case of complex business, it’s difficult to select a base for organization as well as difficult to compare. * Allocation of Common Costs: Common costs are likely to be allocated, bringing segment information into question * Pricing Inter-segment Transaction: No specific method for inter-segment pricing, different method use for cost, cost plus market price and negotiable price. * Costs of Segment Disclosure: Increased competition may result segmental disclosures where profitable segment may attract competitors, & loss making segment arise the take over situation. Foreign companies are not required to provide segmental reports. * Management Conservatism: Management determination of segments implies that what is useful to management is useful to investors. FASB’s 5 possible objective for interim reporting: 1. To estimate annual earnings 2. To make projections 3. To identify turning points 4. To evaluate Management Performance 5. To supplement the annual Report. Problems in Interim Reporting * Accounting Problems: * Inventory Problems: There are three types of problems; * Determination of Inventory quantities * Valuation of inventories * Adjustment of valuation * Matching principle: Business operations are not similar throughout the year. Resources are acquired & output may be sold & there are many...

Words: 1926 - Pages: 8

Premium Essay

Positive Accounting Theory

...It is implied by the positive accounting theory that managers base decisions based on personal or organizational objectives such as higher compensation or increased implementation of corporate governance procedures (Mattessich 2007). The two standard setting bodies try to implement policies in order to ensure better reliability and transparency of financial statements relevant to specific managers applying these standards. The two bodies set standards to improve accounting practice in their respective regions so they act on improving areas of corporate governance. Decision usefulness deals with the process of decision making based on accounting theories, concepts and principles. This theory involves the development of procedures that can be applied to make decisions in a useful manner (Cyert and DeGroot 1987). The standards proposed by both standard setting bodies entail a thorough process and involve significant research to make standards more useful to accountants, investors, shareholders and other users of financial statements in the decision making process. The moral hazards in accounting are concerned with risks between two parties when one party is not willing to work honestly or in a trustworthy manner (Wessels 2006). If any of the standard setting bodies does not want to apply same techniques and strategies in issuing standards then the other board is subject to moral hazards or risks. Measurement approaches deal with measurement of several items based on hypothetical...

Words: 257 - Pages: 2