GODFREY HODGSON HOLMES TARCA

CHAPTER 1 INTRODUCTION

Overview of Accounting Theory

What is a theory?
Hendriksens definition: the coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.

Overview of Accounting Theory

What is an accounting theory? Hendriksens definition: logical reasoning in the form of a set of broad principles that provide a general framework of reference by which accounting practice can be evaluated and guide the development of new practices and procedures.

Overview of Accounting Theory

Whether a theory is accepted depends on how:
well it explains and predicts reality well it is constructed both theoretically and empirically acceptable its implications are

Overview of Accounting Theory

Accounting theory is a modern concept compared to mathematics or physics Even Paciolis treatise on double-entry accounting focused on documenting practice and did not explain the underlying theoretical basis for it

Overview of Accounting Theory

The development of accounting theory has been mostly unstructured Chambers: Accounting has frequently been described as a body of practices which have been developed in response to practical needs rather than by deliberate and systematic thinking.

Overview of Accounting Theory

Was developed to resolve problems as they arose reactive Ad hoc approach Led to inconsistencies in practice
e.g. different depreciation methods

Accounting standard setting

Conceptual framework projects have not resolved inconsistency in practice
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Pre-theory (1400s 1800)

Goldberg:
No theory of accounting was devised from the time of Pacioli down to the opening of the nineteenth century.

Pragmatic accounting (1800 1955)

The general scientific period
based on empirical observation of practice provided an explanation of accounting practice focused on the existing viewpoint of accounting

Normative accounting (1956-1970)

Sought to establish norms for the best accounting practice Focused on what should be (the ideal) v. what is

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Normative accounting (1956-1970)

Degenerated into battles between competing viewpoints Two groups dominated:
conceptual framework proponents critics of historical cost

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Normative accounting (1956-1970)

Factors prompting the demise of the normative period include:
the unlikelihood of one particular normative theory being generally accepted the application of financial economic principles the availability of empirical data and new testing methods

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Normative accounting (1956-1970)

The major criticisms of normative theories were:
they do not necessarily involve empirical hypothesis testing they are based on value judgements

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Positive accounting (1950 to the

present day)
A shift to a new form of empiricism called positive theory Had its origins in the general scientific period It seeks to explain the accounting practices being observed

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Positive accounting (1950 to the present day)

Its objective is to explain and predict accounting practice e.g. the bonus plan hypothesis

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Positive accounting (1950 to the present day)

It helps predict the reactions of players, such as shareholders, to the actions of managers and to reported accounting information

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Positive accounting (1950 to the present day)

Major deficiencies are:
wealth maximisation has become the answer to explain all accounting practices and reported information it relies excessively on agency theory and dubious assumptions about the efficiency of markets

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Positive accounting (1950 to the

present day)
Behavioural research:
concerned with the sociological implications of accounting numbers and the associated actions of key players emerged in the 1950s
despite growing acceptance since the 1980s, positive accounting theory still dominates

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Recent developments
Academic and professional developments in accounting theory have tended to take different approaches Academic research focuses on capital markets, agency theory and behavioural aspects The profession has sought a more normative approach what accounting practices should be adopted
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Recent developments

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Recent developments
Conceptual framework resurrected in 1980s
states the nature and purpose of financial reporting Establishes criteria for deciding between alternative accounting practices SACs 14

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Recent developments
Conceptual framework Recent Developments
Joint project between IASB & FASB International harmonisation of accounting practices through a single consistent set of international financial reporting standards (IFRS)

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Recent developments
The conceptual framework underpinning the IFRS favours a move toward
accounting practices that provide information for enhancing decision making by investors and others recognising all gains and losses in the accounting periods in which they occur measurement using exit values

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Content outline
Part 1: Accounting theory (chapters 1 3) Part 2: Theory contributing to practice (chapters 4 10) Part 3: Accounting and research (chapters 11 14)

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Summary
Accounting theory Major periods of accounting theory development Normative accounting Positive accounting Conceptual framework IFRS
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Key terms and concepts

Theory Accounting theory Normative theory Positive theory Behavioural theory Conceptual framework IFRS
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