LECTURE 1

AN INTRODUCTION TO ACCOUNTING THEORY

ARTHIK DAVIANTI, SE. MSI. AK. CA.

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AN OVERVIEW

OVERVIEW OF ACCOUNTING THEORYWhat is a theory? Hendriksen’s definition: …the coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.

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OVERVIEW OF ACCOUNTING THEORYWhat is an accounting theory? Hendriksen’s 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.

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OVERVIEW OF ACCOUNTING THEORYWhether a theory is accepted depends on how:

well it explains and predicts reality well it is constructed both

theoretically and empirically acceptable its implications

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OVERVIEW OF ACCOUNTING THEORY

Accounting theory is a modern concept compared to mathematics or physics

Even Pacioli’s treatise on double-entry accounting focused on documenting practice and did not explain the underlying theoretical basis for it

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OVERVIEW OF ACCOUNTING THEORYThe development of accountingtheory 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.

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OVERVIEW OF ACCOUNTING THEORYWas developed to resolve problems as they arose – reactiveAd hoc approachLed to inconsistencies in practice

e.g. different depreciation methodsAccounting standard setting

Conceptual framework projects have not resolved inconsistency in practice

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HISTORIC FRAME OF ACCOUNTING THEORY

PRE-THEORY (1400S – 1800)Goldberg:

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

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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

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NORMATIVE ACCOUNTING (1956-1970)Sought to establish ‘norms’ for the best accounting practiceFocused on what should be (the ideal) vs what isDegenerated into battles between competing viewpointsTwo groups dominated: conceptual framework proponents critics of historical cost 12

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 observedIts objective is to explain and predict accounting practice

e.g. the bonus plan hypothesis15

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 informationMajor 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 16

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 DEVELOPMENTSAcademic and professional developments in accounting theory have tended to take different approachesAcademic research focuses on capital markets, agency theory and behavioural aspectsThe profession has sought a more normative approach – what accounting practices should be adopted

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RECENT DEVELOPMENTS

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RECENT DEVELOPMENTSConceptual framework – resurrected in 1980s

states the nature and purpose of financial reporting

Establishes criteria for deciding between alternative accounting practices

SACs 1–4Joint project between IASB & FASBInternational harmonisation of accounting practices through a single consistent set of international financial reporting standards (IFRS)

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RECENT DEVELOPMENTSThe 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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