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PPT TAK Chapter 1
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GODFREYHODGSON
HOLMESTARCA
CHAPTER 1 INTRODUCTION
Overview of Accounting Theory
What 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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What 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 Theory
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
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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 Theory
The 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 Theory
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• 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
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 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 1–4
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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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