GODFREYHODGSONHOLMESTARCACHAPTER 1 INTRODUCTION

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Overview of Accounting TheoryWhat 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.*

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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

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Overview of Accounting TheoryWhether a theory is accepted depends on how:well it explains and predicts realitywell it is constructed both theoretically and empiricallyacceptable its implications are

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Overview of Accounting TheoryAccounting theory is a modern concept compared to mathematics or physicsEven Paciolis 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 Theory

*Was developed to resolve problems as they arose reactiveAd hoc approachLed to inconsistencies in practicee.g. different depreciation methodsAccounting standard settingConceptual 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.

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Pragmatic accounting (1800 1955)The general scientific periodbased on empirical observation of practiceprovided an explanation of accounting practicefocused 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) v. what is

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Normative accounting (1956-1970)Degenerated into battles between competing viewpointsTwo groups dominated:conceptual framework proponentscritics 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 acceptedthe application of financial economic principlesthe 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 testingthey 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 theoryHad its origins in the general scientific periodIt 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 informationit 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 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 1980sstates the nature and purpose of financial reportingEstablishes criteria for deciding between alternative accounting practicesSACs 14

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Recent developmentsConceptual framework Recent DevelopmentsJoint 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 othersrecognising all gains and losses in the accounting periods in which they occurmeasurement using exit values

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Content outlinePart 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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SummaryAccounting theoryMajor periods of accounting theory developmentNormative accountingPositive accountingConceptual frameworkIFRS

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Key terms and conceptsTheoryAccounting theoryNormative theoryPositive theoryBehavioural theoryConceptual frameworkIFRS

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