CHAPTER 1

INTRODUCTION TO
ACCOUNTING THEORY
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Historical development of Accounting

Early history of Accounting (b)
Dating back 3000 BC
Chaldean-Babylonian, Assyrian & Sumerian civilization
Organized government, oldest government, oldest written language
Egyptian civilization pivots on which the whole machinery of the
treasury and others departments turned
Chinese civilizations, accounting playing a key & sophisticated role
during Chao Dynasty (1112 256 BC)
Greek civilization, Zenon introduce system of responsibility accounting.
Roman civilization law requires taxpayers to prepare statement of
financial position, civil right = property declare by them
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The Italian Method

1340 i.e.. development of commercial republic of Italy, used
double entry bookkeeping method
Medieval (belonging to middle age) accounting i.e. tools for
management control as describes by Raymond de Rover;
Balancing of the books as primary objective
Developing cost accounting
Introducing reserves
Adjustments (accruals & differed items)
Audited financial statement
But little progress in analysis of financial statement
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Luca Pacolis Contribution

Franciscan monk, 1494 wrote the 1St book, Summa de Arithmetica
Geomatrica, Proportioni et Proportionalita (Review of Arithmetic,
Geometry & Propotions) (he didnt invent double-entry bookkeeping)
2 chapters, de Computis et Scripturis, describing double entry
bookkeeping,
Know as the method of Venice or the Italian method
He stated;
purpose of bookkeeping was to give the trader without delay information as to
his assets & liabilities
All entries has to be double entries, that is, if you make one creditor, you must
make someone debtor
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Not only was the name of buyer or seller recorded, as well as the
description of the goods with its weight, size or measurement, price and term of
payment
The receive or disburse, the record was shown of the kind of currency and its
converted value.

He advice the computation of periodic profit and the closing of

the book;
it is always good to close the book each year, especially if you
are in a partnership with others. Frequent accounting makes for long
friendship

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Development of accounting

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Pragmatic Accounting
18001955
General scientific period
theory based on observations of practice rather
than deductive logic that is critical in current practice.
Overall framework to explain why accountants
account as they do
Wall Street Crash (1929), lead to creation of Securities
& Exchange Commission
Lead to improve financial regulation & reporting
1930s give rise to several notable accounting
publications (A Tentative Statement of Accounting
Principles affecting corporate reports)
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relevance of accounting history

Important to accounting pedagogy (method & instruction), policy & practice.
Pedagogy
Educated the members to appreciate intellectual heritage
Advance in thought, major contribution to literature, & of crucial study maybe
lost, fragmented, or inadequately recognized in longer term unless they are
documented and incorporated by scholars
Incomplete or unjustified claim about the past

Policy
Better understanding on accounting problems & their institutional context as
well as the formulation of the public policy

Practice
Better assessment of the existing practice by a comparison method used in
the past.
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 betterto understand our present & to forecast or control

our future.
Accounting history is the study of the evolution in
accounting thought, practices & institutions in response to
changes in the environment & social needs. It also
considers the effect this evolution has worked on the
environment
Historical research, includes biography, institutional history,
development of thought, general history, critical theory,
taxonomic & bibliographic database.

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 In 1938 AICPA released A statement of Accounting

Principles
Development in accounting research, the theories
to explain practice become more detail and
complex

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Introduction to Accounting Theory

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Definition of Accounting
Belkaoui (2004);
Accounting is the art of recording, classifying, & summarizing in a
significant manner & in terms of money, transactions, & events which are,
in part at least, of a financial character, & interpreting the result thereof.
(AICPA)

From broader perspective;

The process of identifying, measuring, & communicating economic
information to permit information judgments & decisions by user of
information

Quantitative information;
Accounting is a service activity. Its function is to provide quantitative
information, primarily financial in nature about economic entities that is
intended, to be useful in economic decisions, in making resolve choices
among alternative course of action.
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From the definition;

Accounting: an art or science?
Accounting deals with enterprise, which are certainly social
groups;
It is concerned with transactions & other economic events
which have social consequence & influence societal
relationship;
It produces knowledge that is useful & meaningful to human
beings being engaged in the activities having social
implications;
On the basis of the guidelines available, accounting is a
social science.
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What is an accounting theory?

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Definition of Theory
Popper, K (1968) ,The Logic of
Scientific Discovery-emphasizes
empirical nature of the theory rather
than logicalTheories are nets cast to catch what we
call the world, to rationalize, to explain
and to master it
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 Hendriksen (1970):
1the coherent set of hypothetical,
conceptual and pragmatic principles
forming the general framework of
reference for a field of inquiry.
2logical reasoning in the form of a set
board principles(1) provide a general
framework of reference by which acctg
practices can be evaluated and guided
the development of new practices and
procedures.
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McDonald argues that a theory

must have three elements:
1. encoding of phenomena to symbolic
representation
2. manipulation or combination
according to rules
3. translation back to real-world
phenomena

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 Belkaoui (2000)
..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.

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Accounting Theory Classification

Godfrey et. al. (2010), classified
accounting theory as:
Theory as Language
Theory as Reasoning
Theory as Script

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A. Theory as Language
As language as business
Three question that should asked
about language, word, phrases
What effect will the words have on
listeners?
What meaning, if any, do the words
have?
Do the word make logical sense?
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 Pragmatics study of the effect of

language
Semantics-the study of the meaning
of language
Syntactic the study of the logic or
grammar of the language

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i. Pragmatics
This relation pertains to the effect of words
or symbols on people
How acctg concepts, and their real world
corresponding events or objects, affect
people behaviour.
How people react to the same message in
different way-acctg standard-support &
lobbying
The relation of signs to users of those
signs
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Accounting should provide

useful information for decision
making to certain interested
parties

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Pragmatic theories
Descriptive pragmatics
observe behavior of accountants
no logical assessment of actions
does not allow for change

Psychological pragmatics
observe reactions of users

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ii. Semantics

(the study of meaning)

Concern the relationship of word,

sign or symbol to a real world object
or event
It is established in relation to
individual premises and the
conclusion, but not to the line of
the logic( argument) which can only
be assessed for validity
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Premise 1:
Premise 2:
account.
Conclusion:
balance.

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All asset accounts have debit balances.

The sales returns account is not an asset
The sales returns account has a debit

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iii.Syntactic (A systematic orderly arrangement)

Rules of the language employed
Refer to rules of grammar &
mathematics
Analytical methodology basically
relied upon syllogism (deductive reasoning in which a
conclusion is derived from two premises)

If the combination of premise is valid, so

the conclusion was also true.
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Premise 1: All accounts relating to assets have debit

balances.
Premise 2: The accumulated depreciation account relates
to assets.
Conclusion: The accumulated depreciation account has a
debit balance.

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B. Theory as Reasoning
The debate whether the theory is
argument flow:
General to specific (deductive).
Acctant usually deduce acctg principles
or postulates to provide concrete
applications or rules
Specific to General (inductive).
Acctg principles are induced from the
best current practice.
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i. Deductive Reasoning
Example,
P1: All asset accounts have debit
balances.
P2: The cash account is an asset account
C : The cash account has a debit balances

Objective are important part of

deductive process. P1 & P2 are more
generalize. C is more specifically to
cash account.
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 Advantages of the method;

If postulates or premises is false,

conclusion may also false
To provide the basis for practical rules.

The main objective of theory to provide a

framework for the development of new ideas or
new procedures and to help making choices
among alternative procedures.

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ii. Inductive Reasoning

Arguments begins with a set of a particular
examples, claim that it will representative of
some greater whole, then infer some
generalization about that whole.
Advantages;
Not necessarily constrained by a structure
Free to make relevant observation
Disadvantages
Influenced by the idea of relevant
relationship/observed
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 Example,
P1: The cash account is an asset account and has
a debit balance.
P2: The Vehicles account is an asset account and
has a debit balance.
P3: The land account is an asset account and has
a debit balance.
C : All asset accounts have debit balances
P1, P2, &P3 is so specific for each account. C is
generalization from all P.
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C. Theory as Script
The theory may be
To set forth and explain what and how
financial information is presented and
communicated to users of acctg data
(descriptive or positive)
To prescribed what data ought to be
communicated and how they ought to
be presented. (prescriptive or
normative)
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i. Normative (prescriptive)
1950s & 60s
Explain more on what should be
done rather than what is i.e.
analyzing & explaining accepted
practice
Attempts to discover the best way of
accounting for a transaction & useful
in making decision.
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ii. Positive (descriptive)

1970s
More on the inductive theory nature
Attempts to discover how
management and others decide
which is the best way for them.
More on explanation on what and
how, testing assumptions made by
normative theories.
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TESTING A THEORY
Criteria of truth
Dogmatic basis
believe what we read

Self-evident basis
Reasonableness

(determine the truth, e.g.

accounting must using market price)

Scientific basis
Syntactic

(logical reasoning)

and

induction (refer

to empirical evidence)

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 Criteria of truth
Scientific basis
Popper (try & error: hypothesis & proposition) and
falsification (all hypothesis must be capable of
falsification, if no; there is no informative & doesn't not add
to scientific progress)

Research programs

(encourage discovery of
solutions, involving try & error, able to change)

Kuhnian paradigms, or disciplinary

matrices (dominance of one paradigm, competing
school of thought)

Feyerabends approach

(Society are too complex:

good scientist is one who prepares to develop & accepted
inconsistent ideas & theories)

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Accounting Theory Approach

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THE NATURE OF ACCOUNTING THEORY

APPROACH
The primary objective of accounting
theory is to provide a basis for the
prediction and explanation of
accounting behavior and events.
No single comprehensive theory of
accounting exists at present.

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 theory defined as:a set of inter-related constructs

(concept), definitions and propositions
(suggestions) that present a systematic view
of phenomena by specifying relations
among variables with the purpose of
explaining
and
predicting
phenomena.
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 The General Acceptance of Accounting

Principles (GAAP) guide the acctg profession
to choose acctg techniques and prepare FS
considered to be good acctg practice
(normative approach)

The GAAP are subjected to the reexamination

& critical analysis with regards to the changes
in environments, values and information
needs.
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 Changes in principles may occur as a result of

providing solutions to emerging accounting
problem and formulating a theoretical framework.
Provide a rationale for what accountants do or
expect to be doing.
The process of theory construction should be
completed by theory of verification or
validation.
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 Machlup (1955) defined the process:

The statement implies that the theory should
be subject to a logical or empirical testing
to verify its accuracy.
If the theory is mathematically based, the
verification should be predicted based on logical
consistency. (PAT)

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If the theory is based on the physical and

social phenomena, the verification based
on the deduced events & observations in 44
the real world.

 Therefore, acctg theory should result from

both process of theory construction and
verification(reinforce the idea)
A given theory should explain and predict the
acctg phenomena.
If a given theory is unable to produce the
expected results, it is replace by a better
theory.
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APPROACH IN ACCOUNTING THEORY

1
2
3
4
5
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The
The
The
The
The

Traditional Approach
Regulatory Approach
Positive Approach
Behavioral Approach
Paradigm Approach
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Traditional approaches to accounting

theory
1. Non-theoretical, practical or pragmatic
(informal)
2. Theoretical:
a. Deductive approach
b. Inductive approach
c. Ethical approach
d. Sociological approach
e. Economic approach
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1. Non-theoretical approaches (P&A)

The pragmatic approach:

consists of the construction of a theory that
conforms to real-world practices and suggests
practical solutions
Means that property which fits something
to serve or facilitate its intended
purposes
usefulness to users & relevance for decision
making

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The authoritarian approach:

The formulation of AT, which is employ
primarily by professional
organization, consists of issuing
pronouncements for the regulation of
accounting practices

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 Both approach assume AT (pragmatic

& authoritarian) & the resulting
technique must be predicted on the
basis ultimate use of financial
reports, if accounting is to have
useful function.
A theory without practical
consequence is a bad theory.
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 However;
The approaches have been largely
unsuccessful in reaching satisfactory
conclusions in their attempt to construct
an AT.
For example; balance sheet approach &
profit-oriented; pragmatic & authoritarian
approach absence on theoretical
foundation.
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2. The Deductive Approach

Constructions of AT theory begins
with basic propositions & proceeds to
derive logical conclusions about the
subject under considerations.
Move from general to particular

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Steps used to derive the

deductive approach
1. Specifying the objectives of
financial statements
2. Selecting the postulates of
accounting
3. Deriving the principles of
accounting
4. Developing the techniques of
accounting
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3. The Inductive Approach

The construction of theory begins
with observations & measurements &
moves toward generalized
conclusions.
Lead to Positive approach

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Involved four stages, i.e. :1. Recording all observations

2. Analysing and classifying these
observations to detect recurring
relationships
3. Inductive derivation of
generalisations and principles of
accounting from observations that
depict recurring relationships
4. Testing the generalisations
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Comparing deductive and inductive

approaches
In the inductive approach, the truth or falsity of
the propositions does not depend on other
propositions, but must be empirically verified
In the inductive approach the truth of the
propositions depends on the observation of
sufficient instances of recurring relationships
Accounting propositions that result from inductive
inference imply special accounting techniques
only with high probability
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 Note;
The general proposition formulated
through inductive process
Principles & technique from deductive
process
e.g.; Paton (deductive theorist) &
Littleton (Inductive theorist)

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4. The Ethical Approach

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The basic core consists of the concepts of

fairness, justice, equity and truth
In general, the concept of fairness
implies that accounting statements have
not been subject to undue influence or
bias
Justice; equitable treatment of all
interested parties
Truth; with true & accurate accounting
without misreprsentation
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For example:

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The committee on auditing procedures refers to

concept of fairness of presentation as:
1. conformity with GAAP
2. disclosure
3. consistency
4. comparability

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5. The Sociological Approach

Emphasizes the social effects of
accounting techniques
According to this approach, a given
accounting principle or technique is
evaluated for acceptance on the
basis of its reporting effects on all
groups in society
Implies that accounting data will be
useful in making social welfare
judgments
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 Evolution to new accounting sub

discipline, socioeconomic accounting
The main obj encourage business to
account their impact on business
activities on social environment through
measurement, internalization, &
disclosure in their FS.
Probably play a major role in future
formulation of AT.
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6. The Economic Approach

Emphasizes controlling the behavior of macroeconomic
indicators that result from the adoption of various
accounting techniques
The choice of different accounting techniques depends on
their impact on the national economic good
Accounting policies and techniques should reflect
economic reality, and the choice of accounting
techniques should depend on economic consequences
e.g. LIFO method during continuing inflation period
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The Eclectic (combination) Approach to the

Formulation of Accounting Theory

In general, the formulation of

accounting theory and the
development of accounting principles
have followed an eclectic approach.
a combination of approaches,
rather than just one approach.

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CONTINUE TO SECOND
APPROACH..
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THE REGULATORY
APPROACH

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 Acctg standards dominate accountants work.

Standards are being constantly changed, deleted
and/or added.
They provide practical & handy rules for the
conduct of the accountants work.
They generally accepted as firm rules, backed by
sanction for nonconformity.
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Accounting standards usually

consist of three parts:
1. a description of the problem to be
tackled
2. a reasoned discussion on ways of
solving the problem, then,
3. in line with the decision or theory, the
prescribed solution
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Why Examine Theories of Regulation

Better placed to understand why some
accounting prescriptions become part of
legislation while others do not
accounting standard-setting is a very political
process
while some proposed requirements may be
technically sound and logical, they may not be
mandated due to political power or influence of
some affected parties
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Theories to Explain Regulation

Public interest theory
Capture theory
Economic interest group theory
(private interest theory)

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1.Public Interest Theory

Regulation put in place to benefit society as a
whole rather than vested interests
regulatory body considered to represent
interests of the society in which it operates,
rather than private interests of the regulators
assumes that government is a neutral arbiter

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Criticisms of Public Interest Theory

Critics question assumptions that economic
markets operate inefficiently if unregulated
question the assumption that regulation is
virtually costless
others question assumption of government
neutrality
argue that government will only legislate and
groups will only lobby for regulation if it will
increase their own wealth
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 The regulated seeks to take charge

(capture) the regulator
seek to ensure rules subsequently
released are advantageous to the
parties subject to regulation
although regulating initially in the
public interest, difficult for regulator
to remain independent
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2. Capture of Accounting StandardSetting

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Walker (1987) analysed capture of Australian

standard-setting through the ASRB. Argued
that:
the accounting profession lobbied before
the board established to ensure no
independent research capability, no
academic as chair, to receive admin officer
not a research director
priorities only set after consultation with
AARF
ASRB fast-tracked AARF submissions but
not others
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majority of board membership were

Criticisms of Capture Theory

No reason to suggest that regulated
industry the only interest group able to
influence the regulator
No reason why regulated industries only
able to capture existing agencies rather
than procure the creation of an agency
No reason why regulated couldnt
prevent creation of the regulatory
agency
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3. Economic Interest Group Theory

Assumes groups will form to protect
particular economic interests
groups are often in conflict with each other
and will lobby government to put in place
legislation which will benefit them at the
expense of others
no notion of public interest inherent in the
theory
regulators (and all other individuals)
deemed to be motivated by self interest
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Economic Interest Group Theory

cont.
The regulator is not a neutral arbiter
but is seen as an interest group itself
regulator motivated to ensure re-election
or maintenance of its position of power
regulation serves the private interests of
politically effective groups
those groups with insufficient power will
not be able to effectively lobby for
regulation to protect its own interests
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Examples - Application to Accounting

Standard-setting
Industry groups may lobby to accept or
reject a particular accounting standard
eg. insurance oil & gas industry
large politically sensitive firms found to lobby
in favour of general price level accounting in
US (led to reduced profits)
accounting firms lobbying to protect their own
interests

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Accounting Regulation as an output

of a Political Process
The view that financial accounting should
be objective, neutral and apolitical can be
challenged
will inevitably be political as it affects
wealth distribution within society
standard-setters encourage affected
parties to make submissions on drafts of
proposed standards
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 If standard-setters give consideration to views

in submissions, accounting standards and
therefore financial reports are the result of
various social and environmental
considerations
tied to the values, norms and expectations
of the society in which standards are
developed
questionable whether financial accounting
can claim to be neutral and objective

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 Compliance with accounting standards

usually seen to indicate financial statements
are true and fair ???
can accounts based upon standards
determined from various economic and social
consequences be deemed to be true?

Users may not be aware that financial reports

are the outcome of various political pressures
should regulators consider preparers views
given that standards are designed to limit
what preparers do?
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Influence of the Accounting Profession

on Standards
Standards that do not have support from
accountants and/or the business community
could result in:
1. lobbying by particular interest groups
2. non-compliance
3. refusal of companies to contribute to or
participate in the standard-setting process
4. threat of governmental regulatory
intervention

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It is in the AARFs best interests to issue

standards that are accepted by the business
community and the accounting profession

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Private-sector Regulation of Accounting

Standards
Advantages
The AASB is responsive to various
constituents
The AASB attracts as members people who
possess the necessary technical knowledge
to develop and implement alternative
measurement and disclosure systems
The AASB is successful in generating a
reasonable amount of response from its
constituency base and in responding to this
input
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Disadvantages
The AASB lacks statutory authority and
faces the challenge of being overridden by
government
The AASB has been accused of lacking
independence from dominating interests,
such as the accounting profession
The AASB has often been accused of
responding too slowly to major issues that
are of crucial importance to some of its
constituents
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Arguments in favor:
The ASIC acts as creative irritant and as a
catalyst for change, since the private sector
and market forces do not provide the
leadership necessary to effect such change
The structure of securities regulation
established by the 1991 Corporations Law
serves to protect investors against perceived
abuses
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 The ASIC is motivated by the desire to

create a level of public disclosure deemed
necessary and adequate for decision
making
Unlike the AASB, the ASIC is secured
greater legitimacy through its statutory
authority
Private-sector objectives may sometimes
contradict the public interest.
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Arguments against:
There is a high corporate cost for
compliance with government regulation of
information
Bureaucrats have a tendency to maximise
the total budget of their bureau
There is the danger that standard setting
may become increasingly politicised
Government regulation backed by police
power may hinder the conduct of research
and experimentation of accounting policy
and is not essential to achieving
standardisation of measurement

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Accounting Standards Overload

Too many standards
Too detailed standards
No rigid standards, making selective application
difficult
General-purpose standards fail to provide for
differences in preparers, users and CPAs needs
General-purpose standards fail to provide for
differences between:
public and non-public entities
annual and interim financial statements
large and small enterprises
credited and non-audited financial statements
Excessive disclosures and/or complex
measurements
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Effects of Accounting Standards

Overload
Accountants may lose sight of their real jobs
because of the excessive data required to
comply with standards
Audit failures may result because the
accountant may forget to perform basic audit
procedures
The proliferation of complex accounting
regulations may lead to non-compliance

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Solutions to the Standards Overload

Problem
The AICAP Special Committee on Accounting
Standards evaluated the following possible
approaches:
no change
a change from the present concept of a set
of unitary GAAP for all businesses, to two
sets of GAAP
change GAAP to simplify application to all
business enterprises
establish differential disclosure and
measurement alternatives
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The Positive Approach

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 The subject matter of positive

approach is:
existing accounting practices
managements attitudes towards those
practices

Proponents of the positive approach

argue that the techniques can be
derived from and justified on the basis
of their tested use, or that
management plays a central role in
determining the techniques to be
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 Basic subject matter:

information is an economic commodity
acquisition of information amounts to a problem
of economic choice

Accounting information is evaluated in terms

of its ability to improve the quality of the
optimal choice in a basic-choice problem
that must be resolved by an individual
The information system with the highest
expected utility is preferred
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Positive theory of accounting

The positive theory of accounting
is based on the propositions that
managers, shareholders and
regulators/politicians are rational
and attempt to maximize their
utility
Their choice of accounting policy
rests on comparing the relative
costs and benefits of alternative
accounting procedures so as to
maximize their utility
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The central ideal of the positive approach

1. To enhance the reliability of prediction,
based on the observed smoothed series
of accounting numbers along a trend
considered best or normal by
management
2. To reduce the uncertainty resulting from
the fluctuations of income numbers in
general and the reduction of systematic
risk in particular by reducing the
covariance of the firms returns with
market returns
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The central problem in positive

theories
The central problem is to determine how
accounting procedures affect cash flows,
and therefore managements utility
Theoretical assumptions guiding resolution
of the problem are:
the agency theory evolves to a view of the firm
as a nexus of contracts
given this nexus of contracts perspective, the
role of accounting information is to monitor and
enforce these contracts to reduce the agency
costs of certain conflicts of interest
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The agency problem (dominant theory in positive approach)

The basic agency problem is enriched

by different options concerning:
1. the initial distribution of information and
beliefs
2. the description of the number of periods
3. the description of the firms production
function in terms of:
amount of capital supplied by the
principal
agents level of effort
an exogenously determined, uncertainstate realisation
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4. the description of the feasible set of

actions from which the agent chooses
5. the description of the labour and
capital markets
6. the description of the feasible set of
information systems
7. the description of the legal system that
specifies the type of behavior that can
be legally enforced, and what is
admissible evidence
8. the description of the feasible set of
payment systems
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9. the description of the solution to the

basic agency model
10.the role of self-interest
11.the solution concept and the nature
of optimality

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Income smoothing
Propositions on income smoothing
1. The criterion a corporate management
uses to select among accounting
principles is the maximisation of its
utility or welfare
2. The utility (effectiveness) of management
increases with:
job security
the level and rate of growth in
managements income
the level and rate of growth in the
corporations size
99
99

3. The achievement of the

management goals stated in
proposition to depends in part on
the stockholders satisfaction with
the corporations performance
4. Stockholders satisfaction increases
with the average rate of growth in
the corporations income

100
100

The Behavioural Approach

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101

 Most traditional approaches accounting theory

construction have failed to consider user behavior
in particular and behavioral assumptions in
general
The behavioral approach to accounting theory
formulation emphasizes the relevance to decisionmaking of the information being communicated,
and of the individual and group behavior caused
by the information being communicated
The behavioral approach to accounting theory
formulation is concerned with human behavior as
it relates to accounting information and problems

102
102

 A new multidisciplinary area in the field

of accounting has been conveniently
labeled behavioral accounting
The basic objective of behavioral
accounting is to explain and predict
behavior in all possible accounting
contexts

103
103

Behavioural effects of accounting information

A more recent and exhaustive attempt by

Dyckman, Gibbins and Swieringa illustrates
the nature of studies of the behavioral
effects of accounting information

We may divide these studies into five

general classes:

1.
2.
3.
4.
5.
104

adequacy of disclosure
usefulness of financial statement data
attitudes about corporate reporting practices
materiality judgements
linguistic effects of alternative accounting
procedures
104

(1) Adequacy of disclosure

Three approaches were used to examine

the adequacy of disclosure:
1. the first examined the patterns of use of data
from the viewpoint of resolving controversial
issues concerning the inclusion of certain
information
2. the second examined the perceptions and
attitudes of different interest groups
3. the third examined the extent to which
different information items were disclosed in
annual reports and the determinants of any
significant differences in the adequacy of
financial disclosure among companies
105

105

 The research on disclosure adequacy

and use showed:
general acceptance of the adequacy among
financial statements
recognition that the differences in disclosure
adequacy among financial statements are
due to such variables as company size,
profitability, and size and listing status of
the auditing firm

106
106

(2) The usefulness of financial statement data

Two approaches were used to examine

the usefulness of financial statement
data:

1. the first examined the relative importance of

the investment analysis of different
information items to both users and
preparers of financial information
2. the second examined the relevance of
financial statements to decision-making,
based on laboratory communication of
financial statement data in terms of
107
readability
and
meaning
to
users
in
general
107

 The overall conclusions of these

studies were that:
some consensus (agreement) exists
between users and preparers regarding
the relative importance of the information
items disclosed in financial statements
users do not rely solely on financial
statements when making their decisions
108
108

(3) Attitudes about corporate reporting

practices
Two approaches were used to
examine attitudes about corporate
reporting practices:
1. the first examined preferences for
alternative accounting techniques
2. the second examined attitudes about
general reporting issues, such as how
much information should be available,
how much information is available, and
the importance of certain items
109
109

 These research items showed the

extent to which some accounting
techniques proposed by the
authoritative bodies are accepted,
and also brought to light some
attitude (stance) differences among
professional groups concerning
reporting issues
110
110

(4) Materiality judgments

Two approaches were used to examine
materiality judgments
1. the first examined the main factors
determining the collection, classification and
summarisation of accounting data
2. the second focused on what items people
consider to be material, and sought to
determine the degree of difference in
accounting data that is required before the
difference is perceived as material

These studies indicated that several

factors appear to affect materiality
judgements, and that these judgements
differ among individuals
111
111

(5) Linguistic effects of accounting data

and techniques
Linguistics and accounting have many
similarities
Belkaoui argues that accounting is a
language and that according to the
Sapir-Whorf hypothesis its lexical
(relating to words) characteristics and
grammatical rules will affect both the
linguistic and the non-linguistic
behavior of users
112
112

Linguistic effects of accounting data and techniques

(contd)

Four propositions derived from the linguistic

relativity paradigm to conceptually integrate the
research findings of the impact of accounting
information on the users behavior, are as
follows:
1. users who make certain lexical (relating to
word) distinctions in accounting are enabled
to talk and/or solve problems that cannot be
solved by users who do not
2. users who make certain lexical distinctions in
accounting are enabled to perform tasks more
rapidly or more completely than those who do
not
113

113

Linguistic effects of accounting data and techniques (contd)

3. users who possess the accounting

(grammatical) rules are more predisposed
(liable) to different managerial styles or
emphases than those who do not.
4. accounting techniques may tend to
facilitate or render more difficult various
managerial behaviors on the part of users.

114
114

LAST.COMBINED ANY 1
TO 4
11
5

115

Accounting Paradigms

116

 A paradigm is a fundamental image of the subject matter

of science.
It serve to define what should be asked, & what rules
should be followed in interpreting the answer obtained.
The paradigm is the broadest unit of consensus within a
science & serves to differentiate one scientific
community from another.
It subsumes, defines, & interrelates the exemplars,
theories, methods, & instruments that exists within it.
117

 The value of the predication of a theory to users influences its

uses, it does not solely determined the success
Because cost of errors & the implementing vary, several
theories about the phenomena can exist simultaneously for
predictive purposes.
However, only one will generally accepted by theorist.
In accepting one theory over another, theorist will be influenced
by the intuitive appeal of the theorys explanation for the
phenomena & the range of phenomena it can explain & predict
as well as by the usefulness of the predictions to users.
118

 AAA publication of Statement of Accounting Theory

& Theory Acceptance;
1. The anthropological / inductive paradigm
2. The true-income / deductive paradigm
3. The decision usefulness / decision-model paradigm
4. The decision usefulness / decision maker/
aggregate market- behavior paradigm
5. The decision usefulness / decision-maker/
individual user paradigm
6. The information / economic paradigm
119

1. The anthropological / inductive paradigm

Concern for inductive approach to construction of

accounting theory & a believe the value of

accounting practice.
The research concern on significance of historical
cost in term of accountability & decision making.
Those who adopt this paradigm, the basic
subject mater is;
Existing accounting practice
Management attitude towards those practice

(management plays a central role in determined

technique to be implemented)

 Four theories under this paradigm

I. Information economics
II. The agency model
III. The income smoothing / earning
management hypothesis
IV. The positive theory of accounting

121

2. The true-income / deductive paradigm

The basic subject matter is a concept of ideal income
based on some other method than the historical cost
method.
It generally employed analytic reasoning to justify
the construction of an accounting theory or to argue
the advantage of particular asset-valuation / income
determination model other than historical-coat
accounting.
The theories;
I.
II.
III.
IV.
V.

Price level adjusted accounting;

Replacement cost accounting;
Deprival-value accounting
Net realizable value accounting
Present-value accounting
122

3. The decision usefulness / decision-model paradigm

Rely on empirical technique to

determined predictive ability of
selected items of information.
Two related theories;
i.

Decision models associated with

business decision making (EOQ, Capital
Budgeting etc.)
ii. Deals with different economic events
that may effect a going concern.
123

4. The decision usefulness / decision maker/ aggregate market- behavior

paradigm

Important relationship between

accounting data and market behavior.
Aggregate market behavior & accounting
variables is based on theory market
efficiency.
Those theory include;
I.
II.
III.
IV.
V.

The
The
The
The
The

efficient market model

efficient market hypothesis
capital asset pricing model
arbitrage pricing theory
equilibrium theory of option pricing
124

5. The decision usefulness / decision-maker/ individual user

paradigm

Is the study of how accounting functions & reports

influence the behavior of accountants & non accountants.
The basic subject matter is the individual-user response to
accounting variables.
The objective is to understand, explain & predict human
behavior within an accounting context.
The theories include;
I.
II.
III.
IV.

Cognitive relativism in accounting

Cultural relativism in accounting
Behavioral effect of accounting information
Linguistic relativism in accounting
125

6. The information / economic paradigm

The usefulness of information to the future
development of accounting theory.
The basic subject matter is;
Information is an economic commodity
The acquisition of information amounts to a
problem of economic choice

Generally employ analytic reasoning based on

statistical decision theory & economic theory
of choice.
Central to the information/economic paradigm
is the traditional economic assumption of
consistent, rational choice behavior.
126

Conclusion

12
7

127

As a conclusion;
No single governing theory of acctg is rich

enough to encompass the full range of userenvironment specifications effectively;

Their existence in accounting literature not a

theory of accounting but collections of

theories which can be array over the
differences in user environment specification.

128

To test the theory, according to Propper;

1. Internal consistency
2. Logical form (empirical or scientific

theory)
3. Survive of various test
4. Demands from practice
.No necessarily adopt the same steps;

theorists ???

129

END OF CHAPTER ONE

130