DeeganFAT4e_PPT_ch01kk

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1-1Copyright © 2014 McGraw-Hill Education (Australia) ty !td"s to acco#pany $%%gan& Financial Accounting Theory 4%

'ACA! ACC*+"G "HE*,Craig $%%gan

Slides written by Craig Deegan

ntroduction to .inancial

accounting th%ory

CHA"E, 1




!%arning o/%cti%s

11 Understand that there are many theories of financialaccounting.

12 Understand how knowledge of different accounting

theories increases our ability to understand and evaluate

various alternative financial

13 Understand that the different theories of financialaccounting are often developed to perform different

functions, such as to describe accounting practice, or to

prescribe particular accounting practices.

14 Understand that theories, including theories of accounting,

are developed as a result of applying various value judgements and that acceptance of one theory in

preference to others will in part be tied to one’s own value

judgements.continued




!%arning o/%cti%s (cont)

1 e aware that we should critically evaluate theories!in terms of such things as the underlying logic,

assumptions made and evidence produced" before

accepting them.

15 Understand some alternative perspectives about how

knowledge develops across time.

16 Understand why students of accounting should study

accounting theories as part of their broader

accounting education.




7% ar% studying .inancial accounting

th%ory /ut8 what is a th%ory9

# A coherent set of hypothetical, conceptual and

pragmatic principles forming the general

framework of reference for a field of inquiry

!$endriksen %&'(, p.%"

# A scheme or system of ideas or statements held

as an explanation or account of a group of facts

or phenomena !The Oxford English Dictionary "

# ased on logical !coherent" reasoning, and not adhoc in nature

# Different to a )hunch’continued



1-Copyright © 2014 McGraw-Hill Education (Australia) ty !td"s to acco#pany $%%gan& Financial Accounting Theory 4%

7hat is a th%ory9 (cont)

# * theory could be based on numerous observations!inducti% r%asoning" or developed on the basis of

logic !d%ducti% r%asoning"

# Could be )positive’ or )normative’

# +heories can help us make sense of the world inwhich we live and can provide a structure to

understand our !social" eperiences

# -hat makes a theory a )good’ theory

continued




7hat is a th%ory9 (cont)

/lewelyn !0((1, p. 223" states that4

Theories impose cohesion and stability. o that whene!er"life# is ambiguous $which is most of the time%& people will

work at confronting this ambiguity through "theori'ing#.

Also, because "life# and situations commonly ha!e multiple

meanings and gi!e rise to different assessments ofsignificance, e!eryone has a need for "theory# to go about

their e!eryday affairs. "Theories# do not (ust reside in

libraries, waiting for academics to "dust them down#) they

are used whene!er people address ambiguity,

contradiction or paradox so that they can decide what todo $and think& next. Theories generate expectations about

the world.





1-:Copyright © 2014 McGraw-Hill Education (Australia) ty !td"s to acco#pany $%%gan& Financial Accounting Theory 4%

E;a#pl%s o. us%s o.

accounting th%ori%s# +heories might4

6 prescribe how assets should be valued

6 predict why managers will choose particular accounting

methods

6 explain how an individual’s cultural background affectsaccounting information provided

6 prescribe what accounting information should be provided to

particular classes of stakeholders

6 predict

that the relative power of a stakeholder group will affect

the accounting information it receives

6 explain or predict how accounting disclosures might be used as

part of a strategy to legitimise the operations of an organisation



1-<Copyright © 2014 McGraw-Hill Education (Australia) ty !td"s to acco#pany $%%gan& Financial Accounting Theory 4%

7hy study accounting th%ori%s9# /earning the rules of financial accounting without

considering the implications of accountinginformation is not recommended

# *ccounting plays a very important and pervasive

role within society7.and our theories help to

eplain why4

6 accountants are very powerful members of society8

# Studying theories of accounting enhances yourability to be a critical thinker and differentiates

you from )the average accountant’

continued




7hy study accounting th%ori%s9

(cont)

# Studying theories of accounting eposes students tovarious issues, including4

6 how elements of accounting should be measured

6 the motivations driving organisations to provide certain types of

accounting information 6 the motivations driving individuals to support or lobby regulators for

some accounting methods in preference to others

6 the implications for organisations and their stakeholders if one

accounting method is chosen or mandated in preference to others

6 how and why the capital markets react to particular information

6 whether there is a )true measure’ of income




How can accounting th%ori%s h%lp

th% accounting pro.%ssion9

# -ithout a theoretically informed understanding it isdifficult to4

6 evaluate the suitability of current accounting practices

6 develop improved accounting practices where current

practices are unsuitable for changed business

circumstances

6 defend the reputation of accounting when accounting

practices are blamed for causing companies to fail !as has

been the case with the global financial crisis"




*%ri%w o. th%ori%s o.

accounting# 9any theories of financial accounting eist

# :o universally accepted theory of accounting

6 different perspectives about the central objective, role and

scope of financial accounting

# :o universally accepted perspective about the role of

accounting theory

6 different researchers have different perspectives of the role

of accounting theory !for eample, to eplain and predict

practice versus prescribing particular practice"

6 a researcher’s own values will influence which theory he or

she elects to embrace




Early d%%lop#%nt o.

accounting th%ory# ;elied upon the process of induction

6 *n inductive approach refers to the development of ideas

or theories through observation of )real world’ phenomena

# %&0(s to %&2(s theories developed from observing

what accountants did in practice

6 Common practices were codified as doctrines or

conventions of accounting




Criticis#s o. inducti% #%thod

# "* concentrates on the status quo, is reactionaryin attitude and cannot pro!ide a basis upon which

current practice may be e!aluated or from which

future impro!ements may be deduced # !<ray, =wen

> 9aunders %&?', p.22"

# *ssumes what is done by the majority is the most

appropriate practice

# @erspective of accounting Darwinism




E;a#pl% o. inducti% approach

to th%ory d%%lop#%nt

# <rady !%&23" undertook research commissioned

by the *merican 5nstitute of Certified @ublic

*ccountants !*5C@*"

# Aormed the basis of *@ Statement :o. B )asic

Concepts and *ccounting @rinciples Underlying

the Ainancial Statements of usiness nterprises’

6 reflected generally accepted accounting principles at thetime




"h%ory d%%lop#%nt=

1<50s and 1<60s# +here was a shift in research focus

# +his period became known as the ‘ normative period’ ofaccounting research

# +he normative research sought to prescribe particular

accounting practices

6 known as normative theories !normative theories provide

prescription"# +he research was not driven by eisting practices, and hence

not typically inductive in nature !that is, not based on

observation"

# ;ather, were deductive in nature and, based on logical

argument, sought to develop new methods of accounting

# +heories were critical of historical cost accounting

# Sought to provide improved approaches to asset valuation in

a time of widespread inflation




E;a#pl% o. pr%scripti% th%ory

# %&2% and %&20 studies by 9oonit, and Sprouse and 9oonit

commissioned by the *ccounting ;esearch Division of the

*5C@*

# *uthors proposed that accounting measurement systems be

changed from historical cost to a system based on current

values# Such research should not be evaluated by reviewing current

practice !indeed, there is a general rule that prescriptions about

what should be should not be evaluated by reviewing

observations of what is"

# :ot supported by *5C@* as too radically different from current

practice



1-1:Copyright © 2014 McGraw-Hill Education (Australia) ty !td"s to acco#pany $%%gan& Financial Accounting Theory 4%

or#ati% th%ori%s# ased on what the researcher believes should occur in

particular circumstances

6 that is, they provide prescription and tell us what we should do

6 not developed simply on the basis of observing what people

!accountants" currently do

# ample of normative theory

6 Continuously Contemporary *ccounting !CoCo*" by ;aymond

Chambers

6 +onceptual ramework of Accounting

# Should not be evaluated on whether they reflect actualaccounting practice 6 indeed the prescriptions might reflect

radical departure from eisting practices



1-1<Copyright © 2014 McGraw-Hill Education (Australia) ty !td"s to acco#pany $%%gan& Financial Accounting Theory 4%

"h%ory d%%lop#%nt=#id to

lat% 1<60s

# *nother shift in research focus

# ;esearch began to aim at explaining and

predicting accounting practice rather than

prescribing particular practices, and started tobecome popular

# Enown as positive theories

# Contrast with normative theories




ositi% th%ori%s

# Seek to predict and eplain particular phenomena# egin with assumption!s", and through logical

deduction enable prediction!s" to be made4

6 an assumption might be that all individuals are selfF

interested and are motivated by wealth maimisation

# 5f predictions are sufficiently accurate when tested

against observations of reality, they are regarded as

having provided an eplanation of why things are as

they are




$%%loping positi% th%ori%s

# ;esearchers might firstly identify a number of keyassumptions

6 for eample, that individuals are driven by selfFinterest, that

capital markets are efficient, and so forth

# +hrough logical argument, make predictions andGorprovide eplanations of actual phenomena based

upon assumptions !deduction"

# +est the predictionsGeplanations through actual )real

world’ observations# 9odify the theory, if necessary, based upon the real

world observations




An %;a#pl% o. a positi% th%ory

# @ositive *ccounting +heory 6 is eplored more fully in Chapter '

6 was developed by -atts and Himmerman

6 is a specific eample of a positive theory of accounting

6 seeks to predict and eplain why accountants elect to

adopt particular accounting methods in preference to

others

6 is based on )rational economic person’ assumption

individuals motivated by selfFinterest tied to wealth

maimisation

challenges the view that accountants will be )objective’




Ealuating th%ori%s o. accounting# *s we should now understand, there are a multitude of

accounting theories available

# -hy or how would we select one theory in preference to

another

# Students should consider the merit of the argument and the

research methods employed

# Some researchers may adopt strategies !such as overtcondemnation of alternative theories" to support their own

research and theoretical perspective

# ;esearchers that adopt a given )paradigm’ often challenge the

views of people researching from a different paradigm

# * )paradigm’ can be described as an approach to knowledge

advancement that adopts particular theoretical assumptions,

research goals and research methods !Euhn %&20".




,%olutionary sci%nti.ic

progr%ss (>uhn)# Enowledge advances when one theory is replaced

by another as particular researchers attack the

credibility of an eisting paradigm and advance an

alternative

# Different researchers often embrace different !and

conflicting" paradigms

# @ossible eplanation of why researchers try to

denigrate the credibility of alternative theories

6 but no accounting theory has to date overthrown all other

alternatives




Criticis# o. positi% th%ori%s=

an %;a#pl%

# @ositive theories of accounting have been

criticised for not providing prescription

# +he decision not to provide prescription couldalienate academic accountants from their

counterparts within the profession




Criticis# o. nor#ati% th%ori%s=

an %;a#pl%

# :ormative theories have been criticised for lack of

empirical observation

6 they are based on personal opinion about what should

happen

6 positive theorists argue that they would prefer to provide

information about epected implications of actions and let

others decide themselves what they should do

6 positive theorists also make value judgements




s th% th%ory parsi#onious9

# *nother consideration when evaluating a theory iswhether it is )parsimonious’

# * parsimonious theory is one that provides the most

)logically economic’ eplanation for a particular

phenomenon or event# Aor eample, if we were evaluating two alternative

positive theories with relatively similar eplanatory

ability and the first theory utilised B independent

variables and the second theory utilised 0(independent variables then we would tend to favour

the first theory




Can w% pro% a th%ory9

# Can we epect that a theory of financial accounting!and hence, about people" can provide perfect

predictions in all cases

# * theory might not have perfect predictive

capabilities, but still be useful# Saying that we have proved a theory on the basis of

observations ignores the fact that subseIuent

observations might not be in accordance with the

theory

continued




Can w% pro% a th%ory9 (cont)

# +here is a group of theorists known as)falsificationists’.

6 falsificationists believe that theory develops through trial

and error and )good’ theory should generate hypotheses or

predictions that have the potential to be rejected

6 rejection leads to refinement of theory

6 falsificationists would argue that a theory can never be

proved, though it might be the )best’ available at a particular

point in time

6 safer to say that our evidence supports a particular theory

!rather than )proves’ a theory"




Ealuation o. th%ori%s=th%

position ta?%n in this /oo?# +heories of accounting are only abstractions of

reality

# +he choice of one theory in preference to another

is based on value judgements

# +heories of accounting cannot be epected to

provide perfect eplanations or predictions of

human behaviour or assess what types of

information users actually need




Ealuating th%ori%s=logic and

%id%nc%# -hen evaluating theories, you need to consider4

6 whether the argument supporting the theory is logical

6 whether you agree with the central assumptions of the

theory

6 whether you accept any supporting evidence provided




!ogical d%duction

# *cceptance of an argument must be based on theaccuracy of the premises

6 an argument is logical to the etent that if the premises on

which it is based are true, then the conclusion will be true

# -e do not need to refer to )real world’ observationsto determine the logic of an argument

# $owever, although the argument might be logical, if it

can be shown that a given premise is untrue then the

conclusion or prediction may be rejected# *s an eample, refer to the syllogism on p.%&




"h% rol% o. assu#ptions

# ven though an argument is logical we might onlyaccept the argument if we accept any critical

assumptions being made.

6 5f we reject any central assumptions we may reject the

prediction no matter how logical the theory might be

6 Aor eample, @ositive *ccounting +heory !-atts and

Himmerman" is based on the central economicsFbased

assumption that all individual action is motivated by selfF

interest tied to wealth maimisation. 5f we do not accept this

central assumption then we would dismiss the eplanations

and predictions provided by the theory

continued




"h% rol% o. assu#ptions (cont)

6 *s another eample, in September 0(%( the components

of the revised +onceptual ramework for inancial-eporting were released in which it is stated that4

7the ob(ecti!e of general purpose financial reporting

is to pro!ide information about a reporting entity that is

useful to present and potential equity in!estors,

lenders and other creditors in making decisions in theircapacity as capital pro!iders

6 5f we were not to reject this central assumption then we

would reject the new conceptual framework despite how

logically developed it might be

6 So, we must consider both the logic of the argument and

the central assumptions made




$ishon%st tric?s in argu#%nt

# 5n evaluating theories we sometimes need to be awareof the )dishonest tricks’ some researchers use tosupport their research, or to denigrate the theoriesutilised by others

# +houless !%&'B" identifies 1? dishonest tricks some

writers use to support their argument including4 6 emotionally toned words

6 statements where )all’ is implied but )some’ is true

6 diversion to another Iuestion or to a side issue

6 use of speculative argument

6 prestige by false credentials

6 appeal to mere authoritycontinued




$ishon%st tric?s in argu#%nt (cont)

#-e must be careful that our acceptance of a theoryhas not been )coerced’ through the use of colourful

or emotive language

* i . ? . h




*%ri%w o. ?%y .actors that

in.lu%nc% r%s%arch# Arom the material discussed in this chapter we can

provide the following summarising points4

6 Different theories will generate different research Iuestions,and reIuire different research methods

Aor eample, a positive theory of accounting will ask Iuestions

about when accountants will be likely to use particularaccounting methods, and will empirically investigate actualpractice to answer the Iuestions

6 +heories will often be based on key assumptions that in turnare influenced by the )values’ of the researcher and how theresearcher )sees’ the real world

*ssumptions about individual behaviour and whether there is an)objective reality’ out there are referred to as ontologicalassumptions 6 which are assumptions about how we see theworld




*%ri%w o. ?%y .actors that in.lu%nc%

r%s%arch (cont)

# +herefore, we can summarise by saying that theontological assumptions held by the researcher, theirvalues and beliefs, the theory being used, theresearch Iuestions to be addressed, and theresearch methods to be used are all highly interF

related.Aor eample, a researcher that does not believe in an)objective reality’ in which all people act in the samepredictable manner will not do large scale empiricalresearch utilising statistical testing with the objective of

developing generalisable hypotheses

# +hese interFrelationships are reflected in Aigure %.%on the following slide4






1 40C i ht © 2014 M G Hill Ed ti (A t li ) t !td

@o#% concluding points

Jou should now make sure you4# understand some of the roles of accounting theory

# can describe some of the different functionsperformed by different accounting theories

# can eplain why it is important to critically evaluatetheories before accepting them

# are able to eplain why it is important that futureaccounting professionals have an understanding of

accounting theory

DeeganFAT4e_PPT_ch01kk

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