DEPARTMENT OF COMMERCE

UNIVERSITY OF JAFFNA- SRI LANKA

Programme Title : Third in Bachelor of Commerce -2016/2017
Course Unit : COM ACF E 32072: Accounting Theory and Application
Handout : 1.2 – Evolution of Accounting Theory
Prepared by : Mr. A. Ajanthan
Issued on : 11th of December, 2018
Learning Objective:
After studying this section, the students should be able to:
 Discuss historical development of accounting theory and illustrates how the view of
accounting has changed over time.

Evolution of Accounting Theory

Accounting theory is mainly a modern concept when compared with theories emanating from
mathematics or physics. Accounting developed as a set of tools to record activities or
transactions. Even Luca Pacioli’s treatise on double-entry accounting (which provides the
basis for modern double-entry booking system) was about documenting the processes
involved, not about explaining the underlying basis for this method of recording. Unlike
disciplines that have natural laws, accounting is an instrument of human behaviour. It is
developed and used for the specific purposes of individuals who are preparing the
information. Chambers (1963) summarized the view that accounting has been developed in
an improvised fashion rather than from a structured theory as follows: “Accounting is
frequently described as a body of practices which have been developed in response to
practical needs rather than by deliberate and systematic thinking.” Many accounting
prescriptions or directions have been developed to resolve problems as they arose. Hence,
the theory underlying those prescriptions also developed in a largely unstructured manner.

Pre-theory period
Before the double-entry system was formalised in the 1400s, very little was written about the
theory underlying accounting practices. During the developmental period of the double-entry
system, the main emphasis was on practice. It was not until 1494 that a Franciscan monk,
Fra Pacioli, wrote the first book to document the double-entry accounting system as we
know it. The title of his work was Summa de Arithmetica Geometria Proportioni et
Proportionalita (Review of Arithmetic, Geometry and Proportions). For 300 years following
Pacioli’s treatise, the developments in accounting concentrated on refining the practice. This
period is refereed as ‘pre-theory period.’

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 Until the 1930s, developments in accounting theory were rather random and ill-
defined, evolving as they were needed to justify particular practices (Godfrey, Hodgson,
Holmes, and Tarca, 2010). However, developments in 1800s have led to the formalization of
existing practices. A rapid expansion in technology, accompanied by the large-scale
separation of ownership and control of the means of production occurred during this period
increased the demand for both management and financial accounting information. In
particular, the growth of business sector and the construction of railroad networks in the
United Kingdom (UK) and United States (USA) increased the demand for detailed
accounting information. Further, the introduction of taxation legislation, the increased
government legislation associated with corporate reporting, government and corporate
economic policy decisions based on accounting numbers and rapid progression in economic
theory linked to the demands for accounting information provided impetus for the growth of
theories explaining accounting practice. These developments initially occurred mainly in UK
and subsequently they were shifted to USA.

General Scientific Period (1800-1955): Pragmatic Accounting

The period 1800-1955 is often referred as the ‘general scientific period.’ During this period
most theory developments were concerned with providing explanations of practice. The
emphasis was on providing an overall framework to explain and develop accounting
practice. Hence, accounting theories were developed largely on empirical analysis (i.e. the
method often adopted in the physical sciences). The theories developed during this period
were labeled as ‘general scientific’ because they were aimed at providing a framework for all
accounting issues and they were developed empirically. The general scientific movement
gave rise to several notable publications in accounting, which includes Tentative Statement
of Accounting Principles affecting Corporate Reports released by American Accounting
Association (AAA) in 1936 and A Statement of Accounting Principles released by American
Institute of Certified Public Accountants (AICPA) in 1938.

Normative Period (1956 to 1970): Normative Accounting

The period 1956-1970 is labeled as the ‘normative period’ as during this period accounting
theorists attempted to establish ‘norms’ for ‘best accounting practice.’ In this period, the
accounting researchers were less concerned about what actually happened in practice but
more concerned with developing theories that prescribed what should happen in practice.
The major focus of normative theorists during this period was the impact of changing prices
on value of assets and the calculation of profit owing to the recorded levels of inflation
experienced during this period. Two groups dominated the normative period - the critics of
historical cost accounting and proponents of the conceptual framework for accounting. There
was some overlap between these two groups, especially when historical cost critics tried to

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develop theories of accounting where asset measurement and profit determination
depended on inflation and/or specific price movements. During the normative period, the
idea of a 'conceptual framework' gained increased popularity. A 'conceptual framework' is a
structured theory of accounting. Such frameworks are meant to encompass all components
of financial reporting and are intended to guide practice. However, normative period began
to drawing to an end in the early1970s, and was replaced by the 'specific scientific theory'
period, or the 'positive era' (1970). The two main factors that prompted the end of the
normative period were:
- The unlikelihood (doubtfulness) of acceptance of any one particular normative theory
- The application of financial economic principles, increased supply of data and testing
methods.
Because normative accounting theories prescribe how accounting should be practised, they
are based on opinions of what the accounts should report, and the best way to do that.
Opinions as to the appropriate goals and methods of accounting vary between individuals,
and most of the dissatisfaction with the normative approach was that it provided no means of
resolving these differences of opinion. Henderson, Peirson and Brown outline the two major
criticisms of normative theories in the early 1970s:
 Normative theories do not necessarily involve empirical hypothesis testing.
 Normative theories are based on value judgements.
Further, the underlying assumptions of some normative theories were untested, and it was
unclear whether the theories had strong foundations or assumptions about the purpose of
accounting. Practically, it was also difficult to obtain general acceptance of any particular
normative accounting theory.

Positive Theory / Specific Scientific Theory (1970-2000): Positive Accounting

The end of normative period led to the shift of accounting theory development to a new form
of empiricism, which operates under the broad label of ‘positive theory.’ This ‘specific
scientific theory’ or the ‘positive era’ in fact is not new as it was also based on the empirical
approach, which provided the basis for ‘general scientific theory.’ Positive theory sought to
provide a framework for explaining the practices, which were being observed.

A prominent positive theory in accounting is Positive Accounting Theory (PAT) developed by

Watts and Zimmerman in 1978. According to Watts and Zimmerman (1986, p.7) PAT “is
concerned with explaining accounting practice. It is designed to explain and predict which
firms will and which firms will not use a particular method but it says nothing as to which
method a firm should use.” Three key hypotheses are used in PAT literature to explain and
predict support or opposition to an accounting method - bonus plan hypothesis, debt

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hypothesis and political cost hypothesis, which predict the use of accounting numbers in
compensation and debt contracts and in the political process that affects a firm’s accounting.
PAT, which revolutionised accounting theory development in late 1970s, capitalized on the
concurrent developments in finance and economic, to explain some of the puzzles faced by
accounting researchers and practitioners during that period.

The above discussion on the evolution of accounting theories shows that different
approaches had been adopted in developing different theories in accounting. Some theories
have been predominantly developed on the basis of observation of what accountants
actually do in practice. Thus, these theories have been developed through the process of
induction (research based on observing particular phenomena). There are also theories,
which have been developed by deductive reasoning, which is based more upon the use of
logic rather than observation.

Recent Developments
Both academic and professional interests in theory development have tended to be aligned
in the past. In recent times, however, academic and professional developments in
accounting theory have taken somewhat different approaches. Whereas the academic
research emphasis remains in the area of capital market, agency theory, and behavioural
impacts, the profession has pursued a more normative approach. In particular, the
profession has sought normative theories to unify accounting practice and make it more
homogeneous, whereas academic researchers have sought to better understand the role
and impact of different forms of accounting information. These positive and normative
approaches are not incompatible, since an understanding of the impact of accounting is a
factor that accounting standard setters consider in developing prescriptions for practice. The
following Figure 01 shows the main periods of theory development to the present.

Accounting Theory (Development) Timeline

Source: Godfrey, J., et al. (2010), Accounting Theory, seventh ed.,

John Wiley & Sons, Australia. 11

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