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GODFREY
HODGSON
HOLMES
TARCA

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
pragmatic principles forming the general 
framework of reference for a field of inquiry.

Overview of Accounting Theory
What is an accounting theory?
Hendriksen’s definition: 
…logical reasoning in the form of a set of broad 
principles that
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
• Whether a theory is accepted depends on 
how:
– well it explains and predicts reality
– well it is constructed both theoretically and 
well it is constructed both theoretically and
empirically
– acceptable its implications are 

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
accounting focused on documenting 
practice and did not explain the underlying 
theoretical basis for it

Overview of Accounting Theory
The development of accounting
theory 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 – reactive
• Ad hoc approach
• Led to inconsistencies in practice
d i i i i i
– 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 
f P i li d h i f h i h
century.

Pragmatic accounting (1800– 1955)
• The ‘general scientific period’
– based on empirical observation of practice
– provided an explanation of accounting practice
– focused on the existing 
focused on the existing ‘viewpoint’
viewpoint  of accounting
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
what is

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Normative accounting (1956‐1970)
• Degenerated into battles between competing 
viewpoints
• Two groups dominated:
– conceptual framework proponents
t lf k t
– 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
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
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 
k l i h i i
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, 
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 
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
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
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 –
3 i d h( h 11
14)

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Summary
• Accounting theory
• Major periods of accounting theory 
development
• Normative accounting
i i
• 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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