GODFREY

HODGSON
HOLMES
TARCA

CHAPTER 2
ACCOUNTING THEORY
CONSTRUCTION

Pragmatic theories
Descriptive pragmatic approach:
based on observed behaviour of
accountants
theory developed from how
accountants act in certain situations
tested by observing whether
accountants do act in the way the
theory suggests
is an inductive approach
2

Pragmatic theories
Criticisms of descriptive pragmatic
approach:
does not consider the quality of an
accountants action
does not provide for accounting
practices to be challenged
focuses on accountants behaviour not
on measuring the attributes of the firm

Pragmatic theories
Psychological pragmatic approach:
theory depends on observations of the
reactions of users to the accountants
outputs
a reaction is taken as evidence that
the outputs are useful and contain
relevant information

Pragmatic theories
Criticisms of the psychological
pragmatic approach:
some users may react in an illogical manner
some users might have a preconditioned
response
some users may not react when they should

Theories are therefore tested using

large samples of people
5

Syntactic and semantic

theories
Semantic inputs are the transactions
and exchanges recorded in vouchers,
journals and ledgers
The inputs are then manipulated on
the basis of the premises and
assumptions of historical cost
accounting
6

Syntactic and semantic

theories
Criticised because there is no
independent empirical verification of
the calculated outputs
The outputs may be criticised for
poor syntax inaccurate e.g. different
types of monetary measures are
added together
7

Syntactic and semantic

theories
The outputs may be syntactically
accurate but nevertheless be
valueless due to a lack of semantic
accuracy (a lack of correspondence
with real-world events, transactions
or values)

example
When a company reports better
prospects than previously, investors
force that companys share price to
increase
Metcash is a company that has
reported better earnings per share
than previously
Investors forced Metcash share prices
to increase
9

Syntactic and semantic

theories
Historic cost accounting may produce
accurate outputs but which
nevertheless have little or no utility
That is, they are not useful for
economic decision making except to
verify accounting entries

10

Normative theories
1950s and 1960s golden age
policy recommendations
what should be
concentrated on deriving:
true income (profit)
practices that enhance decisionusefulness

based on analytic and empirical propositions

Financial
Financial statements
statements should
should mean
mean what
what
they
they say
say
11

Normative theories
True income:
a single measure for assets
a unique and correct profit figure

12

Normative theories
Decision usefulness:
the basic objective of accounting is to
aid the decision-making process of
certain users of accounting reports by
providing useful accounting data

13

Normative theories
The decision process

Accounting
Accounting
system
systemof
of
company
companyXX

Prediction
Prediction
model
model of
of
user
user

Decision
Decision
model
modelof
of
user
user

14

Positive theories
Expanded during the 1970s
Based on experiences or facts of
the real world
Explain the reasons for current
practice
Predict the role of accounting
information in decision-making

15

Positive theories
The main difference between
normative and positive theories is
that
normative theories are prescriptive
positive theories are descriptive,
explanatory or predictive

16

Different perspectives
Scientific approach:
has an inherent assumption that the
world to be researched is an objective
reality
is carried out by incremental hypotheses
has an implied assumption that a good
theory holds under circumstances that
are constant across firms, industries and
time
17

Different perspectives
Criticism of the scientific method:
large-scale statistical research tends to
lump everything together
it is conducted in environments that are
often remote from the world of or the
concerns of accountants

18

Different perspectives
Naturalistic approach:
implies that there are no preconceived
assumptions or theories
focuses on firm-specific real-world problems

Naturalistic research starts from specific

real-world situations; the main intention
is to answer the question what is going
on here , not to provide generalisable
conditions for wide segments of society
19

Different perspectives
Alternative ways of looking at the
world:
CATEGORY
CATEGORY ASSUMPTION
ASSUMPTION
1.
1. Reality
Realityas
asaaconcrete
concretestructure
structure
2.
2. Reality
Realityas
asaaconcrete
concreteprocess
process
3.
3. Reality
Realityas
asaacontextual
contextualfield
field of
ofinformation
information
4.
4. Reality
Realityas
asaasymbolic
symbolicdiscourse
discourse
5.
5. Reality
Realityas
asaasocial
socialconstruction
construction
6.
6. Reality
Realityas
asprojection
projectionof
ofhuman
humanimagination
imagination

20

Category 1
Researchers assume that all managers
aim to maximise their personal wealth and
that they are aware of how they can use
accounting techniques to do so
Researchers predicts that all managers
behave in the same manner because they
have shared a view of the world and of the
outcomes of their actions and because
they share preferences for particular
outcomes
21

Category 6
Humans are not expected to behave
according to a set of behavioral rules that
apply to everyone equally
Although individuals may behave rationally
according to their personal understanding
of the world and of the outcomes of
particular actions, they do not share a
common understanding of how the world
works, and they have different preffered
outcomes from their decisions
22

Different perspectives
For categories 1 3 it is more
appropriate to use the scientific
approach
For categories 4-6 the naturalistic
approach is more appropriate

23

Different perspectives

24

Scientific approach
applied
Misconceptions
of purpose
to accounting

Make scientists out of accounting

practitioners
Researchers = practitioners
The desire for absolute truth

25

Scientific approach
applied
The
scientific method does not claim
to accounting
to provide truth
It attempts to provide persuasive
evidence which may describe,
explain or predict

26

Issues for auditing

theory
construction
Auditing is a verification process that
is applied to the accounting inputs
and processes

27

Issues for auditing theory

construction
Auditors provide an opinion on
whether the financial statements accord
with the applicable reporting framework
whether the statements give a true and
fair view

28

Issues for auditing

theory
construction
The normative era of accounting
coincided with a normative approach
to auditing theory
The positive ere of accounting has
led to a positive approach to auditing
theory

29

Summary
Many different approaches to theory
formulation in accounting
Evolution of accounting theory
positive v. normative
scientific v. naturalistic

30

Key terms and concepts

Descriptive pragmatic approach

Psychological pragmatic approach
Syntactic and semantic theories
Historical cost accounting
Normative theories
Positive theories
Scientific approach to theory
Naturalistic approach to theory
Auditing theory

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