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Introduction to Accounting Theory
Theory
A statement on belief expressed in a language.
A deductive system in which observable consequences logically follow from the conjunction of observed facts with the set of the fundamental hypotheses … (Braithwaite, 1968)
A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.
A set of premises which is logically related.
Accounting
The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.
Accounting Theory
A set of interrelated concepts, definition and propositions that present a systematic view of  phenomena by specifying relations among variables with the purpose of explaining and predictingthe phenomena.
Logical reasoning in the form of a set of broad principles that provide a general framework of reference by which accounting practice can be evaluated and guide the development of new practicesand procedures.
Nature of accounting theory
a.Accounting as a language
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Perceived as a language of business.
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Business activities are reported in accounting statements using accounting language.
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Translate economic event and transactions into smthg that can be understood by users. b.Accounting as a historical record
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Concern with providing a faithful record of the transactions of an entity and manager stewardship of the owner’s resources.c.Accounting as an economic good
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Accounting info is not costless to produce and impose compliance costs.
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Manager chooses accounting rules that minimize info costs and shareholders imposeaccounting rules that improve the ability to control and monitor the actions of managers.d.Accounting as current economic reality
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Balance sheet and income statement should be based on a valuation basis that is morereflective of economic reality rather than historical costs. Focus on current and future prices.e.Accounting as communication-decision information
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Accounting is action oriented. Accounting is prepared to suit the needs of users and willhave impact on the decision-making behaviour of managers and investors.
Accounting Theory Construction and Formulation
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Accounting theory can be constructed by using deductive and inductive method.
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Acceptance of a theory depends on the ability of a theory to explain and predict thevalidity / logical process of the theory’s construction, and the implication of the theory.1.Deductive method
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Begins with basic accounting premises and proceeds to derive by logical meansaccounting principles that serve as guides and bases for the development of accountingtechniques.
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From general to specific. Eg.
 
 
Deductive method:P1 All assets accounts have debit balancesP2 Building & machine accounts are asset accountsC Building & machine accounts have debit balances
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Steps: a. specifying the objectives of financial statements.b. selecting the postulates of accounting.c. deriving the principles of accounting.d. developing the techniques of accounting.
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Advantages- if premises are false, conclusion may also be false. Provide a basis for  practical rules.
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Criticism- misunderstands the meaning of theory. The theory not necessarily to be entirely practical.2.Inductive method
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Begins with observations and measurements and moves toward generalized conclusions.
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From specific to general. Eg.Inductive method:P1 Building account is an asset account and has a debit balanceP2 Machine account is an asset account and has a debit balanceP3 Land account is an asset account and has a debit balanceP4 Vehicle account is an asset account and has a debit balanceC All asset accounts have debit balance
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Steps: a. recording all observations.b. analysis and classifying of these observations to detect recurring relationships(similarities)c. inductive derivation f generalizations and principles of accounting fromobservations that depict recurring relationships.d. testing the generalizations.
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The truth of the propositions depends on the observation of sufficient instances of recurring relationships.
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Advantages: not necessarily constrained by a structure and free to make relevantobservation.
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Disadvantages: influenced by the idea of relevant relationship and raw data are likely to bdifferent.
3 types of relationships in the theoretical structure:-
1.Syntactic relationship
 
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Logical relationship which has to do with the rules of the language used.
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Relates basic concepts at the abstract level.
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Emphasis on the logical reasoning and not the empirical content of the statement in thereal world.
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Refer to a flow of logic, not to the accuracy of an argument’s representation of the realworld.
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If the premise is true, the conclusion must be true. Eg.P1 All accounts related to assets have debit balancesP2 Acc. Depreciation account is related to assetC Acc. Depreciation account has a debit balanceSyntactically, the argument is validIf P1 and P2 are true, then C also true: although the real world / practice, C is false2.Semantic relationship
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Relates basic concepts of a theory with the real world.
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Verification is based on the premises and conclusion, not on the logical reasoning.
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Make a theory realistic and meaningful. Eg.P1 All assets accounts have debit balancesP2 Sales return account is not an asset accountC Sales return account has a debit balanceP1 is false. Syntactically, the argument is not validHowever, semantically, C can be accepted because in the real world/ practice, C is true.3.Pragmatic relationship
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Effects of words or symbols to people.
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How accounting concepts and real world corresponding events or objects affect people behaviour and how people react to the same message in different ways.
Testing a Theory
1.Dogmatic basis
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We believe in statements made by others simply because they have been made by anauthority.
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It is a basis for accountant to accept the validity of rules and procedures.
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Weakness- introspective evidence including personal bias. Individual’s personal opinionabout the person or group making the statement.2.Self-evidence basis
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Determination of truth- reasonableness, sensibility or obviousness of a statement based ongeneral knowledge, experience and observation.
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Does not matter where the idea come from when constructing a theory.
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