GODFREY

HODGSON
HOLMES
TARCA
CHAPTER 1
INTRODUCTION
Overview of Accounting Theory
What is a theory?
Hendriksens definition:
the coherent set of hypothetical, conceptual and
pragmatic principles forming the general
framework of reference for a field of inquiry.

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What is an accounting theory?
Hendriksens definition:
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 practices and
procedures.
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Overview of Accounting Theory
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
empirically
acceptable its implications are

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Overview of Accounting Theory
Accounting theory is a modern concept
compared to mathematics or physics
Even Paciolis treatise on double-entry
accounting focused on documenting
practice and did not explain the underlying
theoretical basis for it
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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
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Was developed to resolve problems as they
arose reactive
Ad hoc approach
Led to inconsistencies in practice
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
century.
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Pragmatic accounting (1800 1955)
The general scientific period
based on empirical observation of practice
provided an explanation of accounting practice
focused on the existing viewpoint 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

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Normative accounting (1956-1970)
Degenerated into battles between competing
viewpoints
Two groups dominated:
conceptual framework proponents
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
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
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
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,
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
alternative accounting practices
SACs 14
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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
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
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
14)
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Summary
Accounting theory
Major periods of accounting theory
development
Normative accounting
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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