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.

Overview of Accounting
Theory
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.
3

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

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.

Pre-theory (1400s
1800)
Goldberg:
No theory of accounting was devised from
the time of Pacioli down to the opening of
the nineteenth century.

Greek in 5th Century BC

In 1915, scientist discovered Zenon Papyri
Contains information about the construction
projects, agricultural activities and business
operations of the private estate of
Apollonius for a period of about 30 years
during the 3rd century BC
A written record of all transactions, a
personal account for wages paid to
employees, inventory records and a record
of asset acquisitions and disposals
7

Italy
The Romans kept elaborate records
but since they expressed numbers
through letters of the alphabet, they
were not able to develop any
structured system of accounting

Italy (Renaissance 13001500)

The Italians were vigorously pursuing
trade and commerce, and the need
to keep accurate records arose
Italian merchants borrowed the
arabic numeral system and the basis
of arithmetic and an evolving trend
toward the double-entry bookkeeping
system
9

Italy, 1494
An Italian monk, Fra Luca Pacioli,
Summa de Arithmetica Geometria
Proportioniet Proportionalita, a book
on arithmetic
Desribed doube-entry bookkeeping
Formalized the practices and ideas
that had been evolving over the
years
10

1600
Statement of profit & loss and
statement of balances
The primary motive for separate
financial statements was to obtain
information regarding capital
Balance sheet data were stressed
while income and expense date were
viewed as incidental
11

1800
Evolution of joint ventures into
business corporations in England
Bookkeeping expanded into accounting
The concept of net worth (owners
original contribution +/- profits/losses)
emerged
Periodic reporting for owners and
prospective owners
12

1800
Companies Acts in England stimulated the
development of accounting standards and
laws to safeguard shareholders against
improper actions by corporate officers
Dividends were required to be paid from
profits and accounts were required to be
kept and audited by persons other than
the directors
Industrial revolution
13

Later part of 1800

Industrial revolution arrived in the US
Railroad industries created the need for
supporting industries, led to increases in
the market for corporate securities and
an increased need for trained
accountants
Accountants were initially trained
through an apprenticeship system , later
private commercial college emerged
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1900- 1915
The concept of income determination was
not well developed
Debate over which financial statement
should be viewed as more important
1904 : international congress of
accountants in US which formed American
Associaton of Public Accountants. In 1916
Many universities began offering
accounting courses
15

After the Great Depression

1933 : Securities Act
1934 : Securities Exchange Act which
established SEC
1935 : American Association of
University Instructors in Accounting
changed into American Accounting
Association
1936 : AICPA
16

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

17

Normative accounting
(1956-1970)
Sought to establish norms for the
best accounting practice
Focused on what should be (the
ideal) v. what is

18

Normative accounting
(1956-1970)
Degenerated into battles between
competing viewpoints
Two groups dominated:
conceptual framework proponents
critics of historical cost

19

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
20

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

21

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

22

Positive accounting (1950

to the present day)
Its objective is to explain and predict
accounting practice
e.g. the bonus plan hypothesis

23

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

24

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

25

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
27

Recent developments

28

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

29

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)

30

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
33

Key terms and concepts

Theory
Accounting theory
Normative theory
Positive theory
Behavioural theory
Conceptual framework
IFRS
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