Chapter 2:

Approaches to the Formulation of

Accounting Theory

After studying this chapter, you will be able

to:
1. Differentiate between traditional and new
approaches to accounting theory
construction.
2. Focus on different concepts in the ethical,
social and economic approaches to the
development of accounting theories.
3. Distinguish between the deductive
approaches and inductive approaches to
 Chapter 2:
Approaches to the Formulation of
Accounting Theory

After studying this chapter , you will be able to:

4. Explain the electric approaches to the formulation

of accounting theory.
5. Sketch the new approaches to the development
of accounting theories.
• Attempts to formulate a generally accepted
accounting theory have not succeeded so
far because of different assumptions
,methodologies and users.

• A theory should, therefore, justify or refute

the existing practices.

• If the a given theory fails to produce the

expected results ,it replaced by a better
theory.

See page 26 27
• We shall discuss in brief the different
approaches to the formulation of an
accounting theory under two heads:
1. The traditional Approaches: in these
approaches. to accounting theory
construction , accounting practice and
verification are considered synonymous.
2. The new Approaches: in these approaches. to
accounting theory construction , attempts are
made to logically or empirically verify the
theory.
• It should ,however , be understood clearly that
these approaches are not independent of one
another. Generally , more than one approach ,is
used in the development of accounting principles.
• Most of these approaches are theoretical,
except Pra g m a tic and an Autho riz a tio n
approach are practical.
1. The Pragmatic Approach.
2. The Authorization Approach.
3. The Deductive Approach.
4. The Inductive Approach.
5. The Ethical Approach.
6. The Sociological Approach.
7. The Economic Approach.
8. The Eclectic approach.
• This approach consists of the formulation of a
theory which is in conformity with real (current)
practices.
• Based upon the concept of utility or usefulness –
(utility approach).
• In this approach ,accounting techniques and
principles are chosen because they are useful to the
different categories of “users of accounting
information and their relevance to decision making.
• an attempt to find a practical solution .
• Most accounting theory was developed using
this approach
• This approach is used by professional organization
and the governments.
• It consist of issuing pronouncements for the regulation
of accounting practices .in developing economies,
where financial accounting and reporting practices
differ a lot .
• This approach has its own utility . It also attempts to
provide practical solution.
• In these (utility) approaches ,the emphasis is on
accounting practices, and the logical conclusion is
that accounting theory is to be derived from practices.

• Hindriksen says “ a the o ry witho ut

p ra c tic a l c o ns e q ue nc e s is a ba d
the o ry ”
• These approaches lack theoretical foundations
• In this approach we go from general
to particular .
• In accounting , this approach
begins with basis accounting
propositions (Assumptions) and
proceeds to derived by logical
means the accounting principles.
 3.The Deductive Approach
• Steps used to derive the deductive approach in
accounting:
1. Specifying the objectives of financial statements.
2. Selecting the ‘Assumptions’-basic accounting
propositions- of accounting.
3. Deriving the ‘principles’ of accounting.
4. Developing the "techniques of accounting”.

* Thus, the sequence is { objectives – assumptions – principles

– techniques }
• In this approach we go from particular to
general. On the basis of particular
observation and measurement ,generalized
conclusion are drawn.
• The inductive approach in accounting
“begins with observation of financial
information of business enterprise and
proceeds to draw generalization and
principles of accounting “.
• Thus, accounting and financial information
leads to the formulation of principles.
- The inductive approach to a theory involves the
following four stages:
1. observations , and Recording of all
observations
2. Analysing and classifying these
observations.
3. Inductive derivation of generalisations
and principles of accounting from
observations .
4. Testing of the generalisations
• It will be noted that to develop accounting theory ,
there has been an application of both the
approaches . Principles are derived by deductive
process , while the general proposition are formulated
through an inductive process .a combination of the
two approaches has been used by most authors.
• This approach should not taken as an
independent approach.
• The basic core consists of the concepts of
fairness, justice (equity), and truth. These
concepts as the main criteria in the formulation
of accounting theory.
- “Fairness: refers to the basic concept that
accounting data should be fair ,unbiased”.
- “Justice: equitable treatment to all interested
parties”.
- “Truth: true , and accurate financial accounting
statements without misrepresentation”.
• In general, the purpose of having these approach
that accounting statements have not been subject to
undue influence or bias
• The words “true and faire” have to be special
mentioned in audit reports.
• Corporate activities have economic as well
as social impacts.
• The economic impact of corporation is
measured by financial accounting methods
and reported in financial statement,
however, no established methods and
standards for measuring and reporting on
corporate social performance.
• Emphasizes the social effects of accounting
techniques
• According to this approach, a given
accounting principle or technique is
evaluated for acceptance on the basis of its
reporting effects on all groups in society
• Implies that accounting data will be useful
in making social welfare judgments
• We have noted that the ethical approach focuses
on the concepts of “Fairness", and the sociological
approach focused on “ Social welfare”. The
economic approach focuses on the concept of
“general economic welfare”

• The choice of different accounting techniques

depends on their impact on the national economic.

• Accounting policies and techniques should reflect

‘economic reality’, and the choice of accounting
techniques should depend on ‘economic
consequences’
• The choice accounting techniques
depend on the particular economic
situation .

• Example : during the Inflation ,there is

widespread shift from FiFO to LIFO for
inventory valuation purposes.
• In general, the formulation of accounting
theory and the development of accounting
principles have followed an eclectic approach
(a combination of approaches), rather than
just one school of thought.
• Eclectic approach means a combination of
approaches . To reflect the viewpoints of
professional institutes, industry ,government
and individuals , the establishment of
concepts and principles of accounting results
in the electric approach.
• One great weakness in traditional
approaches is that accounting practice
and verification are considered
synonymous. No attempts is made to
logically verify the theory. In the new
approaches to accounting theory
construction , attempts are made to
logically or empirically verify the theory.
• As mentioned, the new approaches to
accounting theory construction , attempts
are made to logically or empirically verify
the theory.
• The new approaches have not yet been
accepted by various users of accounting
information.
• There is always a time gap between theory
and practices.
• The new approaches that have been discussed in brief
are:
1- The Events Approach.
2- The Decision Model Approach.
3- The Behavioral Approach.
4- The Predictive Approach.
5- The Information-Economics Approach.
• Each of these approaches has generated new
methodologies and interest, and has employed unique
ways of looking at accounting problems.
• “An event is an occurrence , phenomenon , or
transaction that is assumed to be observable”.
• The characteristics of event – monitory values and non-
monetary values- are directly observed and significant to
the user
• The events approach suggests that the purpose of
accounting is ‘to provide information about relevant
economic events that might be useful in a variety of
decision models’
• The events approach suggests a huge expansion of the
accounting data presented in financial reports.
• It is not yet certain that the events approaches will lead
to better prediction , or that “ measurement of events is
more verifiable than measurement of objects”
1- In the decision model approach , accounting
theory is developed by a normative
assumptions about how accounting information
should be used . ( in goals , decision and
information needs of users).
2- Derives the accounting principles and methods
best suited for meeting theses needs.
• In this model , its acknowledged that different
information may be needed for different users
of the financial statements or for different kind
of decisions.
• The behavioral approach to accounting theory formulation
is concerned with human behavior as it relates to
accounting information and problems.

• In this approach , the behavior of users of financial

information is an important consideration in the selecting
of an accounting technique.
• The behavioral approach to accounting
theory formulation emphasizes the
relevance to decision-making of the
information being communicated, and
of the individual and group behavior
caused by the information being
communicated

See page 36
• Its contributions:
1- exchange the accounting function from bookkeeping
system to information system.
2- identify the users of information.
3- management accounting.
4- concentrate on Relevance characteristic.
5- establishment of theoretical principles of financial reports
which multi-purposes.
• The predictive approach to the
formulation of accounting theory
uses the criterion of predictive
ability . That accounting
measurement alternatives , which
has the greatest predictive power
will be regarded as the best by
users.

See page 37
- This approach suggests that all accounting –reporting
decisions should be evaluated within the cost-benefit
framework.
- So, the information approach implies that the
efficiency of the utilization of information as a
resources is measured by matching the costs of
information against the benefits .