CLASSIFICATION OF ACCOUNTING THEORY

PRESENTED BY:
ALOHAN Osayamen Bright
SPGS/ACC/18508

BEING A PAPER PRESENTED IN PARTIAL FULFILMENT

OF THE REQUIREMENTS OF FINANCIAL ACCOUNTING
THEORY (ACC 821) FOR THE AWARD OF MASTER OF
SCIENCE (M. Sc) DEGREE IN ACCOUNTING IN THE
DEPARTMENT OF ACCOUNTING, SCHOOL OF SOCIAL
AND MANAGEMENT SCIENCES, WELLSPRING
UNIVERSITY, BENIN CITY.

COURSE LECTURER:
PROF. OKOYE A. E.

SEPTEMBER, 2019
INTRODUCTION

Accounting Theory can be classified in different ways. It can be classified in relation

to time periods. It can also be classified in terms of the level of information that is
expected from the accounting system that it represents. Theories are propositions from
which objectives and conclusions are derived. They can be positive or normative.
Accounting theories are therefore a set of broad principles that provide a general
frame of reference by which accounting practice can be evaluated and also guide the
development of new practices and procedures. These theories are formulated using
different approaches. These approaches could be traditional or new. In most cases, the
level of information needed by users as well as the way accounting information is
generated from the accounting system determines how accounting theories are
classified. In this paper therefore, issues such as the meaning and types of theories
shall be discussed. What accounting theory means as well as the different approaches
to the formulation of accounting theories shall also be considered. Finally, the
classification of these theories which form the nexus of this paper will also discussed.

MEANING OF A THEORY

Theory is typically a set of propositions from which we reach our conclusions and
decisions. It could also be said to be a set of ideas used to explain real-world
observations. Furthermore, a theory has also been described as the coherent set of
hypothetical, conceptual and pragmatic principles forming the general framework of
reference for a field of inquiry.
According to Manukriti (2019), a theory can be described simply as the logical
reasoning underlying the statement of a belief. Whether the theory is accepted
depends on:
 how well it explains and predicts reality
 how well it is constructed both theoretically and empirically
 how acceptable are the implications of the theory to a body of scientists,
professionals and society as a whole.
When we exercise our professional judgement, we are applying a theory.
There are 2 types of theories:
1. Positive theories–describe how people do act, regardless of if it is good or not and
explain why people act like this.
2. Normative theories–are prescriptive –they describe how people should act in order
to achieve a ‘good’ outcome.
These two theories can assist each other. For example, normative theorists say how we
should classify a certain lease and then positivists test this to see how accountants
actually are testing it. Or positive theory can provide an understanding of the role of
accounting which, in turn, can form the basis for developing normative theories to
improve the practice of accounting. (Manukriti, 2019).

MEANING OF ACCOUNTING THEORY

Hendriksen (1977), defined Accounting Theory as ‘a set of broad principles that (1)
provide a general frame of reference by which accounting practice can be evaluated
and (2) guides the development of new practices and procedures’. This definition
allows us to perceive accounting theory as providing a coherent set of logically
derived principles that serve as a frame of reference for evaluating and developing
accounting practices. McDonald 1972 argues that a theory must have three elements:
(1) encoding of phenomena to symbolic representation, (2) manipulation or
combination according to rules, and (3) translation back to real – world phenomena.
Each of these theory components is found in accounting. First, accounting employs
symbolic representations or symbols; ‘debit’ , ‘credit’ , and a whole terminology are
proper and unique to accounting. Second, accounting employs translation rules;
encoding (symbolic representations of economic events and transactions) is a process
of translation into and out of symbols. Third, accounting employs rules of
manipulation; techniques for the determination of profit may be considered as rules
for the manipulation of accounting symbols.

APPROACHES TO THE FORMULATION OF ACCOUNTING THEORY

Manukriti (2019) highlights some approaches to the formulation of accounting
theories. These approaches are discussed below:
Traditional approaches: Traditional approaches cover: non-theoretical &
theoretical. Non-theoretical approaches to accounting theory are concerned with
developing a theory or accounting techniques and principles that will be useful to
users, particularly decision makers. This approach can be developed in a pragmatic or
authoritarian way. In essence, this is the approach the accounting profession has used
in the past to develop an accounting theory and it is fairly apparent it has not been able
to resolve conflict in accounting practices or principles. Theoretical approaches to the
development of an accounting theory are many but Riahi-Belkaoui, in his text
Accounting Theory, categorizes these as: deductive & inductive, ethical &
sociological, economic & eclectic.

Deductive approach. This approach involves developing a theory from basic

propositions, premises and assumptions which results in accounting principles that are
logical conclusions about the subject. The theory is tested by determining whether its
results are acceptable in practice. Historical cost accounting was also derived from a
deductive approach.
Inductive approach. For this approach we start with observed phenomena and move
towards generalized conclusions. The approach requires empirical testing, i.e. the
theory must be supported by sufficient instances/observations that support the derived
conclusions. Quite often the deductive and inductive approaches are mixed as
researchers use their knowledge of accounting practices. As Riahi-Belkaoui states:
General propositions are formulated through an inductive process, but the principles
and techniques are derived by a deductive approach.
Sociological approach. This is actually an ethical approach that centres on social
welfare. In other words, accounting principles and techniques are evaluated for
acceptance after considering all effects on all groups in society. Thus, within this
approach we would need to be able to account for a business entity’s effect on its
social environment.
Economic approach. This approach focuses on general economic welfare. Thus
accounting principles and techniques are evaluated for acceptance depending on their
impact on the national economy. Sweden, in its national GAAP, uses an economic
approach to its development. The IASB in developing its standards does tend to take
an economic approach into account. For example, the current discussion on
accounting for leases focuses on the effect that a standard requiring the capitalization
of all leases, whether finance or operating, might have on the economy or business in
general. Traditionally, accounting standards have been set without considering
economic consequences but lobby pressures from groups who perceive themselves as
being affected can be strong (Riahi-Belkaoui, 2014).
Eclectic approach. This is perhaps our current approach where we have a
combination of all the approaches already identified appearing in our accounting
theory. This approach has come about more by accident than as a deliberate attempt,
due to the interference in the development of accounting theory by professionals,
governmental bodies and individuals. This eclectic approach has also led to the
development of new approaches to accounting theory.
Regulatory approaches. Many would regard this as the approach we currently have
to accounting theory. They hold this view because to them it does not appear that
standards, even those of the IASB, are based on broad, relevant theories but are
developed as solutions to current conflicts that emerge in our attempts to provide
useful information to users. Indeed, they might argue that new standards are only
developed when a particular user complains about misinformation or non-information.
But there are questions to consider if we do adopt this approach to the development of
accounting theory. In the main, these questions centre on whether we should adopt a
free market approach to the regulation, a private sector regulatory approach or public
sector regulatory approach. This regulatory approach is also one that tends to identify
solutions to difficulties that have occurred in our reporting rather than providing us
with a theory that anticipates the issues.

New approaches. These attempt to use both conceptual and empirical reasoning to
formulate and verify an accounting framework (Rialhi Belkaoui 2014). The
approaches are: events & behavioural, human information processing & predictive as
well as positive.
Events approach. The events approach was developed in 1969 by George Sorter and
was defined as ‘providing information about relevant economic events that might be
useful in a variety of decision models’. The events approach leaves the user to
aggregate and assign weights and values to the event. The accountant would only
provide information on the economic event to the user, he would not assume a
decision model. Thus, for example, in the event approach, income statement would
not indicate financial performance in a period but would communicate events that
occurred during the period without any attempt to determine a bottom line. Research
has shown that structured/aggregate reports are preferable for high-analytic decision
makers but not for low-analytic decision makers. Thus, the success of the events
approach is dependent on the analytical skills of the user. Users, in attempting to
evaluate all information provided, may reach ‘information overload’. No criteria have
yet been developed for the choice of events to be reported. It will probably prove
difficult to measure all characteristics of an event (Rialhi Belkaoui 2014).
Behavioural approach. The behavioural approach attempts to take into account
human behaviour as it relates to decision making in accounting. Given that financial
reporting is about communicating information to users to enable them to make
decisions, a lack of consideration of how that information influences their behaviour is
indeed unforgivable. Studies in this area have tended to concentrate on the adequacy
of disclosure and usefulness of financial statement data and attitudes about corporate
reporting practices and materiality judgements and decision effects of alternative
accounting practices. In one of these areas - materiality, it was discovered that users’
assessment of materiality was individualistic and that the provider of the information
was not in the best position to determine materiality for a user. There is much work
still to do within the behavioural approach.
Human information processing approach. This is similar to a behavioural approach
in that it focuses on how users interpret and use the information provided.
Predictive approach. This approach attempts to formulate an accounting theory by
focusing on the predictive nature/ability of a particular method of reporting an event
that would be of use to the user. Such approaches are most prevalent in what could be
regarded as management accounting. Efficient market hypothesis, Beta models, chaos
theory are all examples of this approach.
Positive approach. This approach explains why accounting is what it is, why
accountants do what they do, and what effects these phenomena have on people and
resource utilisation. The approach is based on the proposition that managers,
shareholders and regulators are rational and that they attempt to maximize their utility.
The theory became known as ‘the Rochester school of accounting’. The positive
approach is completely opposite to the normative approach and attempts to explain
why accounting procedures and policies areas there are, whereas the normative
approach attempts to prescribe the accounting procedures and policies to be
implemented.

Classifications of Accounting Theory

Accounting Theory could be classified based on time periods. In this regard,

Accounting Theory, could be classified as follows:

(a) Periods before and after 1915: During this period, emphasis on accounting
statements was purely based on stewardship accounting.
(b) Periods Around 1945: During this period, emphasis was on decision usefulness
(c) Periods from 1975 Onwards: At this time, emphasis has shifted to
responsibility accounting. That is, Management Accounting.

However, in the remaining part of this work, attempt shall be made to consider how
other authorities classify accounting theory:

(a) Accounting Structure Theory.

(b) Interpretational Theory.

(c) Decision Usefulness Theory.

(d) Measurement Theory

(e) Information Theory

(a) Accounting Structure Theory:

Accounting structure theory, known by different names such as classical theory,

descriptive theory, traditional theory, attempts to explain current accounting practices
and predict how accountants would react to certain situations or how they would
report specific events. This theory relates to the structure of the data collection process
(accounting) and financial reporting. Thus, this theory is directly connected with
accounting practices, i.e., what does exist or what accountants do. The principal
contributors to the accounting structure theory as stated in Manukriti (2019) include:
William A. Paton (1922). Henry Rand Hatfield (1927). Henry W. Sweeney, (1936).
Stephen Gilman, (1939). W. A. Paton and A. C. (1940). A. C. Littleton, (1953).

This theory, basically concerned with observing the mechanical tasks which
accountants traditionally perform, is based on the assumption that the objective of
financial statement is associated with the stewardship concept of the management role,
and the necessity of providing the owners of businesses with information relating to
the manner in which their assets (resources) have been managed.

In this view, company directors occupy a position of responsibility and trust in regard
to shareholders, and the discharge of these obligations requires the publication of
annual financial reports to shareholders. Theories explaining traditional accounting
practice are desirable to obtain greater insight into current accounting practices, permit
a more precise evaluation of traditional theory and an evaluation of existing practices
that do not correspond to traditional theory. Such theories relating to the structure of
accounting can be tested for internal logical consistency, or they can be tested to see
whether or not they actually can predict what accountants do.

Limitations: The traditional theory is not concerned with judging the usefulness of
the output of accounting practice, but concentrates upon judging the means of
manipulation of input into output. The conventional approach tends to inhibit change,
and by concentrating upon generally accepted accounting principles makes the
relationship between theory and practice a circular one.

(b) Interpretational Theory

Interpretational theory emphasises on giving interpretations and meaning as

accounting practices are followed. This theory provides a suitable basis for evaluating
accounting practices, resolving accounting issues and making accounting propositions.
The principal writers in interpretational theory according to Manukriti (2019) include:
John B. Canning, (1929), Sidney S. Alexander, (1950), Edgar O. Edwards and Philip
(1961), Robert T. Sprouse and Maurice Moonitz,

The above writers in interpretational theory are more analysts and explicators than
advocates and preachers. They analyse and assess what accountants do and seek to do,
they undertake to explain a phenomenon to accountants, and help in understanding the
implications of using accounting concepts in the real business situation. For example,
Sprouse and Moonitz suggest that the assets valuations should be made in terms of
their future services (Manukriti 2019).

In ‘accounting structure’ theory, accounting concepts are un-interpreted and do not

reflect any meaning except actual data resulting from following specific accounting
procedures. Asset valuations, for example, are the result of following a specific
method of inventory valuation and depreciation.

Similarly, specific rules are followed for the measurement of these revenues and
expenses. Interpretational theory gives meaningful interpretations to these concepts
and rules and evaluate alternative accounting procedures in terms of these
interpretations and meanings. For example, it can be said that FIFO is the most
appropriate if objective is to measure current value of inventories. In this case,
selection of FIFO in interpretational theory is made with a view to suggest specific
result and interpretation. It is argued that empirical enquiry should be made to
determine whether information users attach the same interpretations and meanings
which are intended by producers of information.
Items of information vary as to degree of interpretation; some items by nature reflect
higher degree of interpretation and some items are subject to many interpretations. For
example, the item cash in balance sheet is fairly well understood by users to mean
what preparers intend it to mean. On the contrary, the items like deferred expenses and
goodwill may not reflect any specific interpretation. The role of interpretational
theories is to build a correspondence between the interpretations of producers and
users as to accounting information. This theory attempts to find ways to improve the
meaning and interpretations of accounting information in terms of experiences about
human behaviour and information processing capacity. Many of the prominent
interpretational theorists advocate current cost or values.

(c) Decision-Usefulness Theory

The decision usefulness theory of accounting explains the relationship between useful
decisions and accounting principles and concepts. This theory explains how useful
decisions are made using proper judgment. The decision-usefulness theory of
accounting provides direction for all accounting and financial reporting choices.
Under this theory, the primary objective of financial reporting is to provide
information that is useful in making investment decisions. 

Professor Staubus was the first to explicitly identify that objective and to link it to
enterprise cash flows or a cash flow-oriented view of how assets and liabilities are
measured. Staubus' work has surged in importance in recent years as the debate about
accounting's underlying theoretical framework is being re-examined by standard
setters worldwide. Staubus developed the “decision-usefulness theory of accounting”
with his dissertation, An Accounting Concept of Revenue in 1954, and two subsequent
articles in The Accounting Review (1958 and 1959). The theory was presented in his
1961 book, A Theory of Accounting to Investors.

The decision-usefulness theory emphasises the relevance of the information

communicated to decision making and on the individual and group behaviour caused
by the communication of information. Accounting is assumed to be action-oriented—
its purpose is to influence action, that is, behaviour; directly through the informational
content of the message conveyed and indirectly through the behaviour of preparers of
accounting reports. The focus is on the relevance of information being communicated
to decision-makers and the behaviour of different individuals or groups as a result of
the presentation of accounting information. The most important users of accounting
reports presented to those outside the firm are generally considered to include
investors, creditors, customers, and government authorities.

However, decision usefulness can also take into consideration the effect of external
reports on the decisions of management and the feedback effect on the actions of
accountants and auditors. Since accounting is considered to be a behavioural process,
this theory applies behavioural science to accounting. Due to this, decision-usefulness
theory is sometimes referred to as behavioural theory also. In the broader perspective,
decision-usefulness studies analyses behaviour of users of information. A behavioural
theory attempts to measure, and evaluate the economic, psychological and
sociological effects of alternative accounting procedures and modes of financial
reporting.

In adopting the decision usefulness theory or approach, two major aspects or questions
must be addressed.

First, who are the users of financial statements? Obviously, there are many users. It is
helpful to categorize them into broad groups, such as investors, lenders, managers,
employees, customers, governments, regulatory authorities, suppliers etc. These
groups are called constituencies of accounting.

Second, what are the decision models or problems of financial statement users? By
understanding these decision models preparers will be in a better position to meet the
information needs of the various constituencies. Financial statements can then be
prepared with these information needs in mind and in this way financial statements
will lead to improved decision making and are made more useful.

(d) Measurement Theory

Measurement is a significant part of scientific theory. Measurements are made as
demonstrated in accounting because they impart greater information. Because
measurement is an important function in accounting, it is worthwhile for us to
examine measurement theory.

What is Measurement?

Measurement is the assignment of numerals to objects or events according to rules.

Measurement involves the linking of the formal system, the number system, to some
aspect of objects or events by means of semantic rules. These rules consist of the
operations devised to make the operation (operational definition). Different scales of
measurement exist. These include; Nominal Scale, Ordinal Scale, Interval Scale and
Ratio Scale.

What is Accounting Measurement?

Accounting measurement is the computation of economic or financial activities in

terms of money, hours, or other units. An accounting measurement is a unit of some
measurable element that is used to compare and evaluate accounting data. Accounting
is often measured in terms of money. For example, when a company records weekly
sales at N10,000, the same company could record those transactions in terms of units
sold; for instance, 5,000 units (of N2.00 products).

Accounting is often quantified in terms of money but can also be recorded in terms of
alternative units, number of labour hours, number of jobs created, etc. Different
accounting measurements provide different views on the overall health of the
corporation. By using a variety of different accounting measurements, a person can
gain a more comprehensive perspective of a company's operations and more easily
compare them with those of other companies. In accounting we measure profit by:
first assigning a value to capital then calculating profit as the change in capital over
the period.

(e) INFORMATION THEORY

This theory is concerned with the amount of information generated from the
accounting system. For example, information generated from an accounting system
that uses the accrual basis is believed to be more than the amount of information
generated from an accounting system that uses the cash basis.

The value of information is viewed in terms of a cost – benefit criterion within the
formal structure of decision theory and economic theory. This is best stated as
follows:

…the case of the argument on behalf of accrual accounting rests on the premises that
(1) reported income under accrual accounting conveys more information than a less
ambitious cash – flow oriented accounting system would, (2) accrual accounting is
the most efficient way to convey this additional information, and as a corollary, (3)
the value of such additional information system exceeds its cost ( Riahi – Belkaoui
2004).

Accounting information is evaluated in terms of its ability to improve the quality of

the optimal choice in a basic choice problem that must be resolved by an individual or
a number of heterogeneous individuals. Accounting information must therefore be
free from material error. It must be precise, timely, complete and understandable.
CONCLUSION
This paper has considered the meaning of Theory as a concept. Different types

of theories have also been discussed. It also discussed the meaning of

Accounting Theory and the different approaches to the formulation of

accounting theories. It concluded with how these various accounting theories

can be classified. Theories are propositions from which objectives and conclusions

are derived. They can be positive or normative. Accounting theories are therefore a set

of broad principles that provide a general frame of reference by which accounting

practice can be evaluated and also guide the development of new practices and

procedures. These theories can be classified in line with time periods just as they

can also be classified in line with the level of information required. The latter

classifies accounting theory into: Structural, Interpretational, Decision

Usefulness, Measurement and Information Theories.

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