APPROACHES TO THE DEVELOPMENT OF ACCOUNTING THEORY

Accounting theory and its Nature :

 A theory is a supposition or system of ideas that serves as a logical
explanation of a phenomena
 Accounting Theory may be defined as logical reasoning in the
form of a set of broad principles that provide a general frame of
reference by which accounting practices can be evaluated, and
which guide the development of new practices and procedure.
 In accounting there has been a concurrent development in
accounting. While accounting was developing as a practical art, it
was also evolving a body of theoretical premises. The theoretical
evolution of accounting is of recent original, though its practical
development can be traced back five hundred years ago.
 Both the theoretical and practical approaches have contributed to
the existing organized body of knowledge, presently known as
accounting theory. Their approaches are different, but the purpose
is the same: to develop systematic accounting practices.

i. Under the practical approach, accountants have frequently

relied on trial and error as a means to improving accounting
practices. It has involved the following steps:
 Problem identification
 Development of several procedures to solve the problem
by practicing accountants
 Induction (general to Specific)
 Generalization
ii. The theoretical approach relied on logical, conceptual structure
to develop meaningful pattern of accounting practices. It has
involved the following procedures:
1
  Abstraction from the real world of business transactions
 Assumptions development about the transactions
 Deduction (specific to general)
 Conclusion

The Process of Theory Construction

The process of generalization is arrived at through the following
stages :
a) Observation: There are many disputes over the way in which
theories are constructed. But the construction of most of
theories, as also the laws of nature, begins with observation of
the phenomenon. We all know the study behind Newton’s
discovery of the law of gravitation. He observed the
phenomenon that all objects tossed up come down. This
provoked his inquiry which ultimately led to the cause.
b) Defining the problem: Careful definition of the problem will
provide objectivity or a track through which inquiry may be
conducted. If identification of problem is wrong or imprecise it
would be very difficult to reach meaningful conclusions. It may
be observed that the objective or goal of accounting is not
rigorously defined. As a result, until now there is no
comprehensive theory of accounting.
c) Formulation of hypothesis: .Science is a method of approach
to the entire empirical world, i.e., to the world which is
susceptible of experience by man., that we call a hypothesis. It
is the preliminary assumption adopted for the explanation of a
phenomenon. It is formulated before empirical evidences or
facts are gathered.
2
 d) Experimentation or testing the hypothesis: A hypothesis
established around the preliminary assumption must be tested
for probable conclusions. It is important to select the
appropriate method for testing the validity of hypothesis.
e) Verification: The final stage in the formulation of theory is
generalization through verification. If the observed
phenomenon after repeated trial or experimentation produces
the desired result the hypothesis is then said to be confirmed,
the logical consistency of the hypothesis is generalized to
formulate a theory. Scientific theories provide certain
.expectations or predictions about phenomena and when these
expectations occur, they are said to confirm to the theory. When
unexpected results occur, they are considered to be anomalies
which eventually require a modification of the theory or the
construction of a new theory. The purpose of the new theory or
the modified theory is to make the unexpected expected, to
convert the anomalous occurrence in to an expected and
explained
Illustration
You have observed that the timeliness of audit reports is dependent
on the number of staff in the audit department. You collect from 10
companies and reveal the following:
Company A B C D E F G H I J
Staff Size 5 7 15 11 3 8 18 20 10 6
Audit Report Days 59 54 29 42 65 50 22 14 42 58

3
Come up with a theory as to how the staff affects the efficiency of
audit reporting. Use the steps above. Use 95% confidence interval.
Assume the standard errors are 0.8446 and 0.0726 respectively for
the constant and variable.

Step 1- Observation: The number of days seems to vary with the

size of the audit staff with a large size generally taking shorter
periods to complete the report and the small sizes taking relatively
long period.
Step 2- Problem: Although the audit staff size seems to affect the
efficiency of the audit process, it is still not clear how this size
exactly affects the audit reporting period.
Step 3- Hypothesis Formulation : It normal practice to assume no
effect of one variable on the other (null hypothesis). Is this is
rejected after the testing, then the alternative is taken as theory.
H0: There is no significant effect of audit staff size on the efficiency
of the audit reporting
H1: Audit staff size improves the efficiency of audit reporting
NB:
 Size is the number of staff members in the department (X)
 Audit efficiency is represented by the number of days taken to
produce the audit report (Y). The short the period, the more
efficient the process.
4
 𝑌 = 𝛽0 + 𝛽1 𝑋 + 𝑒
 Mathematically: the coefficient of X (β1) is not significantly
different from zero
𝐻0 ∶ 𝛽1 ≈ 0

Step 4- Testing Hypothesis: For a linear relationship, assume

linear regression.
One must first collect the data before analyzing and coming up
with a generalization.

Company A B C D E F G H I J
X 5 7 15 11 3 8 18 20 10 6
Y 59 54 29 42 65 50 22 14 42 58

Automatic use of calculator:

1. Clear calculator memory: Shift -˃ mode -˃ 3 -˃ = -˃ =
2. Pick regression mode: Mode -˃ 3 -˃ 1
3. Enter data: X, Y -˃ 1 M+
4. Retrieve
a. β0: Shift -˃ 2 -˃ Replay Right -˃ Replay Right -˃ 1 -˃ =
b. β0: Shift -˃ 2 -˃ Replay Right -˃ Replay Right -˃ 2 -˃ =
c. β0: Shift -˃ 2 -˃ Replay Right -˃ Replay Right -˃ 3 -˃ =

5
β0: 74.23
β1: -2.98
r: -0.998

To test hypothesis compare the computed t with standard t from

the student t tables.

𝐵𝑒𝑡𝑎
𝐶𝑜𝑚𝑝𝑢𝑡𝑒𝑑 =
𝑆𝑒
74.23
𝐶𝑜𝑚𝑝𝑢𝑡𝑒𝑑 𝑡 𝑓𝑜𝑟 𝛽0 = = 87.7423
0.8446

−2.98
𝐶𝑜𝑚𝑝𝑢𝑡𝑒𝑑 𝑡 𝑓𝑜𝑟 𝛽1 = = −41.0468
0.0726
To test hypothesis, compare the output t with the standard t
(2.0000).
Since t of 41 is greater than the standard t of 2, reject null
hypothesis as assume that audit staff size (X) has a negative effect
of the number of days of the audit report.
β0 is also significant since its t of 87.7423 is greater than 2.

6
The resultant equation appears as follows:
𝑌 = 74.23 − 2.98𝑋

NB: The computer output appears as follows

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.997639103
R Square 0.995283781
Standard Error 1.241023917
Observations 10

ANOVA
df SS MS F Significance F
Regression 1 2600.178877 2600.178877 1688.273965 1.35536E-10
Residual 8 12.3211229 1.540140363
Total 9 2612.5

Coefficients Standard Error t Stat P-value Lower 95%

Intercept 74.2307429 0.844623715 87.88616941 3.13498E-13 72.28303712
- -
X -2.983567271 0.072612999 41.08861113 1.35536E-10 3.151013147

Step 5- Verification and Generalisation: The theory is

confirmed after several verification tests.

Theory: Audit Staff size improves audit efficiency

Characteristics of a Good Theory

A good theory should fulfil the following criteria :
7
a) It should explain or predict phenomena, i.e., they should be
empirical.
b) Theories should be capable of being tested empirically. Theories
which fail tests are not of universal applicability, therefore, must
be replaced by better or non-refutable theories.
c) Theories should be consistent both internally and externally.
Internal consistency is present when the analytical properties of
theory ensure that the given theory predicts the same outcome in
every identical case. External consistency implies that the theory
should be consistent with theories in other disciplines.
d) A theory should be exhaustive so as to cover the full range of
variations relating to the nature of the phenomena is question.
e) Theory should be helpful in providing guidelines for research into
empirical problems.
Approaches to Accounting Theory
Several approaches to the development of accounting theory have
emerged in the last two decades. These approaches may be
identified as follows:
a) Descriptive Approach
b) Normative general Approach
c) Decision-making Approach
 Empirical
 Normative specific
d) Welfare

The Descriptive Approach

8
 Theories developed using the descriptive approach are essentially
concerned with what accountants do. A descriptive theory
describes a particular phenomenon as it is, without any value
judgment. It describes accounting practice as it is without
adjudging whether it is wrong or right.
 Such descriptive theories are concerned with the behaviour of the
practicing accountants and what they do. This approach
emphasizes accounting practice as the basis from which to
develop theory.
 In developing such explanations, descriptive theories rely on a
process of inductive reasoning, which consists of making
observations and of drawing generalized conclusions from those
observations.
 In effect, the objective of making observations is to look for
similarity of instances, and to identify a sufficient number of such
instances as will induce the required degree of assurance needed
to develop a theory about all the instances which belong to the
same class of phenomena.
 As applied to the construction of accounting theory, the
descriptive approach has emphasized the practice of accounting
as a basis from which to develop theories. This approach has
attempted to relate the practices of accountants to a generalized
theory about accounting.
 In this view, accounting theory is to be discovered by observing
the practices of accountants
 The descriptive approach results in descriptive or positive theories
of accounting, which explain what accountants do and enable
predictions to be made about behaviour, for example, how a
particular matter will be treated. Thus, it is possible to predict that
9
 the receipt of cash will be entered in the debit side of the cash
book.
 In effect, the descriptive approach is concerned with observing the
mechanical tasks which accountants have traditionally performed.
In 2012, the Institute of Chartered Accountants in England and
Wales stated that 'the primary purpose of the annual accounts of a
business is to present information to proprietors showing how
their funds have been utilized, and the profits derived from such
use'.
 Underlying the descriptive approach is the belief that the objective
of financial statements 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 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.
 With the growth of very large corporate enterprises, the
weakening of the links between ownership and management
created a need for a more elementary notion of stewardship, in
which the disclosure of financial information was aimed at
protecting shareholders from fraudulent management practices.
Sterling provides a perceptive comment on the significance of the
descriptive approach in the following terms: “Probably the most
ancient and pervasive method of accounting theory construction
is to observe accountants' actions and rationalize these actions by
subsuming them under generalized principles. For example, if the
accounting anthropologist has observed that accounting man
10
 normally records a conservative figure and generalizes this as the
principle of conservatism, then we can test this principle by
observing whether or not accounting man does in fact record a
conservative figure.' (Sterling, 2000.).
 It is evident that the descriptive approach to theory construction
in accounting plays a very influential role in shaping perceptions
of the problems of accounting and the manner in which they
should be solved.
 In effect, the Accounting Standards Committee has been
concerned with discussing the variety of practices used by
accountants and with reaching a consensus on the most feasible
basis on which to reduce the diversity of these practices through
the process of standardization.

The Normative General Approach

 The 2000s and 2000s began to witness a much greater concern on
the part of academic accountants with the problems of accounting
theory. In particular, the search for a 'general theory of accounting'
based on a coherent set of logical principles, was an attempt to
provide accounting with similar foundations as other sciences,
such as mathematics, physics and chemistry.
 Protagonists of the 'general theory school' argued that
'Accountants do not appear to have any complete system of
thought about accounting. There are unquestionably several
systems of thought about the practice of accounting: systems
which attempt to categorize the kinds of things accountants do in
practice.
 These systems are almost all the subject can boast of in the way
of a theory, and for this reason accounting lacks the sharpness, the
11
 progressiveness and the vitality of other technology.' (Chambers,
2005.).
 The initial stages in the debate on the needs for a coherent theory
of accounting was marked by the publication in 2005 of
Chambers' 'Blueprint for a Theory of Accounting'. This argued
that accounting theory and accounting research should be less
concerned with describing current practice, and should be more
concerned with the development of better accounting practice.
 It included an 'exposure list' in the form of four major propositions
as building blocks for a theory of accounting. Its particular
importance lay in the emphasis which it attached to the
construction of a normative general theory of accounting.
 The normative approach to theory construction is concerned with
establishing 'what should be', and in this context is less influenced
by observations of 'what is'. It asserts that it is feasible and
desirable to develop theories of accounting which are independent
of current practice.
 The normative approach reflected a degree of disillusionment
with the problem of relating accounting practice to economic and
social realities. It was concerned with the possibility of
developing normative theories which might serve the purpose of
imposing theoretical standards on the quality of information and
theoretical standards of relevance on the information output of
conventional accounting systems. In particular, it reflected a
concern with the lack of comparability between financial
statements arising from the use of a variety of alternative
accounting rules.
 Chambers' 'Blueprint for a Theory of Accounting' stated in clear
terms the nature and purpose of theory and practice: that 'It is
12
 necessary to distinguish between systems of rules relating to the
practice of accounting and a theory of accounting.
 A system of rules is necessary for the consistent practice of any
art, and it is useful to attempt to sort out the rules which appear to
be followed. Only if the rules are adequately described is it
possible to discover inconsistencies in the system.
 But adequate description does not assist in determining which of
two inconsistent rules should be adopted and which should be
abandoned. The question must be referred to a more fundamental
proposition or set of propositions, to the theory of the subject.'
(Chambers, 2005.)
 Normative theories are concerned essentially with stating specific
objectives which are regarded as imperatives, for example, 'that a
theory of business income should be addressed to the problem of
determining the amount which may be distributed to shareholders
during the accounting period whilst ensuring that the capital of the
business is not thereby diminished'. Such a statement of objective
typifies the sort of hypothesis on which normative theories are
based.
 Normative theories rely heavily on the process of deductive
reasoning, which begins with a basic set of propositions about the
subject under study, as seen in the example of 'business income'
mentioned above. Deductive reasoning is the converse of
inductive reasoning which, as we saw in the previous section, is
the basis of reasoning used in constructing descriptive or positive
theories. Deductive reasoning moves from the making of general
statements to the making of particular statements. The
construction of a theory is based on deductive reasoning.

13
 A major criticism of this approach is that if the assumptions are
stated broadly enough to secure general agreement, they may be
dismissed as self-evident. Alternatively, if they are stated
specifically, they may fail to gain general agreement. A good
example of this dilemma was the reception given to two
documents issued by the Accounting Principles Board in the
U.S.A., namely, 'The Basic Postulates of Accounting' ( 2011) and
'A Tentative Set of Broad Accounting Principles for Business
Enterprises' ( 2012). The hope was that these two studies would
provide the foundation for subsequent studies and for the issue of
further statements by the Accounting Principles Board. Postulate
A-2 mentioned in the first document stated that 'most of the goods
and services that are produced are distributed through exchange,
and are not directly consumed by producers'. Clearly, no one
would dispute that assertion. On the other hand, the principle
mentioned in the second document that 'profit is attributable to the
whole process of business activity' and the suggestion that
concepts of value should be brought into accounting was viewed
by some commentators as an 'accounting revolution'. The
Accounting Principles Board summarized the situation as follows:
'The Board believes, however, that while these studies are a
valuable contribution to accounting thinking, they are too
radically different from present generally accepted accounting
principles for acceptance at this time.' (A.I.C.P.A., 2012.)

Decision-making Approaches

14
The expansion of behavioural research into accounting during the
2000s resulted in an interest in decision making theories of
accounting. This mood was well captured in the following
statement by the American Accounting Association in 2001:

'To state the matter concisely, the principal purpose of accounting

reports is to influence action, that is, behaviour. Additionally, it
can be hypothesized that the very process of accumulating
information, as well as the behaviour of those who do the
accounting, will affect the behaviour of others. In short, by its very
nature, accounting is a behavioural process.' (A.A.A., 2001.)
Two types of decision-making theories of accounting have resulted
from this approach, namely,

i. Empirical theories
ii. Normative specific theories.

Empirical Approaches
 The early 2000s witnessed a substantial increase in empirical
research. One reason for this development was dissatisfaction
with the normative approach, which had failed to produce the
desired single and all-encompassing framework for treating the
problems of accounting theory.
 Indeed, none of the efforts invested in the 2000s in developing a
normative theory of accounting gained sufficient acceptance.
Many of the studies conducted produced untested conclusions,
and often contained untested value judgements about accounting.

15
 According to Caplan, 'They have neglected a fundamental aspect
of scientific reasoning-they provide no evidence to support their
logic except the opinions of authors. Although these theory
formulations often contain valuable insights about accounting, in
the final analysis they represent only 'armchair' theorizing, which
the reader can accept or reject depending on his own perceptions.
They simply do not stand by themselves as convincing and
compelling works or research. The essential difficulty is, of
course, one of methodology.' (Caplan, 2002.)
 As a reaction to the period associated with studies in normative
accounting theories, the empirical approach sought to make
accounting research more rigorous and to improve the reliability
of results. Sophisticated statistical techniques became
increasingly used for this purpose. Furthermore, the expansion of
university courses in accounting increased the number of students
with a quantitative background, who could conduct research in
this way.
 The university departments of accounting, desiring to enhance
their status within the universities, viewed the possibility of
empirical research based on the 'scientific method' as a useful
springboard to this end. The implications of the empirical
approach to research in accounting were significant for the
development of accounting theory.

The Normative Specific Approach

 The essential feature of Normative Theory is the existence of
value judgement. Normative Theories tend to justify what ought
to be, rather than what it is. It imposes on the accountants

16
 responsibility of determining what should be reported rather than
merely reporting what some on else has requested.
 Unlike empirical research, which concentrates on how users of
accounting information apply this information in decision
making, the normative specific approach to theory construction is
concerned with specifying the manner in which decisions ought
to be made as a pre-condition to considering the information
requirement.
 The normative specific approach focuses on the decision models
which should be used by decision makers seeking to make rational
decisions. This focus is seen as providing insights on the
information needs of decision makers, as a basis for developing
accounting theory.
 The normative specific approach is used in this text as a basis for
examining the information needs of investors and employees.

The Welfare Approach

 The welfare approach is an extension of the decision-making
approaches, which considers the effects of decision making on
social welfare. Basically, decision-making approaches limit the
field of interest to the private use of accounting information.
 If accounting information had a relevance limited to private
interests, the decision-making approaches would provide a
sufficient analysis of information needs. It is because of the
external social effects of decisions made on the basis of
accounting information that there is imputed a social welfare
dimension to accounting theory.
 The theoretical objective of the welfare approach is the
maximization of social welfare, which is defined as the benefits
17
 accruing to all members of society from decisions made by
individuals about the use of resources under their control. In this
respect, a disadvantage of the classical individual decision-
making approach which hitherto has been reflected in the debate
about accounting policies is that it does not provide a basis for
developing accounting policies which would maximize social
welfare. In this respect, the Trueblood Report took the view that
the appropriate policy for accounting was the provision of
information for making economic decisions (A.I.C.P.A., Study
Group on Financial Objectives, 2003).
 Implicit in this view is that accounting should provide information
for decision making by individuals, without any consideration of
social welfare effects. As May and Sundem pointed out, such a
delineation of what accounting policy makers should be
concerned with precludes the possibility of making comparison
among alternative policies having different social welfare effects
(May and Sundem, 2006).
 The welfare effects which are associated with the use of financial
state-ments may be discussed from various standpoints.

i. The effects of financial information on the welfare of individual

decision makers may be deemed to be one important standpoint.
Since investment decisions imply the comparison of alternative
investments, external users of financial information require as
much consistency and comparability as is practicable between
the financial statements of enterprises generally. It was the lack
of comparability between the financial statements of enterprises
which lay at the root of much criticism of the accounting
profession in the 2000s, and led to the setting up in the United
Kingdom of the Accounting Standards Committee in 2000. The
18
 Press took the view that the accounting profession had a duty to
increase the quality of reported financial information to give
better protection to shareholders and other interested users of
company financial reports.
ii. The effects of financial information on social welfare may also
be seen from the standpoint of the distortion arising from the
possession of superior knowledge by one segment of a
particular group of users, which would have consequential
changes in the distribution of wealth within the group. For
example, if an investor has access to inside information about
an enterprise, and this information is not freely available to
other investors, he would be able to make decisions which may
improve his welfare at the expense of other investors.
iii. The effects of financial information may also be viewed from
the standpoint of the allocation of resources in the economy.
Financial statements provide the investors with data which
assist in establishing the market price of company shares. There
is research evidence to show that accounting data have an
important effect on share prices. Ideally, financial reports
should contain data which make it possible for investors to
evaluate investment opportunities, if the allocation of resources
throughout the economy is to maximize social welfare in
accordance with classical economic theory.
iv. The approaches to accounting theory which have been
mentioned so far assume that information is a free commodity,
and therefore that no costs are incurred in producing
information. Clearly, from a social welfare viewpoint, costs are
significant in considering the level of information to be made
available, given that resources are scarce and could be
employed in other activities. The costs of collecting and
19
 processing data and distributing information should be taken
into account in considering the level of information provided to
users. The difficulty which stands in the way of developing this
analysis further lies in the problem of defining and measuring
the benefits associated with the use of information, for the
optimum level of information output ought also to be seen from
the perspective of the payoffs associated with costs.
v. The effects of financial information on welfare may be viewed
from the standpoint of the vested interests of groups within an
organization. It is evident that the alteration of accounting
policies in favour of one group and away from another group
will affect the distribution of income and wealth within society.
In this respect, the movement towards disclosing information to
employees and the concept of social responsibility accounting,
are clearly causing such a change

The roots of accounting theory:

The development in accounting theory has been influenced by the
technological changes and advances in knowledge in many other
related disciplines. The major disciplines which have influenced
such development are:
i. Decision Theory
ii. Measurement Theory, and
iii. Information Theory
These three disciplines are perceived to be the roots of accounting
theory.

Decision theory:

20
The essence of this theory is that decision-making is not an intuitive
process but a conscious evaluation of the possible alternatives that
leads to best result or optimises the goal. It is a logical sequence that
involves the following stages:
i. Recognition of a problem that needs decision,
ii. Defining all the possible alternative solutions,
iii. Compiling all the information relevant to these solutions,
iv. Assessing and ranking the merits of the alternative solution,
v. Assessing the best alternative solution by selecting that one
which is most highly ranked and,
vi. Valuing the decision by means of information feedback.

Decision theory is both descriptive and normative. As a descriptive

process it attempts to explain how decisions are made, while as a
normative process it suggests which decision is to be made.
Decision theory is significant in the conceptual framework’s
objectives and qualities of accounting information.

Measurement theory:
There is a clear relationship between accounting and measurement
theory. Such relationship has been subjected to extensive analysis
by the eminent writers like Chambers, Ijiri and Mattessich.
Accordingly, accounting has been defined as a measurement
discipline that pertains to .the quantitative description and projection
of income circulation and of wealth aggregates. in explicit monetary
terms.
Thus, although the term measurement has been typically defined as
the assignment of numerals to objects or events according to rules
in relation to accounting measurement implies financial attributes of
economic events that we call accounting valuation. Measurement
21
 theory is normative in character. Therefore, accounting as a
measurement discipline requires specification as to the following:
i. The events or objects to be measured: This is of paramount
importance because, the .identified relationship between
accounting and measurement theory would allow.... to convey
clearly the objectives of accounting.... This indicates that the
identification of accounting property would allow us to explain
more clearly and consistently the purposes, procedure, limitations
and theoretical foundation of accounting.
ii. The standard or scale to be used: One of the fundamental
properties of measurement theory with respect to assigning
numerals to objects or events is that they must be related to a
common numerical relational system. For example, if we assign 3
ft. to represent the length of an object, we must assign the same
common scale to another object so as to make them amenable to
addition and subtraction. This additivity, as Chambers suggests,
is the key to accounting measurement. In accounting, money is
the most common unit of measure, not because that it is
convenient but due to the ability of monetary unit to attach
common significance to diverse events and objects which are
subjected to accounting measurement.
iii. Information theory: The dominant nature of accounting lies in
an information communication system. More precisely,
accounting is an application of the general theory of information
to the efficient economic operations. The significance of
information theory to accounting lies in the fact that it is a part of
the decision-making process that reduces uncertainty and thereby
provides a means to improve the quality of decision. Information
theory in particular can help accounting to resolve certain
important issues such as: What is an information? What is the
22
relationship between information and data ? What should be an
accounting information and what should be the system or systems
by which to communicate the information?

23