Teori Akuntansi Keuangan - Jones

Chapter 1
Sejarah dan
pengembangan
akuntansi
Awal sejarah Akuntansi
 There is evidence of double entry
accounting in many early civilisations:
 Chaldean–Babylonian
 Assyrian
 Sumerian
 Egyptian
 Chinese
 Greek
 Roman
Awal sejarah Akuntansi
 C. Littleton‟s seven preconditions for
the emergence of systematic
bookkeeping are:
 the art of writing
 arithmetic
 private property
 money
 credit
 commerce
 capital
Origins of double-entry
accounting
 Also known as „Italian bookkeeping‟ because it
was promulgated by Italian traders
 First-known double-entry accounting books are
those of Massari of Genoa in 1340
 Luca Pacioli, a Franciscan friar, is credited with
introducing double-entry bookkeeping because
his is the first published discussion on the topic
(1494), in which:
 he described the use of debits and credits to
secure a double entry
 he advised the computation of a periodic profit
and the closing of the books
Cushing‟s 11 developments
1. Introduction of specific journals
2. Periodic financial statements
3. Double-entry system extended to other types
of organisations, e.g. monasteries, the State
4. Separate inventory accounts for different types
of goods
5. Accounting acquired a better status,
characterised by:
 need to inform absentee investors
 need for auditing
 need for cost accounting
 reliance on concepts of continuity,
periodicity and accrual
Cushing‟s 11 developments (cont‟d)
6. Evolution of three methods of treating fixed
assets by the 18th century
7. Development of depreciation methods from
1915 onwards
8. Emergence of cost accounting in the 19th
century
9. Development of techniques of accounting for
prepayments and accruals in the second part
of the 19th century
10. Development of fund statements (late 19th
and 20th centuries)
11. Development of accounting methods for
complex issues
Pengembangan prisnsip-
prinsip Akuntansi
 Management contribution phase (1900–33):
 management had complete control over the
selection of financial information disclosed
in annual reports
 Institution contribution phase (1933–46) and
professional contribution phase (1959–73):
 professional bodies played a significant role
in developing principles
 Overt politicisation phase (1973–present):
 movement towards a politicisation of
accounting
Pase Kontribusi Manajemen
(1900–33)
 Characterised by ad hoc solutions to
urgent problems and controversies
 Lack of theoretical support
 Focus on minimisation of income
taxes
 Smoothing of earnings
 Complex problems avoided in favour
of expedient solutions
(1900–33)
Significant influences of the period

 Interest as a cost controversy:
 the need to invest large amounts of
capital for long periods increased
overhead
 the inclusion of overhead in product
cost became an issue
 Growing effect of taxation of business
income
(1900–33)
Arguments for improvement in

standards of financial reporting
 From 1900, New York Stock Exchange
required corporations to publish annual
financial statements
 Calls for protection of investors
 Board of Examiners established in 1917
to create a uniform certified practising
accountant (CPA) examination
Pase Kontribusi Institusi
(1933–46)
 Increasing role of institutions on development of
accounting principles:
 creation of the Securities and Exchange
Commission to administer federal investment
laws
 emergence of accounting principles
 companies were permitted to choose their
accounting methods but had to disclose them
 Committee on Accounting Procedure (CAP)
began issuing accounting research bulletins
(ARBs) in 1938
Pase Kontribusi Profesional
(1959–73)
 Establishment of the Accounting Principles
Board (APB) and the Accounting Research
Division
 The APB was unsuccessful and was
criticised for being over-dependent on
professional associations:
 no established theoretical framework
 authority of its statements not clear-cut
 alternative treatments allowed flexibility
in the choice of accounting techniques
Overt politicisation phase
(1973–present)
 Development of a theoretical
framework
 Emergence of various interest groups
 Metcalf report released:
 charged that US „big eight‟
accounting firms monopolise the
auditing of large corporations and
control the standard-setting process
 made recommendations aimed at
enhancing corporate accountability
History of accounting in
Australia
 Same major phases as US accounting
 For much of the 19th century, most
colonies adopted the British model of
companies legislation
 Sydney Stock Exchange (SSE) also
influenced accounting practices:
 from 1925, SSE demanded publication
of balance sheets and profit-and-loss
accounts
 such disclosures sometimes preceded
legislation by many years
Institutional contribution
phase in Australia
 Professional opinions on the general
principles of accounting practice were
released in 1937
 The Commonwealth Institute of
Accountants (CIA) appointed a Committee
on Accounting Principles (CAP) in 1938
 The Institute of Chartered Accountants in
Australia (ICAA) issued the first in a
series of Recommended Accounting
Principles in 1944
Institutional contribution phase in
Australia (cont‟d)
 Corporate collapses and the 1960s mining share
boom meant a regulatory agency was required to
protect investors:
1974: The Interstate Corporate Affairs
Commission was created to bring about
uniformity in state companies legislation
1979: The National Companies and Securities
Commission (NCSC) was established
1981: All states adopted the Commonwealth
Companies Act
1989: The Australian Securities Commission
(ASC) was created to replace the NCSE
Professional contribution phase
in Australia
 In the 1960s, the ICAA created
several research committees on
accounting principles
 In 1965, the Accounting Research
Foundation was established by the two
accounting bodies, and:
 was responsible for creating
accounting standards in Australia
 contributed to the development of a
conceptual framework
Politicisation of accounting
phase in Australia
 Corporate collapses of the 1960s led to the
introduction of legislation to regulate
accounting:
1983: Companies and Securities
Legislation (Miscellaneous Amendments)
Act 1983 (Cth) required companies to
comply with ASRB-approved accounting
standards
1991: Australian Accounting Standards
Board (AASB) was established
Link between accounting
and capitalism
 The Sombart thesis argues that double-entry
bookkeeping has contributed to the development
of capitalism because:
 it permits the capitalist entrepreneur to plan,
predict and measure the impact of their
activities
 the separation of owners and business allows
the growth of the corporation
 Yamey argues that double-entry bookkeeping
was originally used only as a record of
transactions – not to keep track of profits and
capital
Chapter 2
The nature and
uses of accounting
Definitions of accounting
„Accounting is the art of
recording, classifying and
summarizing, in a significant
manner and in terms of money,
transactions and events which
are, in part at least, of a financial
character, and interpreting the
results thereof‟
Committee on Terminology of the American
Institute of Certified Public Accountants
(1953)
Definitions of accounting (cont‟d)
„The process of identifying,

measuring, and communicating
economic information to permit
informed judgments and decisions
by users of the information‟
American Accounting Association (1966)
Definitions of accounting (cont‟d)
The objective of financial reports
The provision of relevant and reliable
information, which is primarily
financial in nature, about economic
entities and designed to assist
various user groups to make and
evaluate economic decisions relating
to allocation of scarce resources
Based on the Australian Accounting Research
Foundation‟s Statement of Accounting Concepts
(SAC) No. 2
Accounting: an art or a
science?
• Those who see accounting as an art or
trade suggest that accounting skills
should be taught as would any trade, and
that a „legalistic‟ approach to accounting
is warranted
• Advocates of accounting as a science
suggest the more conceptual approach of
teaching foundations of accounting
measurement models and related
empirics
Accounting as a social
science
• Accounting is widely viewed in academia as a
social science, as argued by Mautz:
„Accounting deals with enterprises, which
are certainly social groups; it is concerned
with transactions … which have social
consequences and influence social
relationships; … it is primarily mental in
nature‟
• This view of accounting has created a schism
between academia and the profession
Types of accounting
measures
• Direct measures are actual measures of
an object or its attributes
• Indirect measures are derived indirectly
by an algebraic transformation of a set of
numbers that themselves represent
direct measure of some objects or
attributes
• Accounting measures can be classified as
a past measure, a present measure, or a
future measure
Types of accounting measures
(cont‟d)
• Accounting measures can be classified

as retrospective, contemporary or
prospective
• Measurements can be either
fundamental measurements or derived
measurements
Types of scales
• A nominal scale assists in determining
equality
• An ordinal scale assists in determining
greater and lesser
• An interval scale assists in
determining the equality of intervals
or differences
• A ratio scale assists in determining the
equality of ratios
Double-entry accounting
Type 1: Classificational double-
entry accounting
• Aims to maintain the fundamental
accounting equation:
assets = liabilities + owners‟ equity
• In this type of accounting, a debit
portrays a classification, while a
credit portrays another classification
Double-entry accounting (cont‟d)
Type 2: Causal double-entry

accounting
• Describes the cause–effect
relationship between an increment
and a decrement
• In this type of accounting, the value
of an increment (debit) is offset by
an equal value of a decrement
(credit)
Generally accepted
accounting principles (GAAP)
• The implicit framework within which
accounting is practised
• A guide to the accounting profession in
the choice of accounting techniques and
the preparation of financial statements
• The conventions, rules and procedures
included in GAAP have substantial
authoritative support
Major sources of GAAP in
the USA
• Financial Accounting Standards Board
(FASB) statements of financial
accounting standards (SFAS)
• Accounting Principles Board (APB)
opinions
• The American Institute of Certified
Public Accountants (AICPA) accounting
research bulletins (ARBs)
Sources of Australian GAAP
• Australian Corporations Law
• Approved Accounting Standards
(AASBs)
• Australian Accounting Standards (AASs)
• Statements of Accounting Concepts
(SACs)
• Exposure Drafts (EDs)
• Accounting Guidance Releases (AGRs)
• ASIC practice notes and policy
statements
Where Australian GAAP differs
from US GAAP
 The LIFO method of valuing inventory is
not allowed in Australia
 The liability method of accounting is
used for deferred taxes in Australia
 The pooling-of-interests method of
accounting for business combinations is
not allowed in Australia
 Changes in accounting policies or new
accounting standards cannot be applied
retroactively in Australia
Where Australian GAAP differs from
US GAAP (cont‟d)
 Non-current assets can be revalued to

market value in Australia
 Other current-value regulations are
more widespread in Australia than in
the USA
 The recognition criteria for assets,
liabilities, revenue and expenses is less
stringent in Australia than in the USA
Special GAAPs
Changing perceptions of GAAPs
• Not seen as a rigid set of measurement rules
• Their numerous applications differ, depending
on the circumstances
• There are individual GAAPs for:
– business enterprises
– government organisations
– regulated business enterprises
– non-profit organisations
– investment companies
– banks
Other comprehensive bases of
accounting (OCBOA)
Four criteria for OCBOA classification
1. A basis of accounting that is necessary to
meet regulatory requirements
2. A basis of accounting that may be used
for income tax returns
3. A basis of accounting based on cash
receipts and disbursements with or
without some accrual support
4. A basis of accounting resulting from the
application of a definite set of criteria
Problems with using OCBOA
statements
• OCBOA statements may not appear
as an acceptable or known
alternative to the user
• OCBOA statements may present
problems for the practitioner due
because of the lack of comprehensive
guidance available
GAAP, special GAAP or
OCBOA?
• GAAP provides uniformity and
comparability
• Special GAAP provides flexibility and
better avenues for dealing with
varying circumstances
• OCBOA is useful in unique
circumstances and reduces standards
overload
Little GAAP versus big GAAP
• According to SAC 1, company size is an
important factor in compliance
• Company size can be determined using
three criteria:
1. separation of ownership from control
2. the greater the economic or political
importance of an entity, the more
likely there are to be dependent
external users
3. financial characteristics (including
sales turnover and indebtedness)
Little GAAP versus big GAAP (cont‟d)
• A major issue of interpretation with the

SAC 1 criteria is that they are
expressed in qualitative rather than
quantitative terms
• APS 1 provides a list of exemptions, but
they are not necessarily denominated
by size, but rather by ownership
Conformity with standards
The Australian Accounting Research Foundation
(AARF) Accounting Policy Statement APS 1
suggests the following entities are not likely to
be reporting entities under SAC 1:
• close corporations
• family trusts
• partnerships
• exempt proprietary companies
• sole traders
• wholly owned subsidiaries of Australian
reporting entities
Definition of a small company
In contrast to the AASB, the FASB defines a
small company in quantitative terms:
• operations are relatively small, with total
revenues of less than $5 million
• the company is owner-managed and has
few other owners, if any
• all owners are actively involved in
conducting the enterprise‟s affairs
• the transfer of ownership interests is
infrequent
• the company has a simple capital structure
Definition of a public company
FASB defines a public company as:

• a company that is required to file
financial statements with the
Securities and Exchange Commission
• a company whose securities trade in
a public market
Users of financial statements
• The primary users of public

companies‟ financial statements are
financial analysts and shareholders
• The primary users of private
companies‟ financial statements are
owner-managers and creditors
Different users of financial
statements
Statement number 4 of the APB
identifies the following different user
groups:
owners, creditors and suppliers,
management, taxing authorities,
employees, customers, financial
analysts and advisers, stock
exchanges, lawyers, regulatory or
registration authorities, financial
press and reporting agencies, trade
associations and labour unions
Individual statements for
different users?
• Statement 4 of the APB considers the
difficulty, cost and confusion involved in
providing individual statements for
different users
• According to SAC 2, the objective of
financial reporting is to serve the needs of
financial-statements users in general and
not the particular needs of specific users
• SAC 1 and SAC 2 do not differentiate
between the information requirements of
different user groups
Little GAAP committee
In the USA in 1974, the Committee on
Generally Accepted Accounting Principles for
smaller and/or closely held businesses was
formed.
Four basic questions were considered:
1. Are there any differences in the application
of generally accepted accounting
principles, and, if so,
2. On what basis should the different
applications be determined?
3. What differences would be appropriate?
4. What impact would this have on the
independent CPA?
Conclusions of the little GAAP
committee
• The same measurement principles
should be applied in all entities‟
financial statements because
measurement should be independent of
the nature of the users
• The nature of the information disclosed
may vary depending on users‟ needs
• There should be a distinction between
those disclosures required by the GAAP
and additional or analytical disclosures
Changes in the USA
• FASB suspended the earnings per share
and segment disclosure requirements
for reporting by private companies
• In contrast to the AASB, the FASB
started including size tests that
exempted small and private companies
from certain requirements
Private companies
The ICPA Technical Issues Committee recommend-
ed changing or eliminating 11 accounting and
disclosure requirements for private companies:
• leases
• capitalisation of interests
• imputed interests
• compensated balances
• business combinations
• troubled debt restructuring
• research and development costs
• discounted operations
• tax benefit of operating loss carried forward
• deferred income taxes
• investment tax credits
Objections to having two sets
of GAAP
• Improvements in reporting to one group of
users should also result in improved reporting
to other groups
• All companies operate in the same
environment, face similar economic
conditions, and could have the same types of
transactions
• Different accounting requirements for different
companies within an industry group could
distort financial comparisons
• Most private companies would eventually
become public
Changes to accounting policy
AASB 1001 notes that policies may be
abandoned or changed for the following
reasons:
• introduction or variation in statutory
requirements, including an approved
accounting standard
• introduction of or variation in
statements of accounting standards
• a decision in the interests of
improved financial reporting
Why do managers make
accounting method changes?
According to Foster:
• compliance with regulatory mandates
• consistency with the accounting model
• presentation of economic reality and
what is „true and fair‟
• comparability with other firms in the
same industry
• economic consequences to the firm
Income smoothing
• Income smoothing represents an attempt on
the part of the firm‟s management to reduce
abnormal variations in earnings to the
extent allowed under accounting and
management principles (Beidelman)
• AASB 1001 tries to prevent income
smoothing by requiring, upon a change in
accounting policy, disclosure of:
– the nature of the change
– the reason for the change
– the financial effect of the change
Beidelman‟s reasons for
smoothing
A stable earnings stream:
• suggests a stable level of future
earnings and dividends, and has a
favourable effect on the firm‟s shares
• counters the cyclical nature of
reported earnings and reduces the
correlation of a firm‟s expected
returns with market returns
Gordon‟s theory on income
smoothing
Four propositions
1. Corporate management selects among
accounting principles to maximise its
utility or welfare
2. The utility of management increases
with:
• job security
• level and rate of growth in income
• level and rate of growth in size of
corporation
Gordon‟s theory on income
smoothing (cont‟d)
3. Achievement of management
goals depends upon shareholders‟
satisfaction
4. Shareholders‟ satisfaction
increases with the rate of income
growth and stability of income
Given the above, management
would smooth reported income and
smooth the rate of growth in income
Constraints that lead to
income smoothing
• Competitive market mechanisms that

reduce options available to managers
• A management compensation scheme
that is linked to the firm‟s performance
• The threat of management displacement
Real smoothing versus
artificial smoothing
• „Real‟ smoothing refers to the
transaction that is undertaken or not
undertaken to smooth income
• „Artificial‟ smoothing refers to
accounting procedures that are
implemented to shift costs and/or
revenues from one period to another
(Dascher and Malcolm)
Further dimensions of
smoothing
• Smoothing through events‟ occurrence
and/or recognition (real smoothing)
• Smoothing through allocation over time
(artificial smoothing)
• Smoothing through classification
(classificatory smoothing)
(Barnea and others)
Income smoothing and the
• Income smoothing practices have
contributed to the development of
conceptual frameworks
• Standard setters believe that a
conceptual framework will reduce the
accounting alternatives available to
management
• Income smoothing is explicitly rejected
in SAC 4 and by the AAR
The selective financial
misrepresentation hypothesis
„The problem is not accidental but

instead results from contrived and
flexible reporting rules promulgated
by standard setters who have been
“captured” by the intended
regulatees and others involved in
the financial reporting process‟
(Revsine)
Why is selective financial
misrepresentation favoured?
• Managers prefer „loose‟ reporting
standards because they allow:
– income shifting between years
(bonuses)
– impressing the shareholders
– protecting their jobs by forestalling
takeovers
• Shareholders benefit from lower
standards because this lowers the
volatility of reported earnings,
increasing firm value
Why is selective financial
misrepresentation favoured? (cont‟d)
• Auditors prefer these rules for client

harmony
• Standard setters prefer financial
misrepresentation for self-protection
and altruism
• Academics may favour this
hypothesis because it provides the
opportunity for more theories and
proposals
Insulating the standard-
setting process
Revsine suggests the following:
• educating the public
• improving the process for selecting
and monitoring standard setters
• establishing new funding
arrangements
• creating independence for the
standard setters
Chapter 3
Traditional
approaches to the
formulation of an
accounting theory
Traditional approaches to
accounting theory
• Non-theoretical approaches
• Deductive approach
• Inductive approach
• Ethical approach
• Sociological approach
• Economic approach
The nature of accounting:
various images
Accounting as:
– language
– historical record
– current economic reality
– information system
– commodity
– ideology
Accounting as an ideology
Accounting has been perceived as:
• a means of sustaining and legitimising the
current social, economic and political
arrangements:
– Karl Marx maintained that accounting
perpetuates a form of false consciousness
and mystifies rather than reveals the true
nature of social relationships
– accounting has been perceived as a myth,
symbol and ritual that permits the creation
of a symbolic order within which social
agents can interact
• an instrument of economic rationality and a
tool of the capitalistic system
Accounting as a language
• Accounting is perceived as the language
of business
• According to Hawes, a language has
two components, being symbols and
grammatical rules:
– numerals and words and debits and
credits are examples of the symbols
unique to accounting
– in accounting, grammatical rules refer
to the general set of procedures used
Accounting as a historical
record
• Accounting records provide a history of
the manager‟s stewardship of the
owner‟s resources
• Measurement of the stewardship
concept has evolved over time, in the
following periods:
– pure custodial period
– traditional custodial period
– asset-utilisation period
– open-ended period
Accounting as a current
economic reality
• Balance sheets and income statements

should both be based on economic
reality rather than on historical costs
• The main objective of this image of
accounting is the determination of true
income
Accounting as an
information system
• Accounting links an information source or
transmitter (usually the accountant), a
channel of communication and a set of
receivers (external users)
• This view of accounting:
– assumes that the accounting system is
the only formal measurement system
in the organisation
– raises the possibility of designing an
optimal accounting system capable of
providing useful information
Accounting as a commodity
• Accounting exists because specialised
information is in demand and
accountants are willing and capable of
producing it
• There is a market for accounting
information with its derived demand
and supply
The nature of
accounting theory
• The primary objective of accounting
theory is to provide a basis for the
prediction and explanation of
accounting behaviour and events
• No single comprehensive theory of
accounting exists at present
Definitions of
accounting theory
Hendriksen defines accounting theory
as „a set of broad principles that:
1. provides a general frame of
reference by which accounting
practice can be evaluated
2. guides the development of new
practices and procedures‟
Definitions of accounting theory
(cont‟d)
McDonald argues that a theory must
have three elements:
1. encoding of phenomena to
symbolic representation
2. manipulation or combination
according to rules
3. translation back to real-world
phenomena
How accounting meets these
criteria
Accounting employs:
1. symbols (debit and credit)
2. translation rules
3. rules of manipulation
The two methodologies
• Descriptive methodology:
– attempts to describe accounting
practices that exist and are deemed
useful
• Normative methodology:
– attempts to justify what ought to be
rather than what is
Non-theoretical approaches
• The pragmatic approach:
– consists of the construction of a
theory that conforms to real-world
practices and suggests practical
solutions
• The authoritarian approach:
– consists of issuing pronouncements
for the regulation of accounting
practices
The deductive approach
Steps used to derive the deductive
approach
1. Specifying the objectives of
2. Selecting the „postulates‟ of
accounting
3. Deriving the „principles‟ of
accounting
4. Developing the „techniques‟ of
accounting
The inductive approach
Four stages
1. Recording all observations
2. Analysing and classifying these
observations to detect recurring
relationships
3. Inductive derivation of
generalisations and principles of
accounting from observations that
depict recurring relationships
4. Testing the generalisations
Comparing deductive and
inductive approaches
• In the inductive approach, the truth or falsity of
the propositions does not depend on other
propositions, but must be empirically verified
• In the inductive approach the truth of the
propositions depends on the observation of
sufficient instances of recurring relationships
• Accounting propositions that result from inductive
inference imply special accounting techniques
only with high probability
• Accounting propositions that result from
deductive inference lead, on the other hand, to
specific accounting techniques with certainty
The ethical approach
• The basic core consists of the concepts of
fairness, justice, equity and truth
• In general, the concept of fairness implies
that accounting statements have not been
subject to undue influence or bias
• The committee on auditing procedures
refers to „fairness of presentation‟ as:
1. conformity with GAAP
2. disclosure
3. consistency
4. comparability
The sociological approach
• Emphasises 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
judgements
The economic approach
• Emphasises controlling the behaviour of
macroeconomic indicators that result from
the adoption of various accounting
techniques
• The choice of different accounting
techniques depends on their impact on the
national economic good
• Accounting policies and techniques should
reflect „economic reality‟, and the choice of
accounting techniques should depend on
„economic consequences‟
Eclectic approach
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
Chapter 4
The regulatory
approach to the
formulation of an
accounting theory
The nature of accounting
standards
Accounting standards usually consist
of three parts:
1. a description of the problem to be
tackled
2. a reasoned discussion on ways of
solving the problem, then,
3. in line with the decision or theory,
the prescribed solution
Requirements under
accounting standards
Edey divides accounting standards into four types:
1. Requires accountants to tell people what they
are doing by disclosing the methods and
assumptions adopted
2. Aims at achieving some uniformity of
presentation of accounting statements
3. Calls for the disclosure of specific matters in
which the user may be called to exercise his or
her own judgement
4. Requires implicit or explicit decisions to be
made about approved asset value and income
determination
Reasons for establishing
standards
• To provide users with information about a firm‟s
financial position, performance and conduct
• To provide public accountants with guidelines
and rules of action
• To provide the government with databases on
variables that are deemed essential to the
conduct of taxation, regulation of enterprises,
planning and regulation of the economy, and
enhancement of economic efficiency and other
social goals
• To generate interest in principles and theories
among all those interested in the accounting
disciplines
Approaches to accounting
policy questions
• A representational faithfulness
approach:
– favours neutral reporting and the
pursuit of faithful representations
through the standard-setting process
• An economic consequences
approach:
– favours the adoption of standards
with good economic consequences
Pre-1999 standard-setting
arrangements
• Australian Accounting Standards Board
(AASB) was created in 1989
• The AASB replaced the Accounting
Standards Review Board (ASRB)
• The AASB has similar standard-setting
functions, but broader responsibilities
than the ASRB
The ASRB
• The ASRB was created in 1983 to improve
the enforceability of Australian accounting
standards
• At this time, the rules governing
compliance were outlined in APS1:
– members of the accounting profession
responsible for financial statement
preparation were to attempt to ensure
that any departures from accounting
standards were adequately disclosed in
the accounts
The ASRB (rules governing
compliance cont‟d)
– members of the accounting

profession who were auditors were
required to issue qualified audit
reports if a departure from an
accounting standard undermined the
presentation of a true and fair view
– if APS1 was not observed by
members of the profession, then the
councils of the two accounting bodies
could take disciplinary action
APS1 deficiencies
• APS1 only applied to members of the
profession
• APS1 only required mandatory
disclosure of non-compliance rather
than compliance
Legislative backing of the AASB
• In contrast to other boards of the AARF, the
AASB had a line of authority to the
government and not to the accounting
profession
• The accounting standards of the AASB have
legal backing
• If publicly listed companies do not comply,
they risk punitive action from the Australian
Securities Commission
• The Attorney-General and federal cabinet must
approve all 11 members of the AASB and
appoint the chairman
Functions of the AASB
• To develop a conceptual framework, not
having the force of an AASB standard, for the
purpose of evaluating proposed AASB
standards
• To review proposed AASB standards
• To sponsor or undertake the development of
possible AASB standards
• To engage in such public consultation as may
be necessary to decide whether or not it
should make a proposed AASB standard
• To make such changes to the form and
contents of a proposed AASB standard as it
considers necessary
The Public Sector Accounting
Standards Board (PSASB)
• Created in the early 1980s by the
ASCPA and the ICAA as a board of the
AARF
• It reviewed the standards for relevance
and applicability to the public sector
• It developed a conceptual framework
and accounting standards that were
compatible with private-sector
standards
Responsibilities of the PSASB
• To devise and implement a process for the
formulation and maintenance of AASs,
statements of accounting practice (SAPs) and
SACs of relevance to public sector reporting
entities
• To prepare AASs, SAPs and SACs of relevance
to public sector reporting entities
• To prepare and issue accounting guideline
releases and exposure drafts of AASs, SAPs
and SACs
• To keep under review existing AASs, SAPs,
SACs and accounting guideline releases
Other boards of the AARF
• The Auditing Standards Board (AuSB) is
responsible for promulgating
statements of auditing practice and a
conceptual framework for auditing
practice
• The Legislative Review Board (LRB)
reviews relevant companies‟ legislation
for consistency and applicability to
existing accounting standards
The AARF
• Funded jointly by the ASCPA and the

ICAA
• Primary function is to act as
secretariat to the AASB, PSASB and
other AARF boards
Principal duties of the AARF
• To provide the boards with relevant
technical advice on accounting and policy
matters
• To develop and write technical discussion
papers and accounting-theory monographs
• To develop, write, expose and issue
exposure drafts to provide whatever other
technical assistance the boards require. and
to release statements of accounting
concepts, accounting standards and other
releases on behalf of the boards
The Australian Securities and
Investment Commission (ASIC)
• Founded in 1991, the ASIC is the supreme
corporate regulator in Australia, and is
comparable to the Securities Exchange
Commission in the USA
• The ASIC oversees the administration and
compliance of the Corporations Law and
companies‟ legislation generally
• Members are appointed by the Governor-
General on the nomination of the
Commonwealth Attorney-General
Interpretation of accounting
standards
• The ASIC delegates responsibility for
standard setting for the AASB, however
company compliance with AASB standards
is enforced by the ASIC
• It is not always clear whether the AASB as
opposed to the ASIC should be clarifying or
interpreting accounting standards
• It has been argued that if the AASB sets
the standards then it should interpret their
meaning and applicability
The Urgent Issues Group
(UIG)
• Formed by the AARF and its boards
early in 1995
• The UIG‟s main function is to provide
timely guidance releases on urgent
accounting issues
• Any decision of the UIG can be
vetoed by the AASB and PSASB
Influence of the accounting
profession on standards
Standards that do not have support from
accountants and/or the business community
could result in:
1. lobbying by particular interest groups
2. non-compliance
3. refusal of companies to contribute to or
participate in the standard-setting process
4. threat of governmental regulatory
intervention
It is in the AARF‟s best interests to issue
standards that are accepted by the business
community and the accounting profession
Consultative groups
• Each board consults with members of

its consultative group to increase the
involvement of interested groups in the
standard-setting process
• Consultative group members include
representatives of the parties interested
in and affected by accounting standards
Exposure drafts
• Draft exposure drafts are prepared by
the boards and refined through
discussion
• The draft is then issued as an exposure
draft by the AARF, which invites
comment from all interested parties,
usually over a period of at least three
months
Finalisation of accounting
standards
• Draft is forwarded to the National Councils of the
Society and Institute and to the Federal Attorney-
General‟s Department and the Australian
Securities Commission
• After the exposure draft and consideration of
comments are received, a draft statement of
accounting concepts (or draft accounting
standard) is prepared
• A 30-day review period applies
• Statements of accounting concepts are issued by
the AARF and the AASB
• The AARF issues AASs
• The AASB makes and issues AASB standards
Comparability with
International Accounting
Standards
• This is an important aspect of
accounting standard setting in Australia
• Australian Accounting Standards carry
an endorsement indicating compatibility
with International Accounting Standards
• Where an Australian Accounting
Standard differs from an International
Accounting Standard, reasons for
material differences are given (where
appropriate)
Peirson Report 1990
• Commissioned to recognise defects
in standard setting by reviewing
existing institutional arrangements
for accounting standard setting in
Australia
• Reviewing comparable arrangements
internationally
• Recommending appropriate
arrangements for Australia
Recommendations of the
Peirson Report
• The formation of two broadly constituted
consultative groups, one for the private
sector and one for the public sector
• Replacement of the AARF with a
reconstituted Australian Accounting
Standards Foundation, which would be
independent of the accounting
profession, business and government
• The merging of the AASB and the PSASB
into a single national accounting
standards-setting body of the AASF
Benefits of the reforms
• Accounting standard setting will be independent
of interest groups including the accounting
profession, business and government
• There will be a significant increase in the numbers
involved in the standard-setting process
• Merging the PSASB and the AASB will enable
more efficient use of the scarce resources
available for standard setting
• There will be a coordinated national approach to
setting accounting standards
• Legislative backing for accounting standards will
continue
• The funding for the AASF will be broadly based,
insuring its independence
Rejection of the Peirson
Report
• The Peirson report was largely rejected
by the Attorney-General‟s Department
• Proposals may have been too far-
reaching and ambitious
• There may have been a perception that
the status quo was working satisfactorily
• It is most likely is that the government
did not wish to relinquish its control over
the standard-setting process
Changes effected by the
Peirson Report
• In 1994, broad-based consultative
groups were established
• Membership of the AASB was increased
from nine to 11 members
• The Attorney-General‟s Department
supported a merger of the AASB and
PSASB
Post-1999 structure and the
Corporate Law Economic
Reform Program Act
• The Corporate Law Economic Reform Program
(CLERP) was announced in 1997
• Under the new legislation, standard setting is
now within the domain of the federal treasurer
• Two questions addressed in CLERP Position
Statement No. 1 were:
1. How should existing standard-setting
arrangements and structures be reformed?
2. Should Australia continue to develop its own
accounting standards or adopt international
accounting standards?
Reforms to institutional
arrangements
Perceived deficiencies of the present system
according to CLERP
• Existing arrangements for accounting standards
setting are confusing and inefficient
• There is duplication between the AASB and PSASB
• Australian Accounting Standards are not well
understood internationally
• The standard-setting process is perceived to be
dominated by the accounting profession and there
is no real accountability to its users
• Accounting standards do not reflect modern
business practices
Changes proposed by CLERP
and adopted by the 1999 Act
• Creation of the Financial Reporting Council
(FRC) to oversee the setting of accounting
standards
• Creation of a new AASB
• The new AASB will follow the strategic
direction determined by the FRC
• Project advisory panels of experts on
particular subjects are to be used in the
development of standards
• The FRC will appoint members of the AASB
International harmonisation
Major recommendations by CLERP
• Australia should continue to harmonise its
standards with the International Accounting
Standards
• The prime focus of the AASB should be to
influence the development of high-quality
and relevant IASC accounting standards
• A key role of the FRC should be to ensure
that the AASB is committed to and works
towards the adoption of IASC standards
Benefits of adopting IASC
standards
• Many of Australia‟s trading partners in Asia
have now adopted IASC standards
• Foreign-listed companies are permitted by
the Australian Stock Exchange to register
using IASC standards
• The international profile of Australian
companies needs to be lifted to facilitate
access to foreign capital markets at a
lower cost
• Harmonisation will facilitate creation of a
common language around the world
Public accounting firms
• The most influential public accounting firms are:
– Ernst & Young
– Arthur Andersen
– Coopers and Lybrand
– KPMG Peat Marwick
– Price Waterhouse
– Deloitte Haskins & Sells
– Touche Ross
– Lavanthol & Horwath
• The work of public accounting firms consists of
auditing, accounting, tax and management-
advisory services
Users of financial statements
Direct users include:
• the owners of a corporation and its
shareholders
• creditors and suppliers
• the firm‟s management
• the firm‟s workers
• taxing authorities
• customers
Indirect users of financial
reports
Indirect users include:
• financial analysts and advisers
• stock exchanges
• lawyers
• regulatory or registration authorities
• the financial press and reporting agencies
• trade associations
• labour unions
• competitors
• the general public
• other government departments
Different users‟ needs
• Direct and indirect users have different
information needs
• Three kinds of financial statements may be
prepared:
– general purpose financial statements that
meet the common needs of the users
– specific purpose financial statements that
meet the needs of specific user groups
– differential disclosures may present
different figures for the user to select
Theories of regulation
Two major categories
• Public interest theories:
– maintain that regulation is supplied in
response to a public demand for the
correction of inefficient or inequitable
market prices
• Interest group or capture theories:
– maintain that regulation is supplied in
response to the demands of special-
interest groups in order to maximise
their members‟ income
Arguments against regulating
accounting
• Arguments for an unregulated market
use the agency theory to question the
existence of incentives for reliable and
voluntary reporting to owners
• Firms have an incentive to report
voluntarily to the capital market
because they compete for scarce
resources: failure to report might be
interpreted as bad news
Arguments for a regulated
market
• Those arguing for a regulated market use a
public interest argument
• Either market failures or the need to achieve
social goals dictates regulation of accounting
• Causes of market failures include:
– a firm‟s reluctance to disclose information
about itself
– the occurrence of fraud
– the underproduction of accounting
information as a public good
The free-market approach
• Assumes that accounting information is an
economic good that:
– is subject to the forces of demand and
supply
– results in an optimal amount of
information disclosed at an optimal price
• Advocates of a regulatory approach
maintain that there are market failures in
the private market for information
Market failures
• Explicit: In explicit market failure, the
quantity and quality of information differ
from the social optimum
• Implicit: Implicit market failures focus on
the following defects:
– monopoly control over information by
management
– naïve investors
– functional fixation
– misleading numbers
– diversity of procedures
– lack of objectivity
Private-sector regulation of
Advantages
• The AASB is responsive to various
constituents
• The AASB attracts as members people who
possess the necessary technical knowledge to
develop and implement alternative
measurement and disclosure systems
• The AASB is successful in generating a
reasonable amount of response from its
constituency base and in responding to this
input
Private-sector regulation of
Disadvantages
• The AASB lacks statutory authority and faces
the challenge of being overridden by
government
• The AASB has been accused of lacking
independence from dominating interests,
such as the accounting profession
• The AASB has often been accused of
responding too slowly to major issues that
are of crucial importance to some of its
constituents
Public-sector regulation of
Arguments in favour
• The ASIC acts as „creative irritant‟ and as a
catalyst for change, since the private sector
and market forces do not provide the
leadership necessary to effect such change
• The structure of securities regulation
established by the 1991 Corporations Law
serves to protect investors against
perceived abuses
accounting standards (cont‟d)
Arguments in favour (cont‟d)
• The ASIC is motivated by the desire to
create a level of public disclosure deemed
necessary and adequate for decision
making
• Unlike the AASB, the ASIC is secured
greater legitimacy through its statutory
authority
• Private-sector objectives may sometimes
contradict the public interest
accounting standards (cont‟d)
Arguments against
• There is a high corporate cost for
compliance with government regulation of
information
• Bureaucrats have a tendency to maximise
the total budget of their bureau
• There is the danger that standard setting
may become increasingly politicised
• Government regulation backed by police
power may hinder the conduct of research
and experimentation of accounting policy
and is not essential to achieving
standardisation of measurement
Accounting standards overload
• Too many standards
• Too detailed standards
• No rigid standards, making selective application
difficult
• General-purpose standards fail to provide for
differences in preparers‟, users‟ and CPA‟s needs
• General-purpose standards fail to provide for
differences between:
– public and non-public entities
– annual and interim financial statements
– large and small enterprises
– credited and non-audited financial statements
• Excessive disclosures and/or complex
measurements
Effects of accounting
standards overload
• Accountants may lose sight of their real
jobs because of the excessive data
required to comply with standards
• Audit failures may result because the
accountant may forget to perform basic
audit procedures
• The proliferation of complex accounting
regulations may lead to non-compliance
Solutions to the standards
overload problem
The AICAP Special Committee on Accounting
Standards evaluated the following possible
approaches:
• no change
• a change from the present concept of a set
of unitary GAAP for all businesses, to two
sets of GAAP
• change GAAP to simplify application to all
business enterprises
• establish differential disclosure and
measurement alternatives
Solutions to the standards overload
problem (cont‟d)
• a change in CPAs‟ standards for
reporting on financial statements
• an alternative to the GAAP as an
optional basis for presenting financial
statements
The outcome
• The AICAP Special Committee on
Accounting Standards recommended either
establishing disclosure and measurement
alternatives or adopting an alternative to
GAAP
• The alternative to GAAP rests on three
possibilities:
– a new basis accounting method (BAM)
– the cash or modified cash basis
– the income tax basis
The outcome (cont‟d)
• A BAM is out of the question because it
would create more costs than benefits
• The committee suggested that the
issuance of compiled, reviewed or
audited other comprehensive-bases-of-
accounting (OCBOA) financial
statements would help alleviate the
burden of accounting standards
overload for small non-public entitieS
Chapter 5
A conceptual
framework for
financial
accounting and
reporting
Conceptual framework
• A conceptual framework is a formal
set of interrelated concepts
specifying the function, scope and
purpose of financial accounting and
reporting
• In Australia, the SACs represent the
conceptual framework or constitution
for financial reporting
Conceptual framework (cont‟d)
• A conceptual framework can be
descriptive, prescriptive or a mixture of
both:
– a descriptive framework attempts to
develop a set of interrelated concepts,
which serves to codify and explain
existing financial reporting practices
– a prescriptive framework attempts to
develop a conceptual basis for what
financial accounting practices should
be
History of the conceptual
framework
• The need for a conceptual framework was
recognised in the USA after the stock market
crash of 1929
• Leaders of the profession recognised the
need to:
– establish basic principles on which to base
company reporting
– correct permissive accounting practices of
the 1920s
– restore public confidence in professional
accountants
The Committee on
Accounting Procedure (CAP)
• The first standard-setting body, which
was established by the American
Institute of Accountants in 1936
• The CAP published bulletins that
provided authoritative opinions or
recommendations on preferred
accounting practices
• The CAP, however, failed to provide a
Discontent in the 1950s
Academic and professional opinion of the
mid-1950s stressed the inadequacies of
company financial reporting:
• The historical cost model, generally
accepted in accounting practice at the
time, was not being applied consistently,
nor were its underlying principles well
understood
• A tradition was developing among
academics that was against the whole
principle of historic cost accounting
The Accounting Principles
Board (APB)
• The APB was established in the USA in
1959 to accelerate the development of a
• The APB set itself the following tasks:
– to establish basic postulates
– to formulate a set of broad principles
– to establish rules to guide the application
of principles in specific situations
– to base the entire program on research
APB Statement No.4
• This statement was titled „Basic
Concepts and Accounting Principles
Underlying Financial Statements of
Business Enterprises‟
• Basically descriptive, it did not provide
a conceptual framework, but influenced
Australian attempts to formulate
objectives of financial statements and
to develop a conceptual framework
Objectives according to
APB Statement No. 4
Paul Grady was commissioned by the APB
in 1963 to develop a more descriptive
framework, which was reflected in the
objectives of APB Statement No. 4:
1. Particular objectives of financial
statements are to present fairly, and in
conformity with GAAP, financial position,
results of operations and other changes in
financial position
APB Statement No. 4 (cont‟d)
2. The general objectives are:
a. to provide reliable information about the
economic resources and obligations of a
business enterprise in order to:
i. evaluate its strengths and
weaknesses
ii. show its financing and investments
iii. evaluate its ability to meet its
commitments
iv. show its resource base for growth
b. to provide reliable information about
changes in net resources resulting from
a business enterprise‟s profit-directed
activities in order to:
i. show expected dividend return to
investors
ii. demonstrate the operation‟s ability to
pay creditors and suppliers, provide
jobs for employees, pay taxes and
generate funds for expansion
iii. provide management with information
for planning and control
c. to provide financial information that
can be used to estimate the
earnings potential of the firm
d. to provide other necessary
information about changes in
economic resources and obligations
e. to disclose other information
relevant to statement users‟ needs
3. The qualitative objectives of financial
accounting are:
a. relevance
b. understandability
c. verifiability
d. neutrality
e. timeliness
f. comparability
g. completeness
Developments in Australia
• The development of a conceptual
framework in Australia followed a
similar pattern to that in the USA
• Australia was able to evaluate and
adapt APB and FASB initiatives for
Australian conditions
The conceptual framework in
Australia
• Australian academics such as Mathews and
Grant, and Chambers, proposed abandoning
the historical cost system in favour of some
form of current cost accounting system
• In response, the accounting profession
commissioned John Kenley, director of the
Accountancy Research Foundation (later the
AARF) to adapt Paul Grady‟s AICPA studies to
Australian conditions
• A largely prescriptive approach was adopted,
which has been very influential to this day
Elements of the Australian
strategy
Elements of the Australian strategy to develop
a conceptual framework were stated by a
previous AARF director as:
1. maximising the use of FASB thinking
2. influenced by the notion that the
importance of a conceptual framework
would not be oversold, but gradually
unveiled
3. the first stage of development was to be
the tentative identification of the building
blocks of a workable framework
Elements of the Australian strategy
(cont‟d)
4. the second stage was to be the selection of
certain building blocks to formalise specific
projects
5. the third stage was to be the investigation of
interrelationships between the building
blocks and any consequential redefinition of
those blocks
6. the fourth stage was to be the
commissioning of projects for the remaining
blocks
7. publication of the SACs would then
commence
Exposure drafts
Six exposure drafts were release between
1987 and 1990:
1. ED 42A (objectives of financial reporting)
2. ED 42B (qualitative characteristics of
financial information)
3. ED 42C (definition and recognition of
assets)
4. ED 42D (definition and recognition of
liabilities)
5. ED 46A (definition of the reporting entity)
6. ED 51A (definition of equity)
7. ED 51B (definition and recognition of
revenues)
SACs
Three SACs were released in August
1990:
1. SAC 1 „Definition of the Reporting
Entity‟
2. SAC 2 „Objectives of General
Purpose Financial Reporting‟
3. SAC 3 „Qualitative Characteristics of
Financial Information‟
The early 1990s
• Section 226(1) of the Corporations Law

(1991) specifically charged the AASB
with the responsibility of developing a
• SAC 4 „Definition and Recognition of
Elements of Financial Statements‟ was
released in March 1992
SAC 4
• Specifies the definition of and rules for
recognition of assets, liabilities, equity,
revenues and expenses in companies‟
financial reports
• Corporate backlash to SAC 4 resulted in
the mandatory status of SACs being
withdrawn in December 1993
• Corporate backlash also resulted in
amendments to SAC 4 being released in
March 1995
The need for a conceptual
framework
According to standard setters, the following
situations demonstrate the need for a
conceptual framework:
• Two or more methods of accounting are
accepted for the same facts
• Less-conservative accounting methods are
used rather than earlier, more conservative
methods
• Reserves are used to artificially smooth
earnings fluctuations
• Financial statements fail to warn of impending
liquidity crunches
The need for a conceptual
framework (cont‟d)
• Deferrals are followed by „big bath‟ write-
offs
• There is unadjusted optimism in estimates
of recoverability
• Off balance-sheet financing is common
• An unwarranted assertion of immateriality
has been used to justify non-disclosure of
unfavourable information or departures
from standards
• Form is relevant over substance
FASB definition
„A conceptual framework is a constitution, a
coherent system of interrelated objectives and
fundamentals that can lead to consistent standards
and that prescribes the nature, function and limits
of financial accounting and financial statements.
The objectives identify the goals and the purposes
of accounting. The fundamentals are the underlying
concepts of accounting – concepts that guide the
selection of events to be accounted for, the
measurement of those events and the means of
summarizing and communicating to interested
parties. Concepts of that type are fundamental in
the sense that other concepts flow from them and
repeated references to them will be necessary in
establishing, interpreting and applying accounting
and reporting standards.‟
Description of a conceptual
framework
• A conceptual framework is therefore
intended to act as a constitution for the
standard-setting process
• The AARF described the conceptual
framework in similar terms, as:
– „a set of inter-related concepts which will
define the nature, subject, purpose and
broad content of financial reporting. It
will be an explicit rendition of the
thinking which is governing the decision-
making of (standard-setters)‟
Advantages of a conceptual
framework
• A conceptual framework is useful in the
development of more consistent and logical
standards and in removing the necessity to
re-debate conceptual issues when preparing
new accounting standards
• The issue of standards overload can be
potentially reduced because a conceptual
framework can enable resolution of
particular accounting problems, which
avoids the necessity of issuing new
Advantages of a conceptual
• Can lead to better communication
among accountants, auditors and users
because all parties are using a common
set of definitions and criteria
• Has potential to reduce the activities
and influence of lobbies and interest
groups
Potential benefits according
to the AARF
According to the AARF‟s Guide to Proposed
Statements of Accounting Concepts, the
potential benefits are:
„a. reporting requirements should be more
consistent and logical, because they will
stem from an orderly set of concepts
„b. avoidance of reporting requirements will
be much more difficult because of the
existence of all-embracing provisions
Potential benefits according to the
AARF (cont‟d)
„c. the Boards which set down the
requirements will be more
accountable for their actions in that
the thinking behind specific
requirements will be more explicit, as
will any compromises that may be
included in particular accounting
standards
„d. the need for specific accounting
standards will be reduced to those
circumstances in which the
appropriate application of concepts is
Potential benefits according to the
AARF (cont‟d)
not clear-cut, thus mitigating the

risks of over-regulation
„e. preparers and auditors should be
able to better understand the
financial reporting requirements
they face
„f. the setting of requirements should
be more economical because issues
should not need to be re-debated
from differing viewpoints‟
Strategic objectives for a
• The literature indicates that conceptual-framework
projects have been developed as an instrument for
the accounting profession‟s self-preservation
• One test used by Hines to determine whether
conceptual frameworks could be viewed as
strategic manoeuvres was to ascertain whether
these projects were undertaken at times of threat
to accountancy‟s legitimacy or at times of
competition
• Hines concluded that „the major rationale for
undertaking conceptual frameworks was not
functional or technical, it was a strategic
manoeuvre for providing legitimacy to standard-
setting bodies …‟
Conflicts of interest
• Financial statements result from the interaction
of three groups:
– firms, which by their operational, functional
and extraordinary activities, justify the
production of financial statements
– users, which include investors, financial
analysts, bankers, creditors, consumers,
employees, suppliers and government
agencies
– the accounting profession, which acts
principally as „auditor‟ in charge of verifying
that financial statements conform to
generally accepted accounting principles
Cyert and Ijiri‟s three
approaches
• Simply stated, these are:
1. the firm-oriented approach
2. the profession-oriented approach
3. the user-oriented approach
• The user-oriented approach is
employed by the SACs in Australia, by
the FASB in the USA and by The
Corporate Report in the UK
Conceptual framework issues
• In the process of developing a
conceptual framework, the AARF and its
Boards have had to resolve several
fundamental conceptual issues
• These issues have determined the
nature and content of SACs
Issue 1: Balance sheet versus
profit and loss account orientation
There are two distinct approaches to
determining an entity‟s income during a
reporting period:
• the asset/liability view, which
maintains that revenues and
expenses result only from changes in
the value of assets and liabilities
• the revenue/expense view, which
holds that revenues and expenses
result from the need for a proper
matching
Criticisms of the
asset/liability view
• It excludes debit and credit items
because they do not constitute economic
benefits or resources to the entity
• It is unwilling, therefore, to recognise as
revenues and expenses anything except
current changes in economic resources
and obligations to transfer resources,
making it incapable of dealing with the
complexities of the modern business
world
The revenue/expense view
Matching comprises two steps:
1. revenue recognition or timing through
the realisation principle
2. expense recognition in three possible
ways:
a. associating cause and effect, such as
for the cost of goods sold
b. systematic and rational allocation, such
as for depreciation
c. immediate recognition, such as for
selling and administrative expenses
Criticisms of the
revenue/expense view
• It has led to the recognition in the
statement of financial position of such
items as „deferred charges‟, „deferred
credits‟, and „reserves‟, none of which
represent economic resources and
obligations
• It places much emphasis on the
importance of the historical cost and
revenue realisation principles
Issue 2: Definition of assets,
liabilities, equity, revenues and
expenses
• Based on the asset/liability view, assets
are restricted to the economic resources of
the firm, which are:
– productive resources of the enterprise
– contractual rights to productive
resources and products
– money
– claims to receive money
– ownership interests in other enterprises
Issue 2: Definition of assets, liabilities,
equity, revenues and expenses (cont‟d)
• According to the revenue/expense view, assets
include not only the assets defined from the
asset/liability viewpoint, but also all items that
do not represent economic resources, but that
are required for proper matching
• A third view of assets arises from the perception
of the balance sheet not as a statement of
financial position, but as „a statement of the
sources and composition of company capital‟.
According to this view, assets constitute the
„present composition of invested capital‟.
• If we exclude the element of „deferred
charges‟ on the statement of financial
position, the definitions of assets
presented in these three different views
have the following characteristics in
common:
1. An asset represents potential cash flow
to a firm
2. Potential benefits are obtainable by the
firm
3. The legal concept of property may

affect the accounting definition of
assets
4. The way an asset is acquired may
be part of the definitions
5. Exchangeability may be an essential
characteristic of assets
Definitions to take into account
for a conceptual framework
1. An asset represents only economic resources
and does not include „deferred charges‟
2. An asset represents potential cash flows to a
firm
3. Potential benefits are obtainable by the firm
4. An asset represents the legal binding right to a
particular benefit, results from a past or current
transaction, and includes all commitments, as in
wholly executory contracts
5. Exchangeability is not an essential characteristic
of assets except for „deferred charges‟
Definitions of liabilities
• According to the asset/liability view,
liabilities are the obligations of the firm to
transfer economic resources to other
entities in the future
• According to the revenue/expense view,
liabilities comprise not only the liabilities
defined from the asset/liability viewpoint
but also certain deferred credits and
reserves that do not represent obligations
to transfer economic benefits but that are
required for proper matching and income
determination
Definitions of liabilities (cont‟d)
• A third view arises from the perception
of the balance sheet as „a statement of
the sources and composition of
company capital‟:
– according to this view, liabilities
constitute sources of capital and
include certain deferred credits and
reserves that do not represent
obligations to transfer economic
resources
Definitions of liabilities (cont‟d)
• If we disregard the element of „deferred
credits‟, the definitions of liabilities
presented in these three different views
have the following characteristics in
common:
1. A liability is a future sacrifice of economic
resources
2. A liability represents an obligation of a
particular enterprise
3. A liability may be restricted to legal debt
4. A liability results from past or current
transactions or events
Definitions of income
income is the net assets of the firm except
for „capital‟ changes
income results from the matching of
revenues and expenses and, perhaps, from
gains and losses:
– gains and losses, therefore, may be
distinguished from the revenues and
expenses, or they may be considered
part of these
Revenues and expenses
revenues are defined as increases in the
assets or decreases in the liabilities that
do not affect capital
• Expenses are defined as decreases in
the assets or increases in the liabilities
arising from the use of economic
resources or services during a given
period
Revenues and expenses (cont‟d)
revenues result from the sale of goods and
services and include gains from the sale and
exchange of assets other than inventories,
interests and dividends earned on investments,
and other increases in owners‟ equity during a
period other than capital contributions and
adjustments
• Expenses comprise all of the expired costs that
correspond to the revenues of the period. If
gains and losses are defined as a separate
element of income, however, revenues are
defined as measures of an entity‟s outputs that
result from the production or delivery of goods
and the rendering of services during a period
Gains and losses
gains are defined as increases in net
assets other than increases from
revenues or from changes in capital
• Losses are defined as decreases in net
assets other than decreases from
expenses or from changes in capital
• Thus, gains and losses constitute that
part of income not explained by
revenues and expenses
Gains and losses (cont‟d)
gains are defined as the excess of
proceeds over the cost of assets sold,
or as windfalls and other benefits
obtained at no cost or sacrifice
• Losses are defined as the excess over
the related proceeds, if any, of all or an
appropriate portion of the costs of
assets sold, abandoned, or wholly or
partially destroyed by casualty, or as
costs that expire without producing
revenues
Relationships between
income and components of
income
Three major relationships exist between
income and the components of income:
1. Income = Revenues – Expenses +
Gains – Losses
2. Income = Revenues – Expenses
3. Income = Revenues (including gains)
– Expenses (including losses)
Income relationships (cont‟d)
• In 1., each component is separate and
essential to a definition of income
• In 2., gains and losses are not separate
and are not essential to the definition of
income. All increases and decreases are
treated similarly as either revenues or
expenses
• In 3., although gains and losses are
separate concepts, they are part of
revenues and expenses
Accrual accounting
• Accrual accounting measures the effects
of transactions having cash
consequences for an entity as they are
incurred, not simply as cash is received
or paid – they are recorded in
accounting records, and reported in the
financial statements of the reporting
period to which they relate
• Accrual accounting rests on the
concepts of accrual, deferral, allocation,
amortisation, realisation and
recognition
FASB definitions
„Accrual is the accounting process of
recognizing non-cash events and
circumstances as they occur; specifically,
accrual entails recognizing revenues and
related increases in assets and expenses
and related increases in liabilities for
amounts expected to be received or paid,
usually in cash, in the future ...
„Deferral is the accounting process of
recognizing a liability for a current cash
receipt or an asset for a current cash
payment (or current incurrence of a
liability) with an expected future impact on
revenues and expenses ...
FASB definitions (cont‟d)
„Allocation is the accounting process of
assigning or distributing an amount according
to a plan or a formula. It is a broader term than
“amortisation”; that is, amortisation is an
allocation process ...
„Amortisation is the accounting process of
systematically reducing an amount by periodic
payments, or write-downs ...
„Realisation is the process of converting non-
cash resources and rights into money; it is
most precisely used in accounting and financial
reporting to refer to sales of assets for cash or
claims of cash. The related terms, “realised”
FASB definitions (cont‟d)
and “unrealised”, therefore identify
revenues or gains and losses on assets
sold and unsold, respectively ...
„Recognition is the process of formally
recording or incorporating an item in the
accounts and financial statements of an
enterprise. Thus, an element may be
recognized (recorded) or unrecognized
(unrecorded). “Realisation” and
“recognition” are not used synonymously,
as they sometimes are in the accounting
and financial literature‟
Issue 3: Concepts of capital
maintenance
• The concept of capital maintenance
allows us to make a distinction between
the return on capital, or income, and the
return of capital, or cost recovery
• There are four possible concepts of
capital maintenance:
1. financial capital measured in units of
money
2. financial capital measured in units of
the same general purchasing power
Issue 3: Concepts of capital
maintenance (cont‟d)
3. physical capital measured in units of
money
4. physical capital measured in units of
the same general purchasing power
Issue 4: Which measurement
method should be adopted?
• The issue of measurement concerns
determination of both the unit of
measure and the attribute to be
measured
• For unit of measure, the choice is
between actual dollars and general
purchasing power adjusted dollars
• For the particular attribute, there are
five options (see next slide)
Measurement options
The five options for measurement of a
particular attribute are as follows:
1. historical cost method
2. current cost
3. current exit value
4. expected exit value
5. present value of expected cash
flows
Issue 5: Applicability of the
conceptual framework to the
public sector
• Australian standard setters have not
maintained a strong distinction between
the private sector, the public sector and
not-for-profit entities
• Standard setters in the USA have tended
to maintain greater distinctions between
profit-seeking and not-for-profit entities
• In Australia, comprehensive accrual
accounting has been progressively
introduced into the public sector
AAS 29 „Financial Reporting by
Government Departments‟
According to AAS 29, government
departments would have the following
similarities to private-sector entities:
1. similarities in the economic
environment
2. similarities in user needs for
information
3. similarities in the objectives of the
SAC 2: Definition of financial
reporting
• There is no generally accepted definition of
general purpose financial reporting, but SAC 2
provides an indication that its scope may extend
beyond financial information:
„Financial reporting encompasses the
provision of financial statements and related
financial and other information‟ (paragraph
10)
• Paragraph 10 of SAC 2 also states that general
purpose financial reports (GPFRs) include:
„financial statements, notes, supplementary
schedules and explanatory material
intended to be read with the financial
statements‟
SAC 2: Definition of financial
reporting (cont‟d)
• Other parts of paragraph 10 obscure the issue

completely:
„This Statement does not attempt to draw a
clear distinction between financial reports
and financial reporting, nor does it attempt
to define the boundaries of general purpose
financial reporting‟
Hence, the scope of financial reporting can be
potentially very broad
What criteria should be used?
A critical issue is what criteria should be
used to determine which information will
be included within the scope of financial
reporting:
1. SAC 2 specifies that the overall objective
of GPFRs is to provide relevant
information for economic decision
making by users
2. SAC 3 specifies the necessary
characteristics that information should
possess, and emphasises the importance
of the relevance and reliability of
information
Definition of a reporting
entity
SAC 1 defines a reporting entity as:
„entities (including economic entities) in
respect of which it is reasonable to
expect the existence of users
dependent on GPFRs for information
which will be useful to them for making
and evaluating decisions about the
allocation of scarce resources‟
Definition of a reporting entity
(cont‟d)
Because the definition of a reporting
entity is linked to the information
needs of external users, the existence
of a reporting entity will not depend
on:
1. the sector within which the entity
operates
2. the purpose for which the entity
was created
3. the manner in which the entity is
constituted
Determination of dependent
external users
SAC 1 provides three general
guidelines to assist in determining the
existence of dependent external
users:
1. separation of management from
economic interests
2. economic or political
importance/influence
3. financial characteristics
Objective of general purpose
financial reporting
SAC 2 states that:
„General purpose financial reports
focuses [sic] on providing information
to meet the common information needs
of users who are unable to command
the preparation of reports tailored to
their particular information needs.
These users must rely on the
information communicated to them by
the reporting entity‟
Objective of general purpose
financial reporting (cont‟d)
• Because efficient resource allocation is

the ideal, SAC 2 states that the primary
objective of GPFRs is to provide
relevant information to various external
users so that they can make and
evaluate decisions about the allocation
of scarce resources
• SAC 2 also describes a secondary
objective, which is to demonstrate the
discharge of accountability
Types of users and information
• SAC 2 describes three classes of user:
1. resource providers
2. recipients of goods and services
3. parties performing a review or oversight
function
• SAC 2 also defines the types of information
these users need in order to make informed
decisions:
1. performance
2. financial position
3. financing and investing
4. compliance
Qualitative characteristics of
financial information
Primary characteristics
• Relevance is defined in SAC 3 to mean that
quality of financial information which exists
when information influences the decisions of
users about the allocation of scarce resources
• Reliability is defined as:
„that quality of financial information which
exists when the information can be
depended upon to represent faithfully, and
without bias or undue error, the
transactions or events that it either purports
to represent or could reasonably be
expected to represent‟
financial information (cont‟d)
Secondary and interactive qualities
• Comparability is defined in SAC 3 as:
„that quality of financial information which
exists when users of that information are
able to evaluate similarities in and
differences between, the nature and effects
of transactions and events, at one time and
over time, either when assessing aspects of
a single reporting entity or a number of
reporting entities‟
• Understandability means that quality of
financial information which exists when users of
that information are able to comprehend its
meaning
Constraints on relevance
• Timeliness: SAC 3 cautions that information
will lose its relevance if there is a delay in
the reporting of that information
• Costs versus benefits: Financial information
will be sought if the benefit to be derived
from the information exceeds its cost
Materiality
• Materiality is defined in SAC 3 as:
„the extent to which relevant and reliable
information may be omitted, misstated or
not disclosed separately without having
the potential to adversely affect the
decisions made about the allocation of
scarce resources made by users‟
• SAC 3 emphasises that consideration must
be given to whether or not the information is
likely to have a significant, or material,
impact on decisions
Definition and recognition of
assets
• SAC 4 embraces the asset/liability viewpoint and
defines assets as future economic benefits or
controlled by the entity as a result of past
transactions or other past events
• SAC 4 further stipulates that an asset should
only be recognised on the balance sheet when:
– it is probable that the future economic
benefits embodied in the asset will eventuate;
and
– the asset possesses a cost or other value that
can be measured reliably
liabilities
• SAC 4 defines liabilities as:
„future sacrifices of economic benefits that
the entity is presently obliged to make to
other entities as a result of past
transactions or other past events‟
• SAC 4 further states that a liability should be
recognised on the balance sheet when:
– it is probable that the future sacrifice of
economic benefits will be required; and
– the amount of the liability can be
measured reliably
equity
• SAC 4 defines equity as a residual interest in
the assets of the entity after the deduction of
its liabilities
• Because equity is defined as residual, the
recognition of equity will be consequential to
procedures used to recognise assets and
liabilities
revenues
• SAC 4 defines revenues as:
„inflows or other enhancements, or savings in
outflows, of future economic benefits in the
form of increases in assets or reductions in
liabilities of the entity, other than those
relating to contributions by owners, that
result in an increase in equity during the
reporting period‟
• A revenue should be recognised in the profit and
loss account when:
– it is probable that the revenue has occurred;
and
– the revenue can be measured reliably
expenses
• SAC 4 defines an expense as:
„consumptions or losses of future economic
benefits in the form of reductions in assets or
increases in liabilities of the entity, other than
those relating to distributions to owners, that
result in a decrease in equity during the
reporting period‟
• An expense should be recognised when:
– it is probable that the expense has been
incurred; and
– the amount of the expense can be reliably
measured
Measurement
• SAC 4 does not explicitly deal with how
assets and liabilities should be measured
• The AARF now seems aware of the need to
address publicly the critical issue of
measurement in financial statements
• In mid-1994, the AARF released a public
Invitation to Comment on a „Proposed
Program for the Development of Concepts on
Measurement of the Elements of Financial
Statements‟
AARF Invitation to Comment
The AARF Invitation to Comment
recognised that measurement is one of
the most significant contemporary issues
in financial reporting because of:
a. the frequently significant impact of
measurement choices on reported
results
b. the existence of widely divergent
views among practitioners, users and
other parties about the relevance of
historical cost accounting
AARF Invitation to Comment (cont‟d)
c. the widely divergent
measurement practices under the
present system of modified
historical cost accounting in
Australia
d. the voluntary adoption of current
market value measurements
industries such as life insurance,
banking and funds management
e. the range of existing accounting
standards that specify current-
value accounting approaches
Display of
financial information
• This level of the conceptual framework
considers in detail the nature of the
information to be displayed in financial
reports
• This involves identifying the appropriate
information groupings (financial
position, performance, investing and
financing, and compliance) and
analysing the components of those
groupings
Standard-setting policy and
enforcement
This lowest level of the conceptual
framework considers policy issues,
such as:
• audit status
• applicability and timing of financial
reporting
• policy enforcement
Corporate backlash
• The only aspect of the Australian
conceptual framework to attract significant
corporate concern was SAC 4
• Many of the concerns were captured in a
statement from a submission by Caltex Oil
Australia:
„(SAC 4) is a laudable aim but I contend
it does not address commercial reality,
or focus on that very important issue of
the credibility of the accounting
profession in Australia‟
Specific corporate concerns
with SAC 4
1. Balance sheet versus profit and loss account
orientation
2. Definition of elements too prescriptive and
uncertain. Accounting treatments that raised
the most controversy were:
a. contracts where agreements are equally
and proportionately un-performed
b. accounting for leases
c. treatment of debt/equity items
d. revaluation practices
e. financial instruments
Specific corporate concerns with
SAC 4 (cont‟d)
3. Recognition criteria – the probability test
4. Inconsistency with existing accounting
standards
5. Departure from international accounting
standards and practices
The AARF‟s backdown
on SAC 4
• In late 1993, a Joint Standing
Committee of the ASCPA and ICAA
decided that SACs should no longer
have mandatory status for members of
the accounting profession
• The AASB and PSASB decided to amend
SAC 4
• An amended SAC 4 was released in
March 1995
Substantive amendments
to SAC 4
1. Removal of mandatory status and
transitional provisions
2. Removal of an operative date
3. Removal of the detailed Appendix that
provided guidance on the interpretation
and application of SAC 4 concepts to a
number of specific accounting
transactions
Substantive amendments
to SAC 4 (cont‟d)
4. Changes to the commentary sections,
including a tightening up in the
classification of liabilities, greater
discussion on the nature of reciprocal
and non-reciprocal transfers and greater
discussion on when an increase in asset
value would constitute an item of
revenue or an equity adjustment
5. Greater attention given to conventional
accounting principles, such as matching
and periodicity
Other concerns with SAC 4
A number of other concerns were not
reflected in the changes made to SAC 4:
• the Boards of the AARF decided against
providing definitions for gains and
losses that were separate from the
general definition of revenues and
expenses
• the Boards maintained their policy on
requiring recognition of agreements
equally proportionately
underperformed in the statement of
financial position
Development of the US
In 1971, The American Institute of
Certified Practicing Accountants
formed two study groups:
1. the „Wheat Committee‟, which was a
study group on the establishment of
accounting principles, and which
was charged with the task of
improving the standard-setting
process
Development of the US conceptual
2. the „Trueblood Committee‟, which was
charged with developing the objective
of financial reporting in terms of:
a. who needs financial statements
b. what information they need
c. how much of this information can be
provided through accounting
d. what framework is required to
provide the information
Objectives of financial
statements
The Trueblood Report identified six
objective-levels:
1. The basic objective – to provide
information on which to base economic
decisions
2. Four objectives that specify the diverse
users and uses of accounting information
3. Two objectives that specify enterprise
earning power and management ability
as the type of information needed
Objectives of financial statements
(cont‟d)
4. One objective (No. 6) that specifies the
nature of the needed information as
factual and interpretive
5. Four objectives that describe the
financial statements required to meet
objective No. 6
6. A number of specific recommendations
for the financial statements are made
in order to meet each of the preceding
objectives
reporting
The Trueblood Report mentioned seven
qualitative characteristics of reporting:
1. relevance and materiality
2. form and substance
3. reliability
4. freedom from bias
5. comparability
6. consistency
7. understandability
Six statements of financial
accounting concepts
1. The objectives of financial reporting
by business undertakings
2. Qualitative characteristics of
accounting financial information
3. Elements of the financial statements
4. Objectives of financial reporting by
non-business entities
Six statements of financial
accounting concepts (cont‟d)
5. Recognition and measurement in
financial statements of business
undertakings
6. A statement of amendments to
previous concepts statements
Comparison of SACs and
SFACs
SFACs are more detailed, more explicitly
stated and more prescriptive than SACs. For
example, SFACs:
1. recommend more conservative recognition
criteria for the elements of financial
statements
2. differentiate between revenues, expenses,
gains and losses in a manner consistent
with conventional practice
3. make greater reference to conventional
The Corporate Report
The Corporate Report was published in
1976 by the Institute of Chartered
Accountants in England and Wales. Its
major findings and recommendations were
that:
• financial statements should be
appropriate to their expected use by
potential users
• responsibility for reporting belongs to the
„economic entity‟ having an impact on
society through its activities
The Corporate Report (cont‟d)
• users are defined as those having a

reasonable right to information,
whose information needs should be
recognised by corporate reports
• the corporate report should be
relevant, understandable, reliable,
complete, objective, timely and
comparable
• there is a need for additional
statements
Additional statements
1. A statement of value added
2. A statement of money exchange with
government
3. A statement of transactions in foreign
currency
4. A statement of future prospects
5. A statement of corporate objectives
The Stamp Report
• The Stamp Report was published in 1980 by
the Canadian Institute of Chartered
Accountants
• The report identifies problems and
conceptual issues and provides solutions in
terms of:
– the objective of corporate financial
reporting
– the users of corporate reports
– the nature of the users‟ needs
– criteria for assessment of the quality of
standards and of corporate accountability
Objectives of corporate
financial reporting
The Stamp Report identified four
objectives:
1. accountability
2. uncertainty and risk
3. change and innovation
4. complexity and the unsophisticated
user
Conceptual framework
conclusions
• In order to be effective, a conceptual framework
must gain general acceptance, represent
collective behaviour, and protect the public
interest in areas in which it is affected by
financial reporting
• One prevailing idea is that it is impossible to
develop a set of accounting standards that can
be applied to accounting alternatives in a way
that will satisfy everybody, and that such
standards could be hampered by the level of
abstractness in definition and recognition criteria
Conceptual framework conclusions
(cont‟d)
• The conceptual framework has been
referred to as a kind of constitution, yet
there are great differences. Solomons, for
example, cites three:
1. a constitution has the force of law
2. constitutions contain many arbitrary
elements, but there is no room for
arbitrariness in a conceptual
framework
3. there are significant differences
among the nations of the world in
their constitutional arrangements
(cont‟d)
Miller’s myths
• Miller points to eight myths about the FASB
conceptual framework, which are:
1. that the APB failed because it did not have
a conceptual framework
2. that FASB cannot succeed unless it has a
3. that a conceptual framework will lead to
consistent standards
4. that a conceptual framework will eliminate
the problem of overload
(cont‟d)
Miller‟s myths (cont‟d)
5. that the FASB‟s conceptual framework

captures only the status quo of
accounting practice
6. that the conceptual framework project
has cost more than it should have
7. that the FASB will revise the existing
standards to make them consistent with
the conceptual framework
8. that the FASB has abandoned the
conceptual framework project
(cont‟d)
• The conceptual framework is not going to
provide all the answers, but at least it will
provide a direction for setting standards and
reduce the influence of personal biases and
political pressures in making accounting
judgements
Chapter 6
The structure of
accounting theory
The structure of an
accounting theory
The structure of an accounting theory contains
the following elements:
• a statement of the objectives of financial
statements
• a statement of the postulates and theoretical
concepts of accounting concerned with the
environmental assumptions and the nature
of the accounting unit
• a statement of the basic accounting
principles
• a body of accounting techniques
The going-concern postulate
• This postulate holds that the business

entity will continue its operations long
enough to recognise its projects,
commitments and ongoing activities
• The postulate assumes that the entity is
not expected to be liquidated in the
foreseeable future or that the entity will
continue for an indefinite period of time
The unit of measure
postulate
• Accounting is a measurement and
communication process of the activities of the
firm that are measurable in monetary terms
• Limitations apply:
– accounting is limited to the prediction of
information expressed in terms of the
monetary unit
– accounting does not record or communicate
other relevant information
• Should units of money or units of general
purchasing power be used?
The accounting-period
postulate
• This postulate holds that financial

reports depicting changes in the wealth
of a firm should be disclosed
periodically
• This postulate imposes accruals and
deferrals
The proprietary theory
• According to Coughlan, the entity is the

„agent, representative or arrangement
through which the individual
entrepreneurs or shareholders operate‟
• The proprietor group as the centre of
interest is reflected in the ways in which
accounting records are kept and
financial statements are prepared
The entity theory
• This theory views the entity as

something separate and distinct from
those who provide capital to the entity
• This view sees the business unit, rather
than the proprietor, as the centre of
accounting interests
The fund theory
• Under the fund theory, the basis of

accounting is neither the proprietor nor
the entity, but a group of assets and
related obligations and restrictions
called a „fund‟
• Fund theory is useful primarily to
government and non-profit
organisations
The cost principle
• The acquisition cost or historical cost is the
appropriate valuation basis for recognition of
the acquisition of all goods and services,
expenses, costs and equities
• The cost principle is justified both in terms of
its objectivity and the going-concern
postulate:
– acquisition cost is objective, verifiable
information
– the entity will continue indefinitely,
therefore current values or liquidation
values for asset valuation are not
necessary
The revenue principle
The revenue principle specifies:
1. the nature and components of
revenue
2. the measurement of revenue
3. the timing of revenue recognition
The nature and components
of revenue
• An inflow of net assets resulting from
the sale of goods or services
• An outflow of goods or services from
the firm to its customers
• A product of the firm resulting from the
mere creation of goods or services by
an enterprise during a given period of
time
The measurement of revenue
• Measured in terms of the value of the
products and services exchanged in an
arms-length transaction
• Two interpretations:
– cash discounts and any reductions in the
fixed prices should be deducted when
computing revenue
– for non-cash transactions, the exchange
value is set equal to the fair market value
of the consideration given or received
Timing of revenue
recognition
According to the American Accounting
Association Committee on Concepts and
Standards, specific criteria for revenue and
income recognition are:
• it must be earned in one sense or another
• it must be in distributable form
• it must be the result of a conversion brought
about in a transaction between the enterprise
and someone external to it
• it must be the result of a legal sale or similar
process
Timing of revenue recognition
(cont‟d)
• it must be severed from capital
• it must be in the form of liquid assets
• both its gross and net effects on
shareholder equity must be estimable with
a high degree of reliability
The matching principle
• Expenses should be recognised in the same
period as the associated revenues
• The association between revenues and
expenses depends on one of four criteria:
1. direct matching of expired costs with a
revenue
2. direct matching of expired costs with the
period
3. allocation of costs over periods benefited
4. expensing all other costs in the period
incurred, unless they have future benefit
The objectivity principle
• This principle holds that the usefulness of
financial information depends on the reliability of
the measurement procedure used
• There are different interpretations of this
objectivity:
– an objective measurement is an impersonal
measure
– an objective measurement is a very viable
measurement
– an objective measurement is the result of
consensus among a given group of observers
– the size of the dispersion of the measurement
distribution may be used as an indicator of the
degree of objectivity
The consistency principle
• This principle holds that similar

economic events should be recorded
and reported in a consistent manner
from period to period
• The consistency principle makes
financial statements more comparable
and more useful
The full-disclosure principle
• This principle holds that no information

of substance or of interest to the
average investor will be omitted or
concealed
• This principle is enforced by various
disclosure requirements within the
AASB and AAS standards
The conservatism principle
• This principle holds that when choosing
between two or more acceptable
accounting techniques, some preference
is shown for the option that has the
least favourable impact on
shareholders‟ equity
• At present, the emphasis on objective
and fair presentation has lessened the
reliance on conservatism
The materiality principle
• Transactions and events having
insignificant economic effects need not
be disclosed
• According to AAS 5, an item of
information is material „if its omission,
non-disclosure or mis-statement would
cause the financial statements to mislead
users when making evaluations or
decisions‟
Two basic criteria for
determining materiality
• The size approach relates the size of
the item to another relevant variable
such as net income
• The change criterion approach
evaluates the impact of an item on
trends or changes between accounting
periods
The uniformity and
comparability approach
• This approach refers to the use of the
same procedures by different firms
• The objective of this approach is to
achieve comparability of financial
statements by reducing the diversity
created by the use of different
accounting procedures by different
firms
Principle supports for
uniformity
Principal supports for uniformity are that it:
• reduces the diverse use of accounting
procedures and the inadequacies of accounting
practices
• allows meaningful comparisons of the financial
statements of different firms
• restores the confidence of users in the
• leads to governmental intervention and the
regulation of accounting practices
Principle supports for
flexibility
Principal supports for flexibility are that:
• the use of uniform accounting procedures poses
the risk of concealing important differences
among cases
• comparability is a utopian goal that „cannot be
achieved by the adoption of firm rules that do
not take adequate account of different factual
situations‟
• „differences in circumstances‟ or „circumstantial
variables‟ call for different treatments so that
corporate reporting can respond to
circumstances in which transactions and events
occur
Chapter 7
Fairness, disclosure
and future trends
in accounting
Fairness in accounting
• This is generally associated with the
measurement and reporting of
information in an objective and neutral
way
• It implies that accounting statements
have not been subject to undue
influence or bias
Unfortunate consequences of
the fairness principle
• A failure to rely on concepts of justice that
dedicate instead a fairness in distribution
• A failure to expand the scope of the
disclosure in financial statements beyond
conventional financial accounting
information towards a fairness in
disclosure
• Creates flexibility in income and earnings
smoothing
• Creates a climate for fraudulent practices
„True and fair‟ doctrine
• There is no comprehensive definition of

the concept of „true and fair‟
• Much confusion exists among producers
and users of accounting information as
to its exact meaning
Williams‟ definition of
fairness
Williams characterised fairness as an
evaluation process with the following
attributes:
• the evaluator is aware of the
conditions that any consequences of
his or her actions will be judged as
fair or unfair
• the evaluation attempts to adopt a
perspective of impartiality
Fairness in distribution
According to Williams:
• decision usefulness (the principle of
organising accounting research and
practice) is incomplete, while
accountability at least possesses
fairness as an inherent property
• the concern of accounting with
efficiency makes accounting‟s fairness
judgement implicit, not absent
Social accounting
• Pallot proposed that a community
perspective be added to the
predominantly individualistic
perspective in accounting
• Corporate social responsiveness as an
expression of fairness involves the
identification, measurement and
disclosure where necessary of the social
costs and benefits of a firm‟s economic
activities
Fairness as a moral concept
of justice
Rawls‟ theory of justice is an egalitarian one
under which people choose two principles:
1. Each person is to have an equal right to
the most extensive basic liberty
compatible with a similar liberty for
others.
2. Social and economic liberties are to be
arranged so that they are both:
• to everyone‟s advantage
• attached to positions and offices open
to all
Rawls‟ economic system
• Rawls‟ theory would probably involve a
„constitutional democracy‟, which
preserves equal basic liberties while
promoting equal opportunity and
guaranteeing a social minimum and a
market-based economy
• There is great disagreement over
whether or not Rawls‟ „difference
principle‟ (calling for the establishment
of social minimums) would assure an
adequate supply of goods and services
according to Rawls
• Rawls calls for an accounting choice that will
eventually lead to solutions that are neutral,
fair and socially just
• Rawls suggests expanding the role of
accounting in the creation of just institutions
and the definition of the social minimum
• Expanding accounting‟s role in creating just
institutions would lead to the elimination of
those aspects of the social world and
accounting that seem arbitrary from a moral
point of view
Nozick‟s theory of justice
• Nozick argues that theories such as Rawls‟,
which are based on the patterned and end-
state principles, violate people‟s rights and
exclude the entitlement principle
• According to Nozick:
– a person who acquires a holding in
accordance with the principle of justice in
acquisition is entitled to that holding
– a person who acquires a holding in
accordance with the same principle from
someone else entitled to that holding is also
entitled to it
– no one else is entitled to a holding except
through the above applications
according to Nozick
• Nozick‟s is a libertarian theory of

distribution based on justice in
acquisition and transfer
• Nozick‟s view sees distributive justice
as relying on a free-market
mechanism, and does not allow for
dealing adequately with fairness as a
distributive function
Gerwith‟s theory of justice
• Gerwith‟s theory sees rights to freedom and
well-being as generic, fundamental and
universal
• Gerwith asserts that every agent logically must
acknowledge certain generic obligations,
including:
– „he ought to refrain from coercing and from
banning his recipients‟
– „he ought to assist them to have freedom and
well-being [when there is] no comparable loss
to himself‟
• Gerwith‟s Principle of Generic Consistency (PGC)
is: „act in accord with the generic rights of your
recipients as well as yourself‟
according to Gerwith
• Gerwithian principles demand
recognition of the rights of all those
affected by the activities of the
organisation
• Gerwith‟s view supports the emphasis
in value-added reporting to report the
total return of all members of the
„production team‟, such as
shareholders, bondholders, suppliers,
labour, government and society
Fairness in disclosure
• The fairness in disclosure principle calls
for an expansion of conventional
accounting disclosures to accommodate
all other interest groups in addition to
investors and creditors
• Bedford called for the development of
new tools under diverse new disciplines
to provide management and decision-
makers with useful information
Characteristics of disclosure
to be expanded
• The scope of users should expand to include
public groups
• The scope of users should expand to providing
for inter-company coordination, meeting
specific user information needs and developing
public confidence in the firm‟s activities
• The type of information disclosed should
expand to reveal both internal activities and
the environmental setting of those activities of
a socioeconomic nature
Characteristics of disclosure to be
expanded (cont‟d)
• Measurement techniques should expand to
encompass the total management science
area
• The quality of disclosure should expand to
offer improved relevance for specific
decisions
• Disclosure devices should expand to
encompass multimedia disclosures based
on the psychology of human
communications
Lev‟s theory of equitable and
efficient accounting policy
Equity of the capital markets
• Equality of opportunity or symmetric
information
• Risk-adjusted returns identical across
investors
• The standard for the equity concept is:
– „The interests of the less informed
investors should, in general, be
favored over the more informed
investors‟
Gaa‟s user primacy
• In Gaa‟s user primacy, the interests of
one group of users is given preference
over others
• A standard setter would be established
to enforce user primacy, thereby
redressing imbalances between
investors and managers
• The standard setter would aid all
securities market agents in exploiting
the potential trading gains provided by
such a market
The Jenkins Committee
• The Jenkins Committee was established
by the AICPA in 1991 to improve
external reporting
• The committee‟s aim was to determine:
– the nature and extent of information
that should be made available to
others by management
– the extent to which the auditors
should report on the various elements
of that information
Jenkins Committee findings
The Committee found that, in order to meet
users‟ need for information, financial
statements should be enhanced in the
following ways:
• improved disclosure of business-segment
information
• disclosures and accounting for innovative
financial instruments to be addressed
• improved disclosures about the identity,
opportunities and risks of off-balance-sheet
financing arrangements, and accounting for
such to be reconsidered
Jenkins Committee findings (cont‟d)
• the effects of core and non-core activities
and events to be reported separately, and
non-core assets and liabilities to be
measured at fair value
• improved disclosures about uncertainty of
measurements of certain assets and
liabilities
• improved quarterly reporting by reporting
separately in the fourth quarter and by
including business-segment data
Jenkins Committee model
The model proposed by the Jenkins Committee
enabled users to make projections, value
companies or assess the prospect of loan
repayments on the basis of the following five
broad categories.
1. Financial and non-financial data:
• financial statements and related disclosures
• high-level operating data and performance
measurements that management uses to
manage the business
2. Management analysis of the financial and non-
financial data:
• reasons for changes in the financial, operating
and performance-related data, and the
identity and past effect of key trends
Jenkins Committee model (cont‟d)
3. Forward-looking information:
• opportunities and risks, including those
resulting from key trends
• management‟s plans, including critical
success factors
• comparison of actual business
performance to previously disclosed
opportunities, risks and management‟s
plans
4. Information about management and
shareholders:
• directors, management, compensation,
major shareholders, and transactions and
relationships among related parties
Jenkins Committee model (cont‟d)
5. Background about the company:
• broad objectives and strategies
• scope and description of business and
properties
• impact of industry structure on the
company
Expanded accounting
disclosures
• The distinction between recognition and
disclosure is emphasised by the FASB and is
consistent with the Australian position, in that
recognition is seen stated in the FASB Concepts
Statement No. 5 as:
– „the process of formally recording or
incorporating an item into the financial
statements of an entity as an asset, liability,
revenue, expense, or the like‟
– „[including] depiction of an item in both words
and numbers, with the amount included in the
totals of the financial statements‟
Expanded accounting disclosures (cont‟d)
• The FASB statement also says that:
– „since recognition means depiction of an item
in both words and numbers, with the amount
included in the totals of the financial
statements, disclosure by other means is not
recognition‟
– „Disclosure of information about the items in
financial statements and their measures that
may be provided by notes or parenthetically
on the face of financial statements, by
supplementary information, or by other
means of financial reporting is not a
substitute for recognition in financial
statements for items that meet recognition
criteria‟
Purposes of disclosure
The FASB statement sees the purposes of
disclosure as being:
1. To describe recognised items and to
provide relevant measures of those
items other than the measures in the
2. To describe unrecognised items and to
provide a useful measure of those items
3. To provide information to help investors
and creditors assess risks and potentials
of both recognised and unrecognised
items
Purposes of disclosure (cont‟d)
4. To provide important information that
allows financial statement users to
compare within and between years
5. To provide information in future cash
inflows or outflows
6. To help investors assess return on their
investments
Required financial statement
disclosures – an analysis
1. The most frequently required disclosures
relate to amounts recognised in the
financial statements, particularly to
disaggregating them and providing relevant
measures other than the measure in the
financial statements –disaggregation of
recognised amounts represents 26 per cent
of all required disclosures
2. Six subjects – stockholders‟ equity, leases,
pensions, income taxes, other post-
retirement employee benefits and
Required financial statement
disclosures – an analysis (cont‟d)
commitments and contingencies – account
for 45 per cent of all required disclosures;
five standards – SFAS nos 15, 87, 88, 106
and 109 – account for 28 per cent
4. Few disclosures explicitly provide
information on future cash inflows or
outflows
5. Few disclosures provide measures of
unrecognised items
6. Disclosure requirements have increased
over time; few have been eliminated
New accounting disclosures
New accounting disclosures under
the principle of fairness in disclosure
are:
• value-added reporting
• employee reporting
• human resource accounting
• social accounting and reporting
• budgetary information disclosures
• cash flow accounting and reporting
Value-added reporting
„Value added‟ is the increase in wealth
generated by the productive use of the
firm‟s resources before its allocation
among shareholders, bondholders,
workers and the government
Computing value added
Step 1: The income statement computes retained
earnings as a difference between sales revenue,
on one hand, and costs, taxes and dividends, on
the other:
R = S – B – DP – W – I – DD – T (1)
where:
R = retained earnings
S = sales revenue
B = bought-in materials and services
DP = depreciation
W = wages
I = interest
DD = dividends
T = taxes
Computing value added (cont‟d)
Step 2: The value-added equation can be

obtained by rearranging the profit equation
as:
S – B = R + DP + W + I + DD + T (2)
or
S – B – DP = R + W + I + DD + T (3)
• Equation 2 expresses the gross value-added

method
• Equation 3 expresses the net value-added
method
Computing value added (cont‟d)
Step 2 (cont‟d)
• In both cases, the left part of the equation
shows the value added among the groups
involved in the managerial production
team (workers, shareholders, bondholders
and the government)
• The right-hand side is also known as the
additive method and the left-hand side as
the subtractive method
Benefits of the value-added
statement
• With the disclosure of value added,
employees get the satisfaction of knowing
the value of their contribution to the total
wealth of the firm
• Value added represents a better base for
the computation of worker bonuses
• Value added information has been proven to
be a good predictor of economic events and
market reaction
Benefits of the value-added
statement (cont‟d)
• Value added is a better measurement of
size than sales
• Value added may be useful to employee
groups because it can affect the
aspirations and thoughts of its negotiating
representatives
• Value added may be extremely useful in
financial analysis by relating various crucial
events to added variables
Employee reporting
Employee reporting has been
necessitated by the emergence of
employees and unions as potential users
of accounting information. Examples of
headings for an employment report are:
• number of people employed (analysed
in various ways)
• location of employment
• age distribution of permanent
workforce
• hours worked during the year
(analysed)
Employee reporting (cont‟d)
• employee costs
• pension information
• education and training (including
costs)
• recognised trade unions
• additional information (race relations,
health and safety statistics etc.)
• employment ratios
Aims and reasons for reporting
to employees
A survey of financial reporting literature by
Lewis and others found that the main
reasons for reporting to employees between
1919 and 1979 were:
• heralding changes
• presenting management propaganda
• promoting interest in understanding of
company affairs and performance
• explaining management decisions
• explaining the relationship between
employees, management and shareholders
Aims and reasons for reporting to
employees (cont‟d)
• explaining the objectives of the company
• facilitating greater employee participation
• responding to legislative or union pressure
• building company image
• meeting information requirements peculiar
to employees
• responding to management fears of wage
demands, strikes and competitive
disadvantages
• promoting a higher degree of employee
interest
Increased interest in
reporting to employees
Lewis‟s survey found that in the years
between 1919 and 1979, the level of
interest in reporting to employees was
higher when four socio-economic factors
were present:
1. use of new technology in the workplace
2. increased mergers in the corporate
sector
3. emergence of anti-union sentiment
4. fears of economic recession
Reasons for increased levels of
employee reporting
Lewis‟s survey also speculated that
management may have hoped to:
• allay fears of lost rank, skill or employment
due to technological advances
• counter fears of „bigness‟, monopoly power,
employee relocation and loss of identity
through corporate mergers
• take advantage of community anti-union
sentiments by bypassing union
communication channels, emphasising
management prerogatives and the need
Reasons for increased levels of
employee reporting (cont‟d)
to control wages and associated costs,
and generally weakening the unions‟
potential to disrupt operations
• prepare employees for hard times,
confirm or dispel rumours of imminent
company failure, allay fears of
unemployment and urge employees to
greater efforts in difficult economic times
Management benefits of
employee annual reports
Taylor, Webb and McGinley identified the
following personal benefits that management
might attempt to seek for itself by providing
an annual report to employees:
• building a favourable employee impression
of the management group
• reducing the resistance of employees to
changes initiated by management
• providing a useful response to union
pressure for more corporate financial
information from management
Employee benefits from
employee reporting
Taylor, Webb and McGinley also identified the
following personal benefits that might accrue
to employees through employee reporting:
• having the basis for deciding whether to
continue employment with the company or
an organisation section of the company
• having the basis for assisting the relative
position of the employees within the
corporate structure, particularly in terms of
getting a „fair go‟
• understanding the image of the company as
a basis for deciding at a personal level
whether to identify with its image
Arguments for direct
disclosure to employees
Foley and Maunders identified arguments
supporting disclosure direct to employees:
• feedback of information to employees will
improve job performance via learning effects
and also serve to increase motivation
• the role of employee reporting is crucial to
effective worker participation, which will
contribute to the efficiency of the company
• the fundamental change in the nature of the
firm and its „social responsibility‟ legitimises
employee reporting
Arguments for direct disclosure to
employees (cont‟d)
• employee reporting may be seen by some
employers as a possible way of
resurrecting the concept of joint
consultation as a means of avoiding
unionisation
• the socialist tradition, with its ultimate
objective of changing the basis of
ownership and the control of resources,
sees employee reporting as a step to
increase „workers‟ control‟ and develop
workers‟ „self confidence‟
Socialist arguments for
employee reporting
The case for employee reporting using the
socialist argument rests on two fundamental
principles:
1. that employee reporting helps employees
establish greater democratisation of
decision-making in industry
2. that employee reporting may usefully act
as a check on those aspects of the market
system which result in adverse external
effects in the form of pollution and
environmental degradation
Social accounting and
reporting
The measurement of social
performance falls in the general area
of social accounting. The four various
activities are:
1. social responsibility accounting
(SRA)
2. total impact accounting (TIA)
3. socioeconomic accounting (SEA)
4. social indicators accounting (SIA)
Definition of social
accounting
Ramanathan defines social accounting as:
– „the process of selecting firm-level
social performance variables,
measures and measurements
procedures; systematically
developing information useful for
evaluating the firm‟s social
performance and communication of
such information to concerned social
groups, both within and outside the
firm‟
Who is pushing for corporate
social reporting?
• According to Gray and others, corporate
social reporting (CSR) is a dialectic between
four different positions, which are:
1. the extreme left wing of politics
2. acceptance of the status quo
3. the pursuit of subject/intellectual
property rights
4. the extreme right wing of politics
Who is pushing for corporate social
reporting? (cont‟d)
• Position 2 appears to represent the true
advocates of CSR and seems to include people
who assume that:
– CSR‟s purpose is to enhance a firm‟s
corporate image, and who see corporate
behaviour as fundamentally benign
– the purpose of CSR is to discharge an
organisation‟s accountability, assuming that a
social contract exists and that this demands
the discharge of social accountability
– CSR is effectively an extension of traditional
financial reporting and its purpose is to inform
investors
Arguments for measuring and
disclosing social performance
1. The existence of a social contract
2. Rawls‟ and Gerwith‟s models argue
for a concept of fairness that is
favourable to social accounting
3. Users‟ needs
4. The existence of social investment
Budgetary information
disclosure
• Accountants and non-accountants alike have
recommended that forecast information be
incorporated into financial statements
• One objective of financial reporting set forth
in the Trueblood Report supports such
disclosures:
– „An objective of financial statements is to
provide information useful for the predictive
process. Financial forecasts should be
provided when they will enhance the
reliability of users‟ prediction‟
Including forecasts in
accounting reports
• In the UK, the revised version of the City
Code on Takeovers and Mergers requires
profit forecasts to be included in takeover-
bid circulars and prospectuses
• In February 1975, the US Securities and
Exchange Commission (SEC) first announced
its intention to require companies disclosing
the forecasts to conform with certain rules to
be laid down by the SEC
• In 1976, the SEC called for voluntary filing of
forecasts
Problems encountered by the SEC
• The definition of earnings forecasts:
– concerns determining which forecasted
items are to be disclosed (the two possible
solutions are disclosing budgets or
disclosing probable results (forecasts))
– Ijiri makes the distinction as follows:
• „Forecasts are estimates of what the
corporation considers to be the most
likely to occur, whereas budgets may be
inflated from what the corporation
considers to be most likely to occur in
order to take advantage of the
motivational function of the budget‟
(cont‟d)
– from the point of view of the user,
therefore, the disclosure of forecasts,
rather than budgets, may be more
relevant
– the trend seems to be in favour of the
disclosure of forecasts
• Whether disclosure should be mandatory or
optional:
– the principle argument in favour of
mandatory disclosure is that it creates a
similar and uniform situation for all
companies
(cont‟d)
– mandatory disclosure could create an
unnecessary burden in terms of competitive
advantage, and certain firms would have to
be viewed as exceptions
– some firms lack adequate technology,
experience and competence to disclose
forecasts adequately, and outlays to correct
this situation may create an unnecessary
burden on these firms
• The possible advantages of such disclosure:
– both companies and analysts have been
unsuccessful in accurately forecasting
earnings
Ijiri‟s primary issues in
corporate financial forecasts
• Reliability:
– related to the relative accuracy of the
forecasts
• Responsibility:
– related to the possible large liabilities of
firms making forecasts and accountants
auditing such forecasts
• Reticence:
– related to the degree of silence and inaction
of firms that are at a competitive
disadvantage due to forecast disclosure
The usefulness of published
forecasts
Acccording to Mautz, three kinds of difference
must be considered when evaluating the
usefulness of published forecasts:
1. differences in the forecasting agilities of
publicly owned firms
2. differences in the attitudes with which
managements in publicly owned companies
might be expected to approach the forecasting
task
3. differences in the capacities of investors to
use forecasts
Cash flow accounting and
reporting
Stewardship function
• Management is entrusted with control
of the financial resources provided by
capital suppliers
• The purpose of financial statements is
to report to concerned parties to
facilitate the evaluation of
management‟s stewardship
• To accomplish this objective, the
reporting system favoured the accrual
system
The accrual basis of
accounting
• Refers to a form of keeping those
records not only of transactions that
result from the receipt and
disbursement of cash, but also of
amounts that the entity owes others
and that others owe the entity
• At the core of this system is the
matching of revenues and expenses
• The system is challenged by proponents
of cash flow accounting
Cash flow accounting
Defined as the recording not only of
cash receipts and disbursements of the
period, but also of the future cash flows
owed to or by the firm as a result of
selling and transferring the title to
certain goods (the accrual basis of
accounting)
Accrual accounting versus
cash flow accounting
• Accrual accounting facilitates the evaluation
of management‟s stewardship and is
essential to the matching of revenues and
expenses
• The efficiency of the accrual system has
been questioned
• Many decision-usefulness theorists
advocate a cash flow accounting system
based on the investor‟s desires to predict
cash flows
Accrual accounting versus cash flow
accounting (cont‟d)
• Most advocates of cash flow accounting
feel that the problems of asset valuation
and income determination are so
formidable as to warrant a separate
accounting system, and propose the
inclusion of a comprehensive cash flow
statement in company reports
Chapter 8
Research
perspectives in
accounting
Classification of accounting
researchers
• The typology of Jung seems to be the
most useful in classifying scientists in
general and accounting researchers in
particular
• Jung classified individuals by the way
they receive information (either by
sensation or intuition) and the way they
reach decisions (either by thinking or
feeling)
Jung and the classification of
researchers
The components of the Jungian dimensions
are, according to Jung:
• „Sensation involves receiving information
through the senses, focusing on detail,
emphasizing the here and now and the
practical‟
• „Intuition … involves input of information
through the imagination, emphasizing the
whole or Gestalt, dwelling in idealism, in
hypothetical possibilities, and taking an
interest in the long term‟
researchers (cont‟d)
• „Thinking is concerned with the use of
reasoning which is impersonal and
formal to develop explanations in
scientific, technical and theoretical
terms‟
• „Feeling … relates to the reaching of
decisions on the basis of highly valued
judgements and focusing on human
values, moral and ethical issues‟
According to Jung, four personality types

result from combinations of Jung‟s
dimensions:
1. sensing-thinking
2. sensing-feeling
3. feeling-intuition
4. thinking-intuition
Jung‟s typology was used by Mitroff
and Kilman to produce a classification
of different types of researchers:
1. Abstract Scientist
2. Conceptual Theorist
3. Conceptual Humanist
4. Particular Humanist
Mitroff and Kilman‟s
classification of researchers
• The Abstract Scientist, a sensing-thinking
person, is motivated by the conduct of
enquiry along a precise methodology and
logic, with a focus on certainty, accuracy and
reliability, and a reliance on a simple, well-
defined and consistent paradigm
• The Conceptual Theorist, a thinking-intuition
person, attempts to generate multiple
explanations or hypotheses for phenomena,
with a focus on discovery rather than testing
Mitroff and Kilman‟s classification of
• The Particular Humanist, a sensing-feeling

person, is concerned with the uniqueness of
particular human beings
• The Conceptual Humanist, an intuition-
feeling person, focuses on human welfare,
directing his or her personal conceptual
enquiry towards the general human good
Accounting methodology
perspectives
• The widely accepted view of the role of accounting
research is that it functions to establish general
laws covering the behavior of empirical events or
objects with which the science is concerned, and
thereby enables us to connect our knowledge of
separately known events
• The natural-science model, which includes careful
sampling, accurate measurement, and good
design and analysis of theory-supported
hypotheses, is generally adopted as the model
supporting good research
• The natural-science model has met with objection,
leading to the ideographic versus nomothetic
methodology debate
Nomothesis versus ideography
• The nomothetic approach:
– seeks only laws and employs only those
procedures admitted by an exact science
– bases research on protocol and technique
• The ideographic approach:
– endeavours to understand a particular
event in nature or society
– is based on the view that the social world
can only be understood by obtaining first-
hand knowledge of the subject under
investigation
Nomothesis versus ideography
(cont‟d)
• The approaches – nomothesis versus
ideography, or enquiry from the outside versus
enquiry from the inside – differ in terms of the
mode of enquiry, the type of organisational
action, and the type and number of analytic
dimensions
• The nomothetic method is interested in the
development of universal knowledge theory
• The ideographic method is interested in the
knowledge of a condition for praxis, which is „a
knowledge of how to act appropriately in a
variety of particular situations‟
Behling‟s five key objections
Orlando Behling raised five key objections to
the natural science model that is used in social
science research and that is applicable to
accounting research, namely:
1. Uniqueness: Each organisation, group and
person differs to some degree from all others
– the development of precise general laws in
organisational behaviour and organisation
theory is therefore impossible
2. Instability: The phenomena of interest to
researchers in organisational behaviour and
organisation theory are transitory
Behling‟s five key objections (cont‟d)
3. Sensitivity: Unlike chemical compounds and
other things of interest to natural science
researchers, the people who make up
organisations, and thus organisations
themselves, may behave differently if they
become aware of research hypotheses abut
them
4. Lack of realism: Manipulating and
controlling variables in organisational
research changes the phenomena under
study
Behling‟s five key objections (cont‟d)
5. Epistemological differences: Although

understanding cause and effect through
natural science research is an appropriate
way of „knowing‟ about physical
phenomena, a different kind of „knowledge‟
not tapped by this approach is more
important in organisational behaviour and
organisational theory
Convergent methodology
• There is an established school of thought

that recommends the use of multiple
methods
• It is generally described as one of
convergent methodology, multi-method/
multi-trait, convergent validation, or what
has been called „triangulation‟
• According to Allport, the ideographic and
nomothetic methods were „overlapping and
contributing to one another‟
Convergent methodology (cont‟d)
• Use of both methods can:

– lead to more confidence in results
– help uncover the deviant or off-quadrant
dimension of a phenomenon
– lead to a synthesis or integration of
theories
– serve as a critical test
Three options
What convergent methodology implies for
research practice is an eventual choice
between three options:
1. pursue both nomothetic and ideographic
research and the aggregate
2. alternate between both nomothetic and
ideographic research, running back and
forth between the two methods to
capitalise on the strengths of one method
in certain cases and overcome the
deficiencies of the other method in other
cases
Three options (cont‟d)
3. Develop a new science described
eloquently as follows:
– „The new science that is gradually
emerging is likely to be more actor
based, experimentally rooted, praxis-
oriented, and self-reflective than the
current image of (positivistic,
objective) science‟
Stephen Pepper‟s „world
hypotheses‟
• Knowledge is the result of a constant
cognitive refinement: the criticism and
improvement of common-sense claims,
referring to common-sense knowledge as
dubitianda – claims to be doubted
• The cognitive refinement is accomplished by:
– multiplicative corroboration – a
confirmation of phenomena by various
subjects, and
– structural corroboration – the use of
theories and hypotheses about the world
and their confirmation by empirical data
Stephen Pepper‟s „world hypotheses‟
(cont‟d)
• Pepper distinguishes four world hypotheses as
adequate structural hypothesis. These are:
– formism, which includes analytic and
dispersive theories
– mechanism, which includes analytic and
integrative theories
– contextualism, which includes synthetic
and dispersive theories
– organicism, which includes synthetic and
integrative theories
Formism
• Relates philosophically to „realism‟ and „platonic
idealism‟, with exponents like Plato and Aristotle
• Its root metaphor is similarity
• It includes both analytic and dispersive theories
• The central activity is description on the basis of
similarities, without concern for the sources of
the similarities
• The description in formism rests on three
categories: characters, particulars and
participation
• What appears in formism is that truth is the
degree of similarity of a description to its object
of reference
Mechanism
• Relates philosophically to the naturalism or
materialism of Democrites, Lucretius, Galileo,
Descartes, Hobbes, Locke, Berkely, Hu and
Reichenbach
• Includes both analytic and integrative theories
• Its root metaphor is a machine
• Like formism, mechanism is an analytical theory
focusing on discrete elements rather than
complexes or contexts
• Unlike formism, mechanism is integrative in the
sense that its world is well-ordered: the facts
occur in a determinate order and, were enough
known, they could be predicted or at least
described as being necessarily just what they are
Mechanism (cont‟d)
• Six features characterise the mechanistic type

of knowledge:
1. like a machine, the object of study is
composed of parts having specified
locations
2. the parts can be expressed in a
quantitative form, corresponding to the
primary qualities of the machine
3. a lawful relationship between the parts of a
study object can be described by functional
equations or statistical correlations … this is
the statement of the interrelationships
among the parts of the machine
4. In addition to the primary qualities, there
are other characteristics that can be
expressed quantitatively, although they are
not directly relevant to the object of study –
these are secondary qualities
5. The secondary qualities are also related by
some principle to the object of study
because „if there were to be a complete
description of the machine we should want
to find out and describe just what the
principle was which kept certain secondary
qualities attached to certain parts of the
machine‟
6. Secondary laws characterise the stable

relationship between the secondary
qualities
• The truth theory of mechanism is whether
the machine works, which is measured by
workability, which comes down to whether
or not one‟s knowledge allows predictions
of the outcomes of any casual adjustments
made in the system
Contextualism
• Relates to the pragmatism of Pierce,
James, Bergson, Dewey and Mead
• It includes both synthetic and dispersive
theories
• Its root metaphor is the historic event or
the act in context
• Unlike formism, contextualism is synthetic,
in that it forcuses on a pattern (a Gestalt)
as the object of study rather than on
disparate facts
Contextualism (cont‟d)
• Like formism, contextualism is dispersive,

in that the focus is on the interpretation of
facts retrieved one by one from a universe
of facts
• These facts are characterised by
continuously changing patterns, making
change and novelty the fundamental
contextualistic categories
Formism in accounting
• Formism in accounting consists of searching
for similarities and differences between
different objects of study without any concern
for potential relationships among them
• It may be argued that all of the technical
knowledge in accounting that is used in the
teaching of accounting and included in
standard textbooks is to a great extent
inescapably formistic
• Formism fits well in accounting practice, where
categorisation is tantamount to reaching
solutions
Mechanism in accounting
• Mechanism in accounting consists of not
only looking for similarities and
differences between objects of study but
also and mainly for quantitative
relationships that allow both description
and prediction
• Mechanism in accounting is also the
search for empirical regularities among
different phenomena through various
forms of statistical correlation
Mechanism in accounting (cont‟d)
• Most empirical research in accounting,

or so called „mainstream‟ research, is to
a great extent inescapably mechanistic
• Mechanism in accounting focuses on
obtaining an ever-more exhaustive
description and finer representation in
order to delineate an abbreviated
representation of the logic linking the
parts of the accounting research object
Contextualism in accounting
• Contextualism in accounting focuses on
the interpretation of independent facts
drawn from a universe of facts in a
specific context that would create a
pattern or Gestalt
• It may be argued that any new
accounting technical knowledge that is
accumulated for specific contexts
constitutes a good example of
contextualism in accounting
Contextualism in accounting (cont‟d)
• Contextualism appears to be more helpful
to the practice of accounting than formism,
by working for specific Gestalt in
accounting where it can pinpoint „what is
useful‟ and „what is not useful‟, and identify
the working of specific organisational
cultures in accounting
• Contextualism in accounting research relies
on an analysis of only facts of direct
verification – facts that are specific to a
given situation, such as a given industry
Organicism in accounting
• Those who adopt organicism in
accounting are focusing on specific
Gestalt as objects of study, which are
composed of well-ordered and
integrated facts that can be described
as well as predicted
• Like mechanism in accounting,
organicism seeks the determination of
empirical regularities between different
phenomena through various forms of
statistical analysis
Organicism in accounting (cont‟d)
• Organicism avoids most of the
limitations of mechanism in accounting
by integrating the research and findings
around a specific context
• Organicism in accounting is viewed as
an important factor of future accounting
research
Perspectives on accounting
research
• Accounting research is elective and diverse
• Like every other social science, accounting bases
its research upon assumptions about the nature of
social science and the nature of society
• An approach applied by Burrel and Morgan to
organisational analysis can be used to differentiate
between four visions of research in accounting:
– functionalist
– interpretive
– radical humanist
– radical structuralist
The nature of social science
Four assumptions about the nature of social
science relate to ontology, epistemology, human
nature and methodology
1. Ontology
• The ontological assumption, concerning the very
essence of the accounting phenomenon, involves
nominalism–realism differences
• The debate concerns whether the social world
external to individual cognition is a compound of
pure names, concepts and labels that give a
structure to reality (as in nominalism) or whether
it is a compound of real, factual and tangible
structures (as in realism)
The nature of social science (cont‟d)
2. Epistemology
• The epistemological debate, concerning the grounds
of knowledge and the nature of knowledge, involves
the antipositivism–positivism debate
• This debate focuses on the utility of a search for
laws or underlying regularities in the field of social
affairs
3. Human nature
• The human-nature debate, concerning the
relationship between human beings and their
environment, involves the voluntarism–determinism
debate
• This debate focuses on whether humans and their
activities are determined by their situation or
environment (as as in determinism) or are the
result of free will (as in voluntarism)
The nature of social science (cont‟d)
4. Methdology
• The methodology debate, concerning the methods
used to investigate and learn about the social
world, involves the ideographic–nomothetic
debate
• This debate focuses on whether the methodology
involves the analysis of the subjective accounts
obtained by participating or getting inside the
situation (as in the ideographic method) or
whether it involves a rigorous and scientific
testing of hypotheses (as in the nomothetic
method)
The framework for analysis of
research
• Any social science discipline, including
accounting, can be analysed through
metatheoretical assumptions about the nature of
science (the subjective–objective dimension),
and about the nature of society (the dimension of
regulation–radical change)
• Using these two dimensions, Burrel and Morgan
were able to develop a coherent scheme for the
analysis of social theory in general and
organisational analysis in particular
The framework for analysis of
research (cont‟d)
• The scheme consists of four distinct

paradigms, being:
– radical humanist, characterised by the
radical change and subjective dimensions
– radical struturalist, characterised by the
radical change and objective dimensions
– interpretive, characterised by the
subjective and regulation dimensions
– functionalist, characterised by the
objective and regulation dimensions
The functionalist view in
accounting
• The functionalist view in accounting focuses on
explaining the social order, in which accounting
plays a role, from a realist, positivist,
determinist and nomothetic standpoint
• It is effective regulation on the basis of objective
evidence
• The functionalist paradigm in accounting views
accounting phenomena as concrete real-world
relations possessing regularities and causal
relationships that are amenable to scientific
explanation
The functionalist view in accounting
(cont‟d)
• As in structural functionalism, the
functionalist paradigm in accounting focuses
on establishing the functions of accounting
needed for the efficient operation of
organisations
• As in system theory, the functionalist
paradigm in accounting focuses on both the
search for analogical representation of the
accounting system and a system analysis
The interpretive view in
accounting
• The interpretive view in accounting would focus
on explaining the social order from a normalist,
antipositivist, voluntarist and ideological
standpoint
• In accounting it would aim to understand the
subjective experience of individuals involved in
the preparation, communication, verification or
use of accounting information
• To the interpretists, accounting is no more than
names, concepts and labels used to construct
social reality
The interpretive view in
Although the interpretive paradigm is not
predominant in accounting, it suffers from
three major limitations:
• it assumes that a „quasidivine‟ observer
can understand social action through sheer
subjectivity and without interference
• it creates the illusion of pure theory by
using a monological line of reasoning
• it fails to be an enquiry of change
The radical humanist view in
accounting
• The radical humanist view in accounting would
focus on explaining the social order from a
nominalist, voluntarist and ideographic
perspective, and place emphasis on forms of
radical methodology
• It would respect any research that reduced
philosophical critique to some normative
methodology
• Critical theory in accounting assumes that
theories, bodies of knowledg and facts are mere
reflections of a realistic worldview
The radical humanist view in
• It would view accountants, accountors and
accountees as prisoners of a mode of
consciousness that is shaped and controlled
through ideological processes
• In short, accounting would be viewed as
creating a „psychic prison‟ where
organisational realities become confirming
and dominating
The radical structuralist view in
accounting
• The radical structuralist view in accounting would
challenge the social order from a realist, positivist,
deterministic and nomothetic standpoint
• It would seek radical change, emancipation,
contradiction and deprivation
• This paradigm would generate accounting theories
based upon metaphors such as the instrument of
domination, schismatic system and catastrophe
• From the point of view of radical structuralists,
organisations are instruments of social forces
concerned with maintaining the division of labour
and the distribution of wealth and power in society
Chapter 9
Accounting: a
multiple paradigm
science
Kuhn‟s thesis
• Kuhn‟s thesis is that a science is dominated by
a specific paradigm at any given point
• Anomalies and a crisis stage may follow,
ending in a revolution in which the reigning
paradigm is replaced by a new, dominant
paradigm
• Central to Kuhn‟s revolutionary pattern is the
definition of a „paradigm‟
• Assuming for the time being that such a
definition is possible, the next step is to
identify the paradigms in accounting
The AAA‟s Statement of
Accounting Theory and Theory
Acceptance
• The American Accounting Association (AAA)
identified the paradigms in accounting with the
publication of its Statement of Accounting
Theory and Theory Acceptance (SOATATA) in
1977
• This statement considers developments in
accounting thought from a „philosophy of
science‟ perspective – that is, in terms of
Kuhn‟s ideas about how progress occurs in
science
SOATATA‟s three dominant
approaches
SOATATA identifies three dominant theoretical
approaches:
1.The classical (true-income/inductive) approach,
used by both the „normative deductionists‟ and
the „positive, inductive writers‟
2.The decision-usefulness approach, used by
those who stress decision models and focus on
decision-makers (behavioural accounting and
market-level research)
3.The information/economics approach, with a
distinction made between the „single-individual
case‟ and the „multi-individual case‟
The state of accounting
• If SOATATA‟s suggestions are accepted,
accounting is a multiple-paradigm science
• To offset the confusion between theories and
paradigms, an adequate definition of a
„paradigm‟ must:
– categorise theories as mere components of
paradigms, and
– differentiate between competing paradigms
• Accounting, like most sciences, lacks a single
comprehensive paradigm
• Thus, competing accounting paradigms should
be properly identified and delineated to
achieve a proper conception of the state of
accounting
The concept of a paradigm
Kuhn uses the term „paradigm‟ in two different
senses:
• On the one hand, it stands for the entire
constellation of beliefs, values and
techniques that are shared by the members
of a given community
• On the other hand, it denotes one sort of
element in that constellation, the concrete
puzzle-solutions, which, employed as
models or examples, can replace explicit
rules as a basis for the solution of the
remaining puzzles of normal science
Ritzer‟s definition of a
paradigm
Ritzer‟ visions of multiple paradigm offered the
following definition of a paradigm:
„A paradigm is a fundamental image of the
subject matter within a science. It serves to
define what should be asked, and what
rules should be followed in interpreting the
answer obtained. The paradigm is the
broadest unit of consensus within a science
and serves to differentiate one scientific
community from another. It subsumes,
defines, and interrelates the exemplars,
theories, methods, and instruments that
exist within it‟
The basic components of a
paradigm
The basic components of a paradigm are:
• an exemplar, or a piece of work that
stands as a model for those who work
within the paradigm
• an image of the subject matter
• theories
• methods and instruments
Chapter overview
This chapter uses Ritzer‟s definition to
analyse scientific communities or sub-
communities in accounting with the
assumptions that:
1. accounting lacks a single
comprehensive paradigm and is a
multiple-paradigm science; and
2. each of these accounting paradigms
is striving for acceptance, even
domination, within the discipline
Paradigms suggested by the
AAA
1. The anthropological/inductive paradigm
2. The true-income/deductive paradigm
3. The decision-usefulness/ decision-model
paradigm
4. The decision-usefulness/decision-
maker/aggregate-market-behaviour
paradigm
5. The decision-usefulness/decision-
maker/individual-user paradigm
6. The information/economics paradigm
The anthropological/inductive
paradigm
• Several studies qualify as exemplars of the
anthropological/inductive paradigm – namely
the works of Gilman, Hatfield, Ijiri, Littleton
and Paton
• The authors of these studies share a concern
for a descriptive-inductive approach to the
construction on accounting practices
Ijiri‟s study
• Ijiri considers the primary concern of
accounting to be the functioning of
accountability relationships among
interested parties
• The objective measurement is the economic
performance of the firm
• Ijiri presents accountability as a descriptive
theory of accounting
• Ijiri presents an axiomatic model of existing
accounting practice that evaluates the
significance of historical cost in terms of
accountability and decision-making
Littleton‟s study
• Littleton arrives at his accounting principles
from observations of accounting practice that
evaluate the significance of historical cost in
terms of accountability and decision-making
• Teachers of bookkeeping and later of
accounting and auditing found it necessary to
supplement the accumulated rules and
descriptions of procedure with explanations
and justifications
• It is appropriate to say that both methods of
practice and the explanations of theory were
inductively derived out of experience
Littleton‟s study (cont‟d)
• Good theory is practice-created, and

moreover is practice-conditioning
• Whenever evidence of integration among
accounting ideas is found, it will strengthen
the conviction that accounting contains the
possibility of being built into a system of
coordinated explanations and justifications of
what accounting is and what it can become
Gordon‟s study
Gordon theorises on income smoothing as follows:
– „Proposition 1: The criterion a corporate
management uses in selecting among
accounting principles is the maximization of
its utility or welfare …
– „Proposition 2: The ability of a
management increases with:
• its job security
• the level and rate of growth in the
management‟s income, and
• the level and rate of growth in the
corporation size
Gordon‟s study (cont‟d)
– „Proposition 3: The achievement of the
management goals stated in Proposition 2 is
dependent in part on the satisfaction of
stockholders … the greater the job security,
income, etc., of the management …
– „Proposition 4: Stockholders‟ satisfaction with
a corporation increases with the average rate of
growth in the corporation‟s income … and
stability of its income
– „Theorem: Given that the above four
propositions are accepted or found to be true, it
follows that a management would within the
limits of its power …:
1. smooth reported income, and
2. smooth the rate of growth income‟
Watts and Zimmerman
• Gordon‟s assumptions that shareholder
satisfaction is solely a positive function of income
and that increases in stock prices always follow
increases in accounting income have been more
seriously contested
• To avoid the pitfalls that may exist in Gordon‟s
model, Watts and Zimmerman attempt to provide
a positive theory of accounting by exploring the
factors influencing management‟s attitudes
regarding accounting standards
• At the outset, Watts and Zimmerman assume that
the management‟s utility is a positive function of
the expected compensation of future periods and
a negative function of the dispersion of future
compensation
Watts and Zimmerman (cont‟d)
• Their analysis shows that the choice of

accounting standards can affect a firm‟s cash
flow through taxes, regulation, political costs,
information-production costs and
management-compensation plans, and that:
– the first four factors increase managerial
wealth by increasing the cash flows, and
hence the share price
– the last factor can increase managerial
wealth by altering the terms of the
incentive compensation
Image of the anthropological/
inductive subject matter
• To those who adopt the anthropological/
inductive paradigm, the basic subject matter
is:
– existing accounting practices, and
– management‟s attitudes towards those
practices
• The accounting-research objective associated
with the anthropological/inductive paradigm
is to understand, explain and predict existing
accounting practices
Image of the anthropological/
inductive subject matter (cont‟d)
• Ijiri views the mission of this paradigmatic
approach as follows:
– „This type of inductive reasoning to
derive goals implicit in the behaviour of
an existing system is not intended to be
pro-establishment to promote the
maintenance of the status quo. The
purpose of such exercise is to highlight
where changes are most needed and
where they are feasible. Changes
suggested as a result of such a study
have a much better chance of actually
being implemented‟
Theories in the anthropological/
inductive paradigm
Four theories may be considered to be
part of the anthropological/inductive
paradigm:
1. information economics
2. the analytical/agency model
3. the income-smoothing/earnings-
management hypotheses
4. the positive theory of accounting
Methods in the anthropological/
inductive paradigm
Those who adopt the anthropological/
inductive paradigm tend to employ
one of three techniques:
1. techniques used in income-
smoothing research
2. techniques used in earnings-
management research, or
3. techniques used in positive-
theory research
The true-income/deductive
paradigm
• Studies that qualify as exemplars of the true-
income/deductive paradigm are the works of
Alexander, Canning, Edwards and Bell, MacNeal,
Moonitz, Paton, Sprouse and Moonitz, and
Sweeney
• These authors share a concern for a normative-
deductive approach to the construction of
accounting theory and, with the exception of
Alexander, a belief that, ideally, income
measured using a single valuation base would
meet the needs of all users
The true-income/deductive
paradigm (cont‟d)
• These researchers are also in complete

agreement that current price information is
more useful than conventional historical-cost
information is to users in making economic
decisions
Paton‟s study
• According to Paton, accounting plays a
significant and relevant role in the firm
and in society
• Paton‟s theory of the accounting system
consists of a logical discussion and
justification of the accounting structure in
terms of the fundamental classes of
accounts:
– proprietorship and liabilities
– property and equity accounts
– types of transactions
Paton‟s study (cont‟d)
– expense, revenue and supplementary
accounts
– account classification
– periodic analysis
– the concepts of debit and credit
Image of the true-income/
deductive subject matter
• To those who adopt the true-
income/deductive paradigm, the basic
subject matter is:
1. the construction of an accounting
theory on the basis of logical and
normative reasoning and conceptual
rigour
2. a concept of ideal income based on
some other method than the
historical-cost method
Image of the true-income/
deductive subject matter (cont‟d)
• Macneal argues for an ideal-income
concept as follows:
–„There is one correct definition of
profits in an accounting sense. A
“profit” is an increase in net wealth. A
“loss” is decrease in net wealth. This
is an economist‟s definition. It is
terse, obvious and mathematically
demonstrable‟
• Alexander also argues for an ideal-income
concept
Theories in the true-
income/deductive paradigm
• Theories that emerge from the true-
income/deductive paradigm present
alternatives to the historical-cost
accounting system
• In general, five theories or schools of
thought may be identified:
1. price-level adjusted (or current-
purchasing-power) accounting
2. replacement-cost accounting
Theories in the true-
income/deductive paradigm (cont‟d)
3. deprival-value accounting
4. continuously contemporary (net-
realisable-value) accounting
5. present-value accounting
• Each of these theories presents
alternative methods of asset valuation
and income determination that allegedly
overcome the defects of the historical-
cost accounting system
Methods in the true-
income/deductive paradigm
• Those who accept the true-income/deductive
paradigm generally employ analytic
reasoning to justify the construction of an
accounting theory or to argue the
advantages of a particular asset-valuation/
income-determination model other than
historical-cost accounting
• Advocates of this paradigm generally proceed
from objectives and postulates about the
environment to specific methods
Chambers
• Chambers was one of the first to point to
the decision-usefulness/decision-model
paradigm
• According to Chambers, „A formal
information-providing system would
conform with two general propositions‟:
– „The first is a condition of all logical
discourse. The system should be
logically consistent; no rule or process
can be permitted that is contrary to any
other rule or process …
Chambers (cont‟d)
– „The second proposition arises from the
use of accounting statements as a basis
for making decisions of practical
consequence. The information yielded by
any such system should be relevant to
the kinds of decision the making of
which it is expected to facilitate‟
• Chambers prefers to base an accounting
theory on the usefulness of „current cash
equivalents‟ rather than on the decision
models of specific user groups
May
• May offers a list of uses of financial
accounts without explicitly employing the
decision-model approach to the
formulation of accounting theory
• According to May, financial accounts are
used as:
1. a report of stewardship
2. a basis of fiscal policy
3. a criterion of the legality of dividends
4. a guide to wise dividend activity
5. a basis for the granting of credit
May (cont‟d)
6. information for prospective investors
7. a guide to the value of investments
already made
8. an aid to government supervision
9. a basis for price of rate regulations
10.a basis for taxation
Beaver, Kennelly and Voss
• Beaver, Kennelly and Voss examine the origin
of the predictive-ability criterion, its
relationship to the facilitation of decision-
making, and the potential difficulties associated
with its implementation
• According to the predictive-ability criterion,
alternative methods of accounting
measurement are evaluated in terms of their
ability to predict economic events
• The predictive-ability criterion is assumed to be
relevant, even when applied in conjunction with
a low specification of the decision model
Sterling
• Sterling develops criteria to be used in
evaluating the various measures of wealth
and income
• Given the conflicting viewpoints about the
objectives of accounting reports, Sterling
chooses usefulness as the overriding
criterion of a measurement method,
emphasising its importance over such
requirements as objectivity and verifiability
Image of the decision-
usefulness/decision-model
subject matter
To those who adopt the decision-
usefulness/decision-model paradigm,
the basic subject matter is the
usefulness of accounting information to
decision models
Theories in the decision-
paradigm
Two kinds of theories may be included within the
decision-usefulness/decision-model paradigm:
1. the first deals with the different kinds of
decision model associated with business
decision-making (EOQ, PERT, linear
programming, capital budgeting, buy versus
lease, etc.)
2. the second deals with the different economic
events that may affect a going concern
(bankruptcy, takeover, merger, bond ratings,
etc.)
Methods in the decision
paradigm
• Those who accept the decision-
usefulness/decision-model paradigm tend to
rely on empirical techniques to determine
the predictive ability of selected items of
information
• The general approach has been to use
discriminant analysis to classify into one of
several a priori groupings, dependent on a
firm‟s individual financial characteristics
The decision-usefulness/
decision-maker/aggregate-
market-behaviour paradigm
The exemplars of the decision-
usefulness/decision-maker/market-
behaviour paradigm are the works of
Gonedes and of Gonedes & Dopuch
Gonedes
• Gonedes extended the interest in
decision-usefulness from the individual-
user response to the aggregate-market
response
• Gonedes developed the aggregate-
market paradigm, which implies that
accounting procedures numbers have
informational content dictated by
market responses
Gonedes and Dopuch
• In their award-winning paper, Gonedes
and Dopuch provided a theoretical
framework for assessing the desirability
and effects of alternative accounting
procedures
• Their approach relies on the use of
prices of firms‟ ownership shares
• Gonedes and Dopuch concluded that
the price-domain analysis is sufficient
for assessing the effects of alternative
accounting procedures
Beaver
• Beaver raised the issue of the
importance of this relationship between
accounting data and security behaviour
• He argued that it is inconceivable that
optimal informational systems for
investors can be selected without
knowledge of how accounting data are
impounded in prices, because these
prices determine wealth, and wealth
affects the multi-period investment
decisions of individuals
Images of the subject matter
• To those who adopt the decision-
usefulness/decision-maker/aggregate-
market-behaviour paradigm, the basic
subject matter is the aggregate-market
response to accounting variables
• The authors who adopt the paradigm
agree that, in general, decision-
usefulness of accounting variables can
be derived from aggregate-market
behaviour
Theories in the paradigm
• The relationship between aggregate-
market behaviour and accounting variables
is based on the theory of capital-market
efficiency
• According to this theory, the market for
securities is deemed efficient in that:
– market prices „fully reflect‟ all publicly
available information, and
– by implication, market prices are
unbiased and respond instantaneously to
new information
Theories in the paradigm (cont‟d)
• Theories confirming the market behaviour

paradigm include:
1. the efficient market model
2. the efficient market hypothesis
3. the capital asset pricing model
4. the arbitrage pricing theory
5. the equilibrium theory of option pricing
Methods in the paradigm
Those who accept the market paradigm
rely on the following methods:
1. the market model
2. the beta estimation models
3. the event study methodology
4. the Ohlson‟s Valuation model
5. the price level balance sheet
evaluation models
6. the information content of earnings
models
7. the models of the relation between
earnings and return
The decision-usefulness/decision-
maker/individual-user paradigm
exemplars
• The work of William Bruns may be considered the
first exemplar of the decision-maker/individual-
user paradigm
• Bruns proposed hypotheses that relate the use of
accounting information and the relevance of
accounting information to the decision-maker‟s
conception of accounting
• These hypotheses are also developed in a model
that identifies and relates some factors that may
determine when decisions are affected by
accounting systems and information
Images of the subject matter
• To those who adopt the decision-
usefulness/decision-maker/individual-
user paradigm, the basic subject matter
is the individual-user response to
accounting variables
• Advocates of this paradigm argue that,
in general, the decision-usefulness of
accounting variables may be derived
from human behaviour
Theories in the paradigm
• The paradigm tends to „borrow‟ theories, most
of which adequately explain and predict
human behaviour within an accounting
context
• These borrowed theories include:
1. cognitive relativism in accounting
2. cultural relativism in accounting
3. behavioural effects of accounting
information
4. linguistic relativism in accounting
5. functional and data fixation hypotheses
Theories in the paradigm (cont‟d)
6. information inductance hypotheses
7. organisational and budgetary slack
hypotheses
8. contingency approaches to the design of
accounting systems
9. participative budgeting and performance
10.human information processing models
Models in the paradigm
Those accepting the decision-
usefulness/decision-maker/individual-
user paradigm tend to use all of the
methods favoured by behaviourists:
• observation techniques
• interviews
• questionnaires
• experimentation
The information/economics
paradigm
Exemplars of the information/economics
paradigm are the words of Crandall,
Feltham, and Feltham & Demski
Feltham
• In his pioneering paper, Feltham provides a
framework for determining the value of a
change in the information decision (the
decision-maker)
• The framework relies on the individual
components that are required to compute the
expected payoff for a particular information
system
• The components are:
1. a set of possible actions at each period
within a time horizon
2. a payoff function over the events that
occur during periods
Feltham (cont‟d)
3. probabilistic relationships between past
and future events
4. events and signals from the information
system, including past and future
signals
5. a set of decision rules as functions for
the signals
• The framework states that the value of
changing from one information system to
another is equal to the difference between
the expected payoffs of the two
alternatives
Crandall
• Crandall examines the usefulness of the
information/economics paradigm to the future
development of accounting theory and offers the
„applied information economics‟ approach as a
new mainstream accounting theory
• This approach consists of recognising explicitly
each component of the information/economics
model and of broadening the scope of accounting
design to include these components, which are:
– the „filter‟
– the „model‟
– the „channel‟
– „decoding‟
– the „decision rule‟
Feltham and Demski‟s „The Use of
Models in Information Evaluation‟
• This exemplar presents and discusses a
model of information choice that views
information evaluation in cost-benefit
terms and as a sequential process
• The entire process is summarised as
follows:
„specification of a particular
information system results in a set
of signals being supplied to the
Feltham and Demski‟s „The Use of Models
in Information Evaluation‟ (cont‟d)
decision maker; the decision maker
may then use the resulting
information in selecting his or her
action; and this action may determine,
in part, the events … of a subsequent
period … In addition, the decision
maker must predict the gross payoff
he or she will derive from the events
of the subsequent period, as well as
the cost of operating the particular
information system …‟
Images of the information/
economics subject matter
• To those who adopt the information/economics
paradigm, the basic subject matter is:
– information is an economic commodity
– the acquisition of information amounts to a
problem of economic choice
• The value of information is viewed in terms of a
cost-benefit criterion within the formal structure
of decision theory and economic theory
• 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
Images of the information/
economics subject matter (cont‟d)
• A single individual must select among different
actions that have different possible outcomes
• The individual may face a two-stage process:
1. the information system produces
different signals
2. the observance of a signal results in a
revision of probabilities and choice of the
conditional best action
(Note that the information system with the
highest expected utility is preferred)
Theories in the information/
economics paradigm
• The information/economics paradigm draws on
insights from:
– the „theory of teams‟, developed by
Marschak and Radner, on
– the statistical decision theory, and on
– the economic theory of choice
• Central to the information/economics
paradigm is the traditional economic
assumption of consistent, rational choice
behaviour
Methods in the information/
economics paradigm
• Those who accept the information/economics
paradigm generally employ analytic reasoning
based on statistical decision theory and the
economic theory of choice
• The approach consists of isolating the general
relationships and effects of alternative
scenarios and applying Bayesian-revision
analysis and a cost-benefit criterion to analyse
questions of accounting policy
• The primary assumption of this approach is
rationality
The science of accounting
• The situation in accounting research has
drastically improved over the years
• The situation has changed in favour of a
dynamic research agenda, as evidenced by
the transformation of accounting into a fully
fledged „normal science‟ with competing
paradigms striving for dominance
• Mainstream accounting research sees a
parallel between physical and social sciences
and accounting, justifying in the process a
hypothetic-deductive account of scientific
explanation and the need for confirmation of
hypotheses
Is accounting a science?
• The primary question – whether
accounting is a science – has never been
answered adequately
• A good definition of a science, provided by
Buzzell, is:
„a classified and systematized body of
knowledge … organized around one or
more central theories and a number of
general principles … usually expressed in
quantitative terms … knowledge which
permits the prediction and, under some
circumstances, the control of future
events‟
Is accounting a science? (cont‟d)
• Accounting meets Buzzell‟s criteria, in

that it:
– has a distinct subject matter
– includes underlying uniformities and
regularities conducive to empirical
relationships, authoritative
generalisations, concepts, principles,
laws and theories
Deconstruction
• Deconstruction in accounting research
calls for more attempts to reveal the
hidden assumptions of accounting texts
• It assumes that all accounting discourse,
even all historical narrative, is essentially
rhetoric
• The accounting deconstructionist will
criticise the accounting text through
various techniques including
demythologising, decanonising,
dephallicising, or de-faming
Conclusion
• Accounting may be approached from the point of
view of the „philosophy‟ of science
• In this chapter, we have adopted a definition of
a „paradigm‟ that is relevant to accounting
• The essential components of such a paradigm
are exemplars, the image of the subject matter,
theories and methods
• Each of the paradigms covered is the object of
investigation and research by established
scientific communities
• A paradigm creates a coherent, unified
viewpoint that determines the way in which
members view accounting research, practice and
even education
Chapter 10
The events and
behavioural
approaches
New approaches in
accounting theory
• Among the new approaches, we may
distinguish:
– the events approach
– the behavioural approach
– the human information processing approach
– the predictive approach
– the positive approach
• Each of these approaches has generated new
methodologies and interest, and has employed
unique ways of looking at accounting problems
The nature of the events
approach
• The events approach was first explicitly
stated after a divergence of opinion
among the members of the Committee
of the American Accounting Association,
which issued a Statement of Basic
Accounting Theory in 1966
• A majority of the Committee members
favoured the value approach to
accounting
The value school
The value school, also called the use-

need school, considers that needs of
users are known sufficiently to allow
the deduction of an accounting
theory that provides optimal input to
the specified decision models
Conventional accounting model
weaknesses
The conventional accounting model, based on
the value approach, suffers from the following
weaknesses:
• its dimensions are limited
• its classification schemes are not always
appropriate
• its aggregation level for information is high
• its degree of integration with the other
functional areas of an enterprise is too
restricted
The events approach
• 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 characteristics of an event may be directly
observed and are of economic significance to the
user
• Given the number of characteristics and the
number of events susceptible to observation that
might be relevant to the decision models of all
types of users, the events approach suggests a
tremendous expansion of the accounting data
presented in financial reports.
Financial statements
• In the value approach:
– the income statement is perceived as an
indicator of the financial performance of
the firm for a given period
– the statement of cash flows is perceived
as an expression of the changes in cash
• In the events approach:
– the income statement is perceived as a
direct communication of the operating
events that occur during a given period
Financial statements (cont‟d)
– the statement of cash flows is better

perceived as an expression of financial
and investment events
– in other words, an event‟s relevance
rather than its output on cash flow
determines the reporting of an event in
the statement of cash flow
The normative events theory
of accounting
• The normative events theory of accounting has
been tentatively summarised as follows:
– „In order for interested persons … to better
forecast the future of social organizations, …
the most relevant attributes … of the crucial
events … which affect the organization are
aggregated … for periodic publication free of
inferential bias‟
• The objective of the normative events theory of
accounting is to maximise the forecasting
accuracy of accounting reports by focusing on
the most relevant attributes of events crucial to
the users
The normative events theory of
• The theory calls for:
1. an explicit taxonomy of real events,
which the accountant is to report
2. more effective classification schemes,
with particular reference to labels that
make it possible to associate
observations of particular events with
other related events
3. the structuring of an events-based
accounting information system
Events-based accounting
information systems
• One way to meet the objective of the normative
events theory is to integrate it with database
approaches to information management that
assume an enterprise creates a centrally
managed database for sharing among a wide
range of users with highly diverse needs
• Such accounting systems include:
– hierarchical models
– network models
– relational models
– entity-relationship models
– REA accounting models
The hierarchical model
• The hierarchical model is based on the idea
of an events-accounting information system
that allows users to make enquiries of a
database
• The components of such a system include:
– a mass database that contains a record of
all events in some generalised format
– a user-defined structure that provides each
user with his or her own conceptual
structure (and aggregation levels) of the
events
– user-defined functions, or operations, for
manipulating the data
The network model
• The network model is based on the
concept of multidimensional accounting
presented by Ijiri, and Charnes,
Colantoni & Cooper
• The network model uses as input the
initially unstructured database and a
collection of queries or data requests to
develop a hierarchical data structure
that will minimise the number of
records to be accessed to answer the
desired set of queries
The entity-relationship model
• The entity-relationship model assumes that
an accounting system is most naturally
modelled in a database environment as a
collection of real-world entities and
relationships among those entities
• This model basically replaced the
traditional chart of accounts and double-
entry bookkeeping procedures by viewing
entity-relationship in the form of entity
tables and relationship tables
Evaluation of the events
approach
• The events approach offers certain advantages
and certain limitations
• The advantages predominantly take the form
of efforts to provide information about
relevant economic events that might be useful
to a variety of decision models
• As a result, more information may be available
to users who can then use their own utility
function to determine the nature and level of
aggregation of the information they need to
make their particular decisions
The usefulness of the events
approach
The usefulness of the events approach may
depend on one or more of the following five
factors:
1. the psychological „type‟ of the decision
maker
2. information overload, which may result
from the attempt to measure the
relevant characteristics of all crucial
events affecting the firm
3. an adequate criterion for the choice of
the crucial events has not been
developed
The usefulness of the events
approach (cont‟d)
4. measuring all the characteristics of an
events approach may prove to be
difficult, given the state of the art of
accounting
5. more research may be needed to
examine the impact of different design
approaches to the events approach
theory, such as the hierarchical,
network, relational, entity-relationship
and REA models
The nature of the behavioural
approach
• Most traditional approaches accounting theory
construction have failed to consider user
behaviour in particular and behavioural
assumptions in general
• The behavioural approach to accounting theory
formulation emphasises the relevance to decision-
making of the information being communicated,
and of the individual and group behaviour caused
by the information being communicated
• The behavioural approach to accounting theory
formulation is concerned with human behaviour as
it relates to accounting information and problems
Behavioural accounting
• Although relatively new, the behavioural
approach has generated enthusiasm and a
new impetus in accounting research that
focuses on the behavioural structure within
which accountants function
• A new multidisciplinary area in the field of
accounting has been conveniently labelled
„behavioural accounting‟
• The basic objective of behavioural accounting
is to explain and predict behaviour in all
possible accounting contexts
Behavioural effects of
accounting information
• A more recent and exhaustive attempt by
Dyckman, Gibbins and Swieringa illustrates the
nature of studies of the behavioural effects of
accounting information
• We may divide these studies into five general
classes:
1. adequacy of disclosure
2. usefulness of financial statement data
3. attitudes about corporate reporting practices
4. materiality judgements
5. decision effects of alternative accounting
procedures
Adequacy of disclosure
• Three approaches were used to examine the
adequacy of disclosure:
1. the first examined the patterns of use of
data from the viewpoint of resolving
controversial issues concerning the inclusion
of certain information
2. the second examined the perceptions and
attitudes of different interest groups
3. the third examined the extent to which
different information items were disclosed in
annual reports and the determinants of any
significant differences in the adequacy of
financial disclosure among companies
Adequacy of disclosure (cont‟d)
• The research on disclosure adequacy and use
showed:
– general acceptance of the adequacy among
– recognition that the differences in disclosure
adequacy among financial statements are
due to such variables as company size,
profitability, and size and listing status of
the auditing firm
The usefulness of financial
statement data
• Two approaches were used to examine the
usefulness of financial statement data:
1. the first examined the relative importance of
the investment analysis of different
information items to both users and
preparers of financial information
2. the second examined the relevance of
financial statements to decision-making,
based on laboratory communication of
financial statement data in terms of
readability and meaning to users in general
The usefulness of financial
statement data (cont‟d)
• The overall conclusions of these studies were

that:
– some consensus exists between users and
preparers regarding the relative
importance of the information items
disclosed in financial statements
– users do not rely solely on financial
statements when making their decisions
Attitudes about corporate
reporting practices
• Two approaches were used to examine
attitudes about corporate reporting
practices:
1. the first examined preferences for
alternative accounting techniques
2. the second examined attitudes about
general reporting issues, such as how
much information should be available,
how much information is available, and
the importance of certain items
Attitudes about corporate reporting
practices (cont‟d)
• These research items showed the
extent to which some accounting
techniques proposed by the
authoritative bodies are accepted, and
also brought to light some attitudinal
differences among professional groups
concerning reporting issues
Materiality judgements
• Two approaches were used to examine
materiality judgements
1. the first examined the main factors
determining the collection, classification
and summarisation of accounting data
2. the second focused on what items people
consider to be material, and sought to
determine the degree of difference in
accounting data that is required before
the difference is perceived as material
• These studies indicated that several factors
appear to affect materiality judgements,
and that these judgements differ among
individuals
Linguistic effects of accounting
data and techniques
• Linguistics and accounting have many
similarities
• Belkaoui argues that accounting is a
language and that according to the Sapir-
Whorf hypothesis its lexical characteristics
and grammatical rules will affect both the
linguistic and the non-linguistic behaviour
of users
Linguistic effects of accounting data
and techniques (cont‟d)
• Four propositions derived from the linguistic
relativity paradigm to conceptually integrate
the research findings of the impact of
accounting information on the user‟s
behaviour, are as follows:
1. users who make certain lexical distinctions
in accounting are enabled to talk and/or
solve problems that cannot be solved by
users who do not
2. users who make certain lexical distinctions
in accounting are enabled to perform
tasks more rapidly or more completely
than those who do not
Linguistic effects of accounting data
and techniques (cont‟d)
3. users who possess the accounting
(grammatical) rules are more predisposed
to different managerial styles or emphases
than those who do not
4. accounting techniques may tend to
facilitate or render more difficult various
managerial behaviours on the part of users
• These propositions have been empirically
tested and verified in two studies that
emphasise the importance of linguistic
considerations in the use of accounting
information and international standard-
setting
Functional and data fixation
• Functional fixation originated as a concept
in psychology, arising from an investigation
of the impact of past experience on human
behaviour
• Dunker introduced the concept of the
functional fixation to illustrate the negative
role of past experiences
• He investigated the hypothesis that an
individual‟s prior use of an object in a
function dissimilar to that required in a
present problem would serve to inhibit the
discovery of an appropriate, novel use for
the object
Ijiri, Jaedicke and Knight
• Ijiri, Jaedicke and Knight viewed the decision
process as being characterised by three
factors:
– decision inputs
– decision outputs
– decision rules
• They introduced the conditions under which a
decision maker cannot adjust his or her
decision process to a change in the accounting
process
• They attributed the inability to adjust, if it
existed, to the psychological factor of
functional fixation
Concepts of functional and data
fixation in accounting
Various hypotheses exist for both the
functional and data fixation results in
accounting studies, namely:
– The conditioning hypotheses: It
may be that the subjects of
experiments, mostly accounting
students, have been conditioned to
react to some form of accounting
outputs and have failed to adjust their
decision processes in response to a
„well-disclosed‟ accounting change
Concepts of functional and data
fixation in accounting (cont‟d)
– Prospect theory and framing
hypothesis: Framing occurs because
the wording of a question has the
potential to alter a subject‟s response
– Primary versus recency ego
involvement: In matters of ego
involvement with an accounting
technique just learned, subjects will give
importance to what is perceived as
relevant, significant or meaningful
Information inductance
• The individual‟s behaviour is influenced by
information in two ways:
1. through information use when acting as a
recipient
2. through information inductance when acting
• As stated by Prakash and Rappaport:
„An individual‟s anticipating the consequences of
his or her communication might lead him or her
– before any information is communicated and,
hence, even before any consequences arise – to
choose to alter the information, or his or her
behaviour, or even his or her objectives. This is
the process of information inductance‟
Time factors and information
inductance
According to Prakash and Rappaport, time
factors seem to govern inductance as follows:
• „First, communication of information that is
either in fact a description of the sender‟s
behaviour, or is regarded as such by the
information sender, or concerning which the
information sender has some apprehension
that it could be so regarded by the
information recipient, will be strongly
conducive to information inductance
• „Second, consequences that represent
possible feedback effects on the information
sender will be strongly conducive to
information inductance‟
The human information
processing approach
• Interest in the human information processing
approach arose from a desire to improve both the
information set presented to financial data users
and users‟ ability to use such information
• Theories and models from human information
processing psychology provide a tool for
transforming accounting issues into generic
information processing issues
• There are three main components of an
information processing model:
– input
– process
– output
Input
• Studies of the information set input (or cues)
focus on the variables that are likely to
affect the way people process information
for decision making
• The variables examined are:
1. the scaling characteristics of individual
cues
2. the statistical properties of the information
set
3. the informational content or predictive
significance
4. the method of presentation
5. the context
Process
Studies of the process component
focus on the variables affecting the
decision maker, such as:
1. characteristics of judgement
2. characteristics of decision rules
Output
• Studies of the output component focus
on variables related to the judgement,
prediction or decision that are likely to
affect the way the user processes the
information
• The variables examined include:
1. the qualities of the judgement
2. self-insight
Four different approaches
The varying emphasis on any of the
three components of an information
processing model led to the use of
four different approaches:
1. the lens model approach
2. probabilistic judgement
3. pre-decisional behaviour
4. the cognitive-style approach
The lens model
• Brunswick‟s lens model allows explicit recognition
of the interdependence of environmental and
individual-specific variables
• The model is used primarily to assess human
judgemental situations in which people make
judgements on the basis of a set of explicit cues
from the environment
• The model emphasises the similarities between
the environment and the subject response
• Most accounting research using the lens model
has been motivated by the need to build
mathematical models that represent the relative
importance of different information cues, and by
the need to measure the accuracy of judgement
and its consistency, consensus and predictability
The lens model (cont‟d)
• Various accounting-decision problems have
been examined using the lens model. These
include:
1. policy-capturing studies, which examine
the relative importance of different cues in
the judgement process, and consensus
among decision makers
2. accuracy of judgements made on the
basis of accounting cues
3. effects of task characteristics on
achievement and learning
Probabilistic judgement
• The probabilistic judgement approach,
sometimes known as the Bayesian
approach, focuses first on a comparison
of intuitive probability judgements and
the normative model
• The normative model for probability
revision, known as Bayes‟ Theorem, is
used as the descriptive model of human
information processing
Bayes‟ Theorem
The a posteriori probability form of Bayes‟
Theorem states that:
where H1 and H2 are the alternative

hypothesis and D is the datum
Probabilistic judgement and
Bayes‟ Theorem
• The basic question examined in the
early research in probabilistic
judgement is whether probabilities are
revised in the direction indicated by
Bayes‟ Theorem
• The findings suggest that this occurs to
a lesser extent than Bayes‟ Theorem
suggests
• The phenomenon had been labelled
conservatism
Heuristics and probabilistic
judgement
• Tversky and Kahneman reported that people
rely on a number of heuristics to reduce the
complex task of assessing probabilities and
predicting values to simpler judgemental
operations
• These heuristics include:
– representativeness, which refers to the
heuristic people use when they assess the
probability of an event on the basis of its
degree of similarity, or representativeness,
to the category to which it is perceived to
belong
Heuristics and probabilistic
judgement (cont‟d)
– availability, which refers to the heuristic
people use when they assess the
probability of an event on the basis of
the ease with which it comes to mind
– adjustment and anchoring refer to the
heuristic people use when they make
estimates by starting with an initial
value and then adjusting the value to
yield the final answer
Pre-decisional behaviour
• Most of the experiments based on the lens
model or on probabilistic judgement involve
highly repetitive situations in which the task
is well-defined, the subject is exposed to
the right cues, and the problems are pre-
specified, meaning that these experiments
fail to explore the stages of pre-decisional
behaviour
• Pre-decisional behaviour applies to the
dynamics of problem definition, hypothesis
formation and information search in less
structured environments
Pre-decisional behaviour (cont‟d)
• Pre-decisional behaviour is generally

examined using process-tracing methods
• Process tracers tend to rely on four
methods:
1. eye movements
2. information search behaviour
3. information cue attending or response
time
4. verbal „think aloud‟ introspective
protocols
The cognitive-style approach
• „Cognitive style‟ is a hypothetical construct used to
explain the mediation process between stimuli and
responses
• Five approaches to the study of cognitive style in
psychology have been reported:
– authoritarianism
– dogmatism
– cognitive complexity
– integrative complexity
– field dependence
• Accounting studies based on these five approaches
have focused on classifying information users by
their cognitive style and on designing information
systems that are best suited to the decision
maker‟s cognitive style
Cognitive relativism in
accounting
• Cognitive relativism in social psychology has
created strong interest in the knowledge
structure used in memory, and also in how
people learn
• Gibbins describes professional judgement in
public accounting as a five-component process:
1. schemas or knowledge structures accumulated
through learning or experience
2. triggering event or stimulus
3. judgement environment
4. judgement process
5. decision/action
Cognitive relativism in accounting
(cont‟d)
• The essence of cognitive relativism in

accounting is the presence of a cognitive
process that is assumed to guide the
judgement/decision process
Cultural relativism in accounting
• Cultural relativism postulates that culture
shapes the cognitive functioning of
individuals who are faced with an accounting
or auditing phenomenon
• This view holds that culture determines the
judgement/decision process in accounting
• The definition of the components of culture is
provided by Hofstede as four dimensions that
reflect a country‟s cultural orientations and
explain 50 per cent of the differences in value
systems among countries, being:
1. individualism versus collectivism
2. large versus small power distance
Cultural relativism in accounting
(cont‟d)
3. strong versus weak uncertainty
avoidance
4. masculinity versus femininity
• This cultural relativism model assumes that
differences among these four dimensions
create different cultural arenas that have
the potential to dictate the organisational
behaviour that may shape the judgement
decision process in accounting
Cross-cultural research in
accounting
There are at least five possible basic approaches
to cross-cultural research in accounting, which
are:
1. parochial studies, being the approach
comprising studies of the USA conducted by
Americans
2. ethnocentric studies, comprising studies that
attempt to replicate American accounting
research in foreign countries
3. polycentric studies, which comprise studies
that describe accounting phenomena in
foreign countries
Cross-cultural research in
4. comparative accounting studies, which
focus on identifying the similarities in
accounting phenomena and cultures
around the world
5. culturally synergistic studies, which
focus on creating universality in
accounting while maintaining an
appropriate level of cultural specificity
Reasons for cross-cultural
research
Cross-cultural research is needed in
accounting for the following five
reasons:
1. it would establish the boundary
conditions for accounting models
and theories
2. it would enable evaluation of the
impact of cultural and ecological
factors on behaviour in accounting
Reasons for cross-cultural research
(cont‟d)
3. although variables are often generally

confounded, the confounding is not
complete, as a few „cultunits‟ may
present deviant cases
4. cultures act as „natural grain-
experiments‟ by being high or low on
variables of particular interest
5. cultures determine aspects of
psychological functioning
Chapter 12
Current-value
accounting
Arguments in favour of
measuring income – I
• Income is a basis for the taxation and

redistribution of wealth among
individuals
• Income is perceived as a guide to a
firm‟s dividend and retention policy
• Income is viewed as an investment and
decision-making guide in general
The AAA‟s normative
shareholders‟ valuation model
• The American Accounting Association‟s
Committee on External Reporting defined a
normative shareholders‟ valuation model
centring on:
– the future dividend-per-share flows to be
derived from an investment
– the risk associated with these flows
• The Committee on External Reporting also
suggested that a firm‟s ability to pay dividends
is a function of the following variables:
– net cash flows from operations
– non-operating cash flows
The AAA‟s normative shareholders‟
valuation model (cont‟d)
– cash flows from changes in the levels of
investment by stockholders and creditors
– cash flows from investment in assets
– cash flows from priority claims
– cash flows from random events
– management attitudes regarding stocks of
resources
– cash dividend policy
Arguments in favour of
measuring income – II
• Income is perceived as a predictive
device that aids in the prediction of
future incomes and future economic
events
• Income may be perceived as a measure
of efficiency
Accounting income
Accounting income is operationally

defined as the difference between the
realised revenues arising from the
transactions of the period and the
corresponding historical costs
Attributes of accounting income
There are at least five attributes of
accounting income:
1. accounting income is based on the
actual transaction entered into by the
firm (primarily revenues arising from
the sales of goods or services minus
the costs necessary to achieve these
sales)
2. accounting income is based on the
revenue principle and requires the
definition, measurement, and
recognition of revenues
Attributes of accounting income
(cont‟d)
3. accounting income requires the
measurement of expenses in terms of
historical cost to the enterprise,
constituting a strict adherence to the cost
principle
4. accounting income requires that the
realised revenues of the period be related
to appropriate or corresponding relevant
costs
5. accounting income is also based on the
period postulate and refers to the financial
performance of the firm during a given
period
Advantages of accounting
income
• Accounting income has survived the test of
time
• Because it is based on actual, factual
transactions, accounting income is measured
and reported objectively and is therefore
basically verifiable
• By relying on the realisation principle for the
recognition of revenue, accounting income
meets the criterion of reliability
• Accounting income is considered useful for
control purposes, especially in reporting on
stewardship
Disadvantages of accounting
income
• The arguments against the use of
accounting income question its
relevance in decision making
• The most serious problem with
accounting income is that it is
predicated on the assumption of a
stable monetary unit, which means that
as a result it fails to recognise increases
in the values of assets and liabilities
held in a given period
Disadvantages of accounting income
(cont‟d)
• A host of authors have observed that,

because the monetary unit is unstable
in modern economies, accounting
income can easily give a mistaken and
misleading impression of an entity‟s
earnings, financial strength and
performance
• Accounting income effectively allows
entities to „manage‟ results
Disadvantages of accounting income
(cont‟d)
• The reliance of accounting income on

the historical-cost principle makes
comparability difficult, given the
different acceptable methods of
computing „cost‟ and the different
acceptable methods of cost allocation
deemed arbitrary and incorrigible
The nature of the economic
concept of income
The concept of income has always been an
important point of interest to economists:
• Adam Smith was the first economist to
define income as an increase in wealth
• most classicists followed Smith‟s concept of
income and linked its conceptualisation to
business practices
• towards the end of the nineteenth century,
the understanding that income is more than
cash was expressed in Von Bohm Bawerk‟s
theories on capital and income
Fisher
Fisher defined economic income as a series of
events that correspond to different states – the
enjoyment of psychic income, real income and
money income:
• psychic income is the actual personal
consumption of goods and services that produce
a psychic enjoyment and satisfaction of wants …
it cannot be measured directly, but it can be
approximated by real income
• real income is an expression of the events that
give rise to psychic enjoyment and is best
measured by the cost of living
• money income represents all the money received
and intended for use in consumption to meet the
cost of living
Lindahl
• Lindahl introduced the concept of income
as interest, referring to the continuous
appreciation of capital goods over time
• The differences between the interest and
consumption anticipated for a given
period are perceived as saving
• This idea led to the generally accepted
concept of economic income as
consumption plus saving expected to take
place during a certain period, the saving
to being equal to the change in economic
capital
Hicks
Hicks used the concepts introduced by
Fisher and Lindahl to develop a general
theory of economic income, defining a
person‟s personal income as:
„the maximum amount he can
consume during a week and still
expect to be as well-off at the end of
the week as he was at the beginning‟
Capital maintenance
• The concept of capital maintenance
implies that income is recognised after
capital has been maintained or costs
have been recovered
• Return on capital (income) is
distinguished from return of capital
(cost recovery)
• SAC 4 identified two concepts of capital
maintenance: financial and physical
Financial and physical capital
maintenance
• Financial and physical capital maintenance
can be in the form of units of money or
general purchasing power
• This gives rise to four concepts of capital
maintenance:
1. money maintenance, being financial
capital measured in units of money
2. general purchasing-power money
maintenance, being financial capital
measured in units of the same purchasing
power
Financial and physical capital
maintenance (cont‟d)
3. productive-capacity maintenance,
being physical capital measured in
units of money
4. general purchasing-power,
productive-capacity maintenance,
being physical capital measured in
units of the same purchasing power
Capitalisation (present value)
• Under the capitalisation method for calculating
current value, the capitalised value of an asset,
group of assets or total assets is the net
amount of the discounted expected cash flows
of such assets during their useful lives
• To compute the capitalised value, four variables
must be known:
1. expected cash flows from asset use or
disposal
2. the timing of those expected cash flows
3. the number of years of the asset‟s remaining
life
4. the appropriate discount rate
Capitalisation (present value)
(cont‟d)
• The present-value income is the total pure-

profit income expected to be accrued up to
the firm‟s planning horizon
• It is an ex ante income, or economic income,
that reflects expectations about future cash
flows
Economic income versus
accounting income
• Economic income is an ex ante income
based on cash-flow expectations
• Accounting income is an ex post or
periodic income based on historical
values
Current entry price
• Current entry price can be defined as the amount
of cash or other consideration that would be
required to obtain the same asset or its
equivalent
• The following interpretations of current entry
price have been used:
– replacement cost – used is equal to the amount
of cash or other consideration that would be
needed to obtain an equivalent asset on the
second-hand market, having the same
remaining useful life
– reproduction cost is equal to the amount of
cash or other consideration that would be
needed to obtain an asset identical to the
existing asset
Current entry price (cont‟d)
– replacement cost – new is equal to the
amount of cash or other consideration
needed to replace or reproduce the
productive capacity of an asset with a new
asset that reflects changes in technology
• The common characteristic of the three
notions of current entry prices is that they all
correspond to the costs of replacing or
reproducing an asset held
Measurement of current
entry prices
• The issue that remains to be solved is
the choice of method of measurement
of current entry prices
• The three most-advocated methods
use:
– quoted market prices
– specific price indexes
– appraisals
Holding gains and losses
• The valuation of assets and liabilities at current
entry prices gives rise to holding gains and
losses as entry prices change during a period
of time when they are held or owed by a firm
• Holding gains and losses may be divided into
two elements:
1. the realised holding gains and losses that
correspond to the items sold or to the
liabilities discharged
2. the holding gains and losses that
correspond to the items still held or to the
liabilities owed at the end of the reporting
period
Backlog depreciation
• Three methods have been suggested to
account for backlog depreciation:
1. charge or credit to retained earnings
2. charge or credit to current income
3. adjust holding gains and losses by the
amount of backlog depreciation
• The three methods result from two
fundamentally different interpretations of
depreciation:
– that depreciation should provide a reserve
for the future replacement of assets so that
backlog depreciation should be treated
according to either of the first two methods
Backlog depreciation (cont‟d)
– that depreciation is a current cost of

operations, so that backlog depreciation
should be treated according to the third
method
Advantages of current-entry-
price-based accounting
The primary advantage of current-entry-price-
based accounting results from the breakdown
and segregation of current-value income into
current operating profit and holding gains and
losses:
• as noted by Edwards and Bell, the dichotomy
between current operating profit and holding
gains and losses is essential for evaluating the
past performance of managers
• the dichotomy between current operating
profit and holding gains and losses is useful in
making business decisions
Advantages of current-entry-price-
based accounting (cont‟d)
• current operating profit corresponds to the
income that contributes to maintaining
physical productive capacity – that is, the
maximum amount that the firm can distribute
and maintain its physical productive capacity
• the dichotomy between current operating
profit and holding gains and losses provides
important information that can be used to
analyse and compare inter-period and inter-
company performance gains
• the current-entry-price method allows a
distinction between realised holding gains and
losses and unrealised holding gains and losses
Disadvantages of the current-
entry-price system
• Each claim about the benefits to be derived
from dichotomising current-value income into
current operating profit and holding gains and
losses has been contested
• The current-entry-price system is based on
the assumptions that the firm is a going
concern and that reliable current-entry-price
data may be obtained easily
• There is also the difficulty of correctly
specifying what is meant by „current entry
price‟
Disadvantages of the current-entry-
price system (cont‟d)
• There have been other conceptual criticisms
of replacement-cost accounting
• There have been suggestions that the
current-entry-price system recognises
current value as a basis of valuation but
does not account for changes in the general
price level, and gains and losses on holding
monetary assets and liabilities
Current exit price – I
• Advocates of exit value accounting
emphasise the notion of opportunity
costs
• Opportunity cost means the value of the
next best alternative
• In order to know the next best
alternative, it is relevant to know the
market value or the selling price of an
asset
Chambers‟ model
• One of the most popular exit-value models was
developed by Chambers in 1966
• His model is better known as continuous
contemporary accounting, or CoCoA
• According to Chambers, a firm must continually
make adjustments to stay in tune with its
environment and the marketplace, in order to
survive and prosper
• Capacity for adaptation necessitates that entities
can quickly modify, replace or redeploy an existing
asset base as the need arises
• Decisions relating to changes in the composition of
resources require knowledge of selling prices, not
buying prices
Continuous Contemporary
Accounting (CoCoA)
According to Chambers (1975), CoCoA is based
on three key ideas:
1. a statement of financial position is only
understandable and significant in relation to
financial dealings if its components are
amounts of money and prices expressed in
money
2. no reasonable action can be taken on the
basis of a statement of financial position
unless the statement corresponds
reasonably well with the actual financial
position of a firm as at the date the
statement bears
Continuous Contemporary
Accounting (CoCoA) (cont‟d)
3. specific price movements in a period

affect both the income of the period
and the financial position at the end
of the period
Current exit price – II
• Current exit price represents the
amount of cash for which an asset
might be sold or a liability might be
refinanced
• The current exit price is generally
agreed to correspond to:
– the selling price under conditions of
orderly rather rather than forced
liquidation
– the selling price at the time of
measurement
Advantages of current-exit-
price-based accounting
• The current exit price and the capitalised
value of an asset provide different measures
of the economic concept of opportunity costs
• Current exit price provides relevant and
necessary information on which to evaluate
the capacity for adaptation and liquidity of a
firm
• Current exit price provides a better guide for
the evaluation of managers in their
stewardship function because it reflects
current sacrifices and other choices
Disadvantages of current-
exit-price-based accounting
• The current-exit-price-based system is relevant
only for assets that are expected to be sold for
a determined market price
• The current-exit-price-based system is not
relevant for assets that the firm expects to use
• Some writers have questioned the relevance of
operating profit as determined under the exit-
value model
• The valuation of certain assets and liabilities at
the current exit price has not yet been
adequately resolved
Disadvantages of current-exit-price-
based accounting (cont‟d)
• The abandonment of the realisation principle

at the point of sale and the consequent
assumption of liquidation of the firm‟s
resources contradict the established
assumption that the firm is a going concern
Other interpretations of
current values
Other proposals for the implementation
of current-value accounting have been
made, such as:
• essential versus non-essential assets
• value to the firm
• SEC replacement-cost proposal
• combination of values
• the concept of business income
Essential versus non-
essential assets
• The Australian Accounting Standards Committee
published a preliminary exposure draft „A
Method of Current-Value Accounting‟ in June
1975
• The exposure draft introduced a form of current-
value accounting that uses different treatments
for essential assets and non-essential assets
• Essential assets are determined on the basis of
„the expected role of particular assets in the
entity‟s operations in the immediately forseeable
future‟
Essential versus non-essential
assets (cont‟d)
• A non-essential asset is valued at its current

exit price
• An essential asset is valued at its current
entry price
Essential versus non-
essential assets
• The holding gains and losses on essential
assets are credited or debited to a
revaluation account
• The holding gains and losses on non-
essential assets are included in income
• The distinction between essential and non-
essential assets represents a modification
of the current-entry-price-based system to
reflect economic realities
The Sandilands Report
• In the UK, the „Report of the Inflation
Accounting Committee‟, which was chaired by
F. E. P. Sandilands, was issued in 1975:
– the Report‟s most important recommendation
is the use of the value to the firm as a
valuation base
– accounting based on the value to the firm is
also described as current-cost accounting
(CCA)
– according to this approach, assets are valued
at an amount that represents the opportunity
cost to the firm
The Sandilands Report (cont‟d)
• The Sandilands Report also recommends

that:
– all holding gains and losses be excluded
from current-cost profit
– a „summary statement of total gains and
losses for the year‟ appear immediately
after the income statement
SEC replacement-cost
proposal
• The Securities Exchange Commission (SEC)
cited replacement cost as the mandatory
method of disclosure for large corporations
• Replacement cost is defined as the lowest
amount that would have to be paid in the
normal course of business to obtain a new
piece of equipment operating at productive
capacity
• The regulation requires that designated firms:
– estimate the current replacement cost of
inventories and productive capacity
SEC replacement-cost proposal
(cont‟d)
– restate the cost of goods sold and
services, depreciation, depletion and
amortisation for the two most recent full
fiscal years on the basis of the
replacement cost of equivalent productive
capacity
• The SEC proposal was a timid attempt to
show the impact of inflation on fixed assets
and inventory, rather than on all monetary
and non-monetary assets
The combination of values
• The combination-of-values approach avoids
some of the disadvantages of the current-exit-
price, current entry price and capitalisation
methods
• The Canadian Accounting Research
Committee‟s preliminary position favours a
combined use of current entry and current exit
prices
• Although the combination-of-values approach
may appear to be based on arbitrary rules,
advocates of this approach have suggested
specific decisions rules for the choice of a
valuation method based on the market-
opportunity costs of assets
The concept of business income
• Edwards and Bell have introduced the
concept of business income
• We have defined accounting income as the
difference between the realised revenues
arising from the transactions of the period
and the corresponding historical costs
• Business income differs from accounting
income in two ways:
1. business income is based on
replacement-cost valuation
2. business income recognises only the
gains accrued during the period
Chapter 13
General price-level
accounting
The dollar‟s purchasing power
• General purchasing power, which refers to the
monetary unit‟s ability to purchase goods or
services, is inversely related to the price of
goods or services for which it may be exchanged
• When the price of goods or services decreases,
the movement is referred to as deflation, which
is also an increase in money‟s general
purchasing power
• Because historical-cost accounting does not
recognise these changes in the general
purchasing power of money, the balance sheet
contains diverse kinds of assets and liabilities
that refer to different dates and that are
expressed in changes in the purchasing power of
the dollar
The dollar‟s purchasing power
(cont‟d)
• General price-level accounting corrects this
situation by completely restating the
historical-cost financial statements in a way
that reflects changes in the dollar‟s purchasing
• Changes in the purchasing power of the dollar
are measured by means of index numbers
• A price index is the ratio of a similar group of
goods or services on another given date,
known as the base year
• Price indices that measure changes in prices
on a general basis reflect the purchasing
power of the dollar
Chambers‟ model
• Assume that a firm‟s balance sheet may be
divided into monetary items and non-monetary
items
• Monetary items may be defined as items for which
amounts are fixed in terms of number of dollars
by contract or otherwise, regardless of changes in
price levels
• For the period t0, the balance sheet equation,
expressed in dollars at time 0, is:
M0 + N0=R0
where:
M0 = net monetary items
N0 = net non-monetary items
R0 = residual equity
Chambers‟ model (cont‟d)
• Let us also assume there is a change in the
general price level p.
By definition, p = (P1/P0) – 1, where P0 is the
price index at time 0 and P1 is the price index
at time 1. The balance sheet equation at t2,
restated for the changes in the general price
level, is:
M0(1 + p) + N0(1 + p) = R0(1 + p)
which is equivalent to:
M0 + M0p + N0 + N0p = R0 + R0p
• Given that, by definition, net monetary assets
are expressed in fixed amounts of dollars, it is
appropriate to remove M0p from each side of the
equation and to replace M0 from each side of the
equation and to replace M0 with M1, meaning
that:
M0 + M0p + N0 + N0P = R0 + R0p
The last equation may be interpreted as follows:
1. M1 represents the net monetary assets at t1
2. N0 + N0 represents the general price-level
restated monetary assets at t1
3. R0 + R0 represents the general price-level
restated residual equity at t1
4. M0 represents the gains or losses on
monetary items: by definition, M0 is equal to
net monetary assets C0 less monetary
liabilities L0
• The balance sheet equation at t2 may be
restated:
C1 + (N0 + N0p) – L1 = (R0 + R0p) – (C0p – L0p)
or
C1 + (N0 + N0p) – L1 = (R0 + R0p) – C0p + L0p
• Consequently, L0p represents the gain from

the outstanding liabilities during the period,
and C0p represents the loss resulting from
holding monetary assets from t0 to t1
• From this simplified model, we can develop
the methodology required for the restatement
of historical-cost amounts in traditional
financial statements into units of general
purchasing power.
• The following steps are necessary:
1. obtain the complete set of historical-cost
2. determine and obtain an acceptable general
price-level index on which data on the index
numbers are available to cover the life of the
oldest item on the balance sheet, and classify
each item on the balance sheet as a monetary
or non-monetary item
3. adjust the non-monetary items by a
conversion factor to reflect the current general
purchasing power
4. calculate the general purchasing power
(general price-level) gains or losses arising
from holding monetary items
General price-level gains and
losses
• Holders of monetary items gain or lose
purchasing power because the general level of
price changes
• Such gains and losses are called general
purchasing-power gains or losses, or general
price-level gains or losses on monetary items
• When prices are rising:
– monetary assets lose purchasing power,
which is recognised by a general price-level
loss
– monetary liabilities gain purchasing power,
gain
General price-level gains and losses
(cont‟d)
• During periods of decreasing prices:
– monetary assets gain purchasing power,
gain
– monetary liabilities lose purchasing power,
loss
Calculating general price-level
gain or loss
General price-level gain or loss is calculated by:
1. computing the net monetary asset position
at the beginning of the period
2. restating the net monetary asset position
at the beginning of the period in terms of
the purchasing power of the dollar at the
end of the period
3. restating all of the monetary receipts for
the year on a year-end basis and adding
the result to the restated net monetary
position at the beginning of the period
Calculating general price-level gain
or loss (cont‟d)
4. restating all of the monetary payments
of the year on a year-end basis and
deducting the result from the total
restated net increase in monetary items
5. Deducting the actual net monetary
assets at the end of the period from the
computed net monetary assets at the
end of the period
gain or loss (cont‟d)
Using our example, these five steps may be
summarised as follows:
Monetary Items
UnadjustedAdjusted
Steps 1 and 2 $10,000 $15,000
Step 3 20,000 24,000
Total $30,000 $39,000
Step 4 $15,000 $18,000
Total $15,000 $21,000
Step 5 $15,000
Purchasing power gain (or loss) $ 6,000
To summarise:
• general price-level gains or losses are
computed by restating the net monetary
position at the beginning of the period and the
net monetary transactions during the period
as units of general purchasing power at the
end of the period
• the result is compared with the actual net
monetary position, and the difference is the
general price-level gain or loss
Treatment of the general
price-level gain or loss
• A lack of agreement exists on the nature of the
general price-level gain or loss and its relevant
accounting treatment. The following approaches
have been suggested:
1. Accounting Research Study No. 6, APB
Statement No. 3, and the FASB and the CICA
Exposure Drafts on general price-level
accounting take the position that the general
price-level gain or loss should be included in
current income
2. only the general price-level gain and loss
should be treated as capital items
3. both the general price-level gain and loss
should be treated as capital items
Treatment of the general price-level
4. both the general price-level gain and loss
should be included in current income, with
the exception of gains and losses related to
long-term debt, which should not appear until
they are realised through the redemption of
the bonds
5. all price-level gains and losses should be
included in current income, with the
exception of gains and losses that arise from
including monetary items in shareholders‟
equity (for example, preferred shares having
monetary characteristics)
• As a general rule, all price-level gains or losses
are recognised in the general price-level income
statement
Non-monetary items
Non-monetary items are restated in
terms of the current general purchasing
power by multiplying the cost of the
item reported on the historical-cost-
based financial statements by the
following conversion factor:
Current Year Index

Index When Non - Monetary Item Was Acquired
Shareholder‟s equity
The restatement of shareholders‟
equity, with the exception of retained
earnings, is similar to the restatement
of non-monetary items. The original
invested capital is multiplied by the
following conversion factor:
Current year Index

Index When Capital Was Invested
Retained earnings
Retained earnings, which cannot be
adjusted by a single conversion factor,
represent net income after dividends
accumulated since the creation of the going
concern. Retained earnings may be stated
as follows:
1. The first time historical-cost financial
statements are restated in terms of units
of current general purchasing power;
retained earnings may be determined
simply as the residual after all other
items in the balance sheet have been
restated
Retained earnings (cont‟d)
2. In the following periods, the end-of-period
retained earnings in units of current
general purchasing power may be
determined by:
– net income in units of current general
purchasing power, report-level gains or
losses on non-monetary shareholders‟
equity items in the general price-level
statement (including general price-level
gains or losses on monetary items)
– adjustments resulting from general
price-level gains or losses on monetary
shareholders‟ equity items
General price-level
accounting versus current-
value accounting
• Under current-value accounting, an
increase in the price of a non-monetary
item results in a holding gain
• Under general price-level accounting,
the adjustment of historical cost is
simply a restatement of a non-
monetary item in terms of the current
general purchasing power, and no gain
or loss is recognised
The monetary–non-monetary
distinction
• It is important to distinguish between monetary
and non-monetary items, because different
treatments are applied to the two types of items
• Non-monetary items must be translated into
dollars of the same purchasing power at the end
of the current period
• Monetary items, on the other hand, are already
stated in end-of-current-period dollars and gain
or lose purchasing power as a result of changes
in the general price level
• Monetary items gain or lose purchasing power:
non-monetary items do not
Monetary items
The official definition adopted in the
various pronouncements of the
accounting bodies considers monetary
items to be items the amounts of which
are fixed by contracts or otherwise fixed
in terms of dollars (or whatever is the
domestic currency), regardless of
changes in specific prices or in the
general price level
Problems with distinguishing
between monetary and non-
monetary items
• Problem areas exist because some assets
and liabilities may exhibit characteristics of
both monetary and non-monetary items
• Various degrees of fixity are therefore
possible, as implied by the word „fixed‟ in
the definition of a monetary item
• Because conditions change, the price of a
monetary item need not be fixed
permanently
Examples of monetary and
non-monetary classifications
• Preferred shares are classified as non-
monetary items in APB Statement No. 3
• The FASB Exposure Draft states that,
„preferred stock carried at an amount equal to
its fixed liquidation or redemption price is
monetary because the claim of the preferred
stockholders on the assets of the enterprise is
in a fixed number of dollars‟
• Deferred income taxes are classified as non-
monetary items on the basis that they are a
cost saving and are deferred as reductions of
expenses in future periods
Examples of monetary and non-
monetary classifications (cont‟d)
• Foreign currency on hand, claims to foreign
currency, and obligations payable in foreign
currency may be interpreted as either
monetary or non-monetary items, as follows:
– if they are perceived as commodities, they
are non-monetary items, because the
prices of commodities may fluctuate
– if they are perceived as similar to domestic-
currency items, they are monetary items
• A more logical viewpoint would be to classify
foreign-currency items as:
– monetary if they are stated at the closing rate
of exchange in the historical-cost financial
statements
– non-monetary if they are stated at the
historical rate of exchange in the historical-cost
• Long-term debts in foreign currency may be
interpreted as either monetary or non-monetary:
– the debt will be interpreted as monetary if it is
stated at the closing rate of exchange
– the debt will be seen as non-monetary if it is
stated at the historical rate of exchange
• Convertible debt is perceived to have
monetary and non-monetary characteristics
• Accounting Research Study No. 6 proposes
that convertible debt be treated as:
– monetary when the market price of its
shares is below the conversion price
– non-monetary when the market price of
shares is at or above the conversion price
• Another position is that convertible bonds
should be treated as monetary debts –
obligations to pay a fixed number of dollars –
until they are converted
Price-level indices
• A price-level index compares general or specific
changes in price from one period to another
• A general price-level index can be defined as a
series of measurements, expressed as
percentages, of the relationship between the
average price of a group of goods and services on
a succession of dates and the average price of a
similar group of goods and services on a common
date
• The components of the series are called price-
index numbers
• The general price-level index is based on a large
range of goods and services
• The specific price-level index refers to a particular
good or industry
Index formulas
We will use the following symbols to
represent the four basic formulas:
The Laspeyres formula
• The Lasperyres formula assumes that the
price index is a weighted sum of current-
period prices divided by a weighted sum of
base-period prices, where the weights are
base-period quantities of commodities
• Such an index, called a Lasperyres index, is
computed thus:
Spnq 0
I 
sp0q 0
The Paasche formula
• The Paasche formula assumes that the price
index is a weighted sum of current-period
prices divided by a weighted sum of base-
period prices, where the weights are current-
period quantities of commodities
• Such an index, called a Paasche index, is
computed thus:
Spnqn
I
Sp0qn
The fixed-weighted formula
• The fixed-weighted formula assumes that
the price index is a weighted sum of
current-period prices divided by a weighted
sum of base-period prices, where the
weights are average period quantities of
commodities
• Such an index, called a fixed-weighted
index, is computed thus:
Spnqa
I
Sp0qa
The Fisher formula
The Fisher formula assumes that the
price index is a geometric average of
Laspeyres and Paasche formulas. The
Fisher index is computed thus:
Spnqn Spnqa
I 
Sp0qn Sp0qa
Price-level accounting and
purchasing power
• General price-level accounting employs a
conversion factor based on changes in
the general price-level index to convert
dollars on one date to the number of
dollars having the same purchasing
power on another date
• An appropriate concept of purchasing
power and an appropriate general price-
level index must be chosen
Price-level accounting and
purchasing power (cont‟d)
• Hendriksen presents different concepts of
purchasing power, these being:
– general purchasing power
– purchasing power of the firm
– specific replacement purchasing power
• General purchasing power measured by a
general price-level index reflects changes
in the value of money and, consequently,
is deemed most relevant for general price-
level accounting
Choice of a general price-level
index
• The concept of general purchasing power
implies the use of a general price-level index
• In the USA, the Department of Commerce
and the Department of Labor regularly
maintain and publish price-level indices.
Among the most common are:
1. The Consumer Price Index (CPI)
2. The Wholesale Price Index
3. The Composite Construction-Cost Index
4. The GNP (Gross National Product)
Implicit Price Deflator (IPD)
Choice of a general price-level index
(cont‟d)
• The two price indices most commonly suggested

for general price-level accounting are:
– the CPI, a base-weighted index designed to
measure price changes as they would affect a
basket of retail goods and services acquired
by middle-income families of specific size
living in urban centres
– the GNP (implicit price deflator (IPD)), a
currently weighted index designed to measure
price changes in all goods and services
produced in a given year
Limitations of the CPI and
the IPI
• The base-weighted CPI fails to account for the
substitution of relatively lower-priced goods
that takes place when relative prices change:
– in other words, the CPI has an upward bias,
in that it overstates the effect of changes in
prices on the cost of living
• The IPI has a downward bias and understates
the price increase in the cost of living
• The IPI covers all goods and services produced
in the economy, whereas the CPI covers only
goods and services purchased by a „typical
consumer‟
Arguments in favour of general
price-level accounting
• First argument:
– financial statements that are not adjusted for
general price-level changes include diverse
kinds of assets and claims expressed in dollars
of different purchasing power
– general price-level accounting is designed to
express the level of changes in the price of
assets and in the purchasing power of claims
– general priced-level statements present data
on the basis of a common denominator – the
purchasing power of the dollar at the end of
the period – and facilitate comparisons
between firms
Arguments in favour of general price-
level accounting (cont‟d)
• Second argument:
– conventional historical-cost accounting does
not measure income properly as a result of
the matching of dollars of different „size‟ on
the profit and loss statement
– expenses incurred in previous periods are
set off against revenues that are used in
current dollars
– general price-level accounting provides a
better matching of revenues and expenses
because common dollars are used
Arguments in favour of general price-
level accounting (cont‟d)
• Third argument:
– general price-level accounting is relatively
easy to apply
– general price-level accounting represents the
last departure from generally accepted
• Fourth argument:
– general price-level accounting provides
relevant information for management
evaluation and use
– general price-level accounting presents the
impact of general inflation on profit and
provides more realistic returns on investment
rates
Arguments against general
price-level accounting
• Most empirical studies indicate that the
relevance of general price-level
information is either weak or not accepted
• General price-level changes account only
for changes in the general price level and
do not account for changes in the specific
price level
• The impact of inflation differs among firms
• The costs of implementing general price-
level accounting may exceed the benefits
Technical problems with price-
level accounting
• The first problem is related to the
choice of an appropriate general price-
level index
• The second problem is that general
price-level accounting requires assets
and liabilities to be identified and
classified as monetary or non-monetary
items
Chapter 14
Alternative asset-
valuation and
income-determination
models
Attributes that may be
measured
There are four attributes of assets and
liabilities that may be measured:
1. historical cost
2. current entry price
3. current exit price
4. capitalised or present value of
expected cash flows
Units of measure
Two units of measure may be used to
measure assets and liabilities:
• money
• purchasing power
Asset valuation and income
determination models
1. Historical-cost accounting
2. Replacement-cost accounting
3. Net-realisable-value accounting
4. Present-value accounting
5. General price-level accounting
6. General price-level replacement cost
accounting
7. General price-level net realisable-value
accounting
8. General price-level present-value
accounting
Present-value models
Although theoretically considered the best
accounting models, present-value models
have recognised practical deficiencies:
• they require the estimation of future net
cash receipts and the timing of those
receipts, as well as the selection of the
appropriate discount rates
• when applied to the valuation of individual
assets, they require the arbitrary allocation
of estimated future net cash receipts and
the timing of those receipts as well as the
selection of the appropriate discount rates
Present-value models (cont‟d)
• when applied to the valuation of individual

assets, they require the arbitrary
allocation of estimated future net cash
receipts among the individual assets
Definition of four attributes
1. Historical cost refers to the amount
of cash or cash-equivalent that
would be paid to acquire an asset, or
the amount of cash-equivalent
liability
2. Replacement cost refers to the
amount of cash or cash-equivalent
that would be paid to acquire an
equivalent or the same asset
currently, or that would be received
to incur the same liability
concurrently
Definition of four attributes (cont‟d)
3. Net realisable value refers to the
amount of cash or cash-equivalent
that would be obtained by selling the
asset currently, or that would be paid
to redeem the liability currently
4. Present or capitalised value refers to
the present value of net cash flows
expected to be received from the use
of the asset, or the net outflows
expected to be disbursed to redeem
the liability
Classification of attributes
• They may be classified with respect to
whether they focus on the past, present
or future
the kind of transactions from which they
are derived
the nature of the event that originates
the measure
Different price levels
• A change in the general price level refers to
changes in the prices of all goods and
services throughout the economy
• A change in the specific price level refers to
a change in the price of a particular product
or service
• A change in the relative price level of a
commodity refers to the part of the specific
price change that remains after the effects of
the general price-level change have been
eliminated
Criteria for comparison and
evaluation: timing errors
The criteria for determining what attributes of
the elements of financial statements should
be measured should favour the attribute that
avoids timing errors, because:
• timing errors result when changes in value
occur in a given period but are accounted
for and reported in another period
• a preferable attribute would be the
recognition of changes in value in the same
period that they occur
Measuring-unit errors
The criteria for determining what unit of
measure should be applied to attributes of
the elements of financial statements
should favour the unit of measure that
avoids measuring-unit errors, because:
• these occur when financial statements
are not expressed in units of general
purchasing power
• a preferred measuring unit would
recognise the general price-level
changes in the financial statements
First criterion: interpretability
• The resulting statement should be
understandable in terms of meaning and use
• Given that we have two possible units of
measure, the interpretation of the accounting
models will be one of the following:
– if it measures using units of money, its results
are expressed in the number of dollars (NOD)
– if it measures historical cost in units of general
purchasing power, its results are still
expressed in NOD
– if it measures current values in units of
general purchasing power, its results are
expressed in the command of goods (COG)
Second criterion: relevance
• The resulting financial statements should be
useful
• Focus on what ought to be measured – COG or
NOD?:
– from a normative point of view, the answer is
COG, because it expresses changes in both
the specific and general price levels
– COG can be defined, in terms of the input
market, as price-level adjusted replacement
cost; and, in terms of the output market, as a
price-level-adjusted net realisable value
Historical-cost accounting
• Historical-cost accounting is characterised
primarily by four aspects:
1. the use of historical cost as the attribute of
2. the assumption of a stable monetary unit
3. the matching principle
4. the realisation principle
• Accordingly, historical-cost income, or
accounting income, is the difference between
realised revenues and their corresponding
historical cost
Historical-cost financial
statements
Historical-cost financial statements:
• contain timing errors
• contain measuring-unit errors
• are interpretable because they are based
on the concept of money maintenance, and
the attribute being expressed is the number
of dollars (NOD)
• are not relevant because the command of
goods (COG) is not measured
Replacement-cost accounting
Replacement-cost accounting is
characterised primarily by five aspects:
1. the use of replacement cost as the
attribute of the elements of financial
statements
4. the dichotomisation of operating income
and holding gains and losses
5. the dichotomisation of realised and
unrealised holding gains and losses
Replacement-cost financial
statements
Replacement-cost financial statements:
• contain timing errors in operating profit
• are interpretable as NOD for profit-and-
loss statement figures and COG for
asset figures
• provide relevant measures of COG only
for asset figures
Net-realisable-value accounting
Net-realisable-value accounting is
characterised primarily by four aspects:
1. the use of net-realisable value as the
attribute of the elements of financial
statements
3. the abandonment of the realisation
principle
4. the dichotomisation of operating income
and holding gains and losses
Net realisable-value financial
statements
Net realisable-value financial statements:
• contain no timing errors
• are interpretable as NOD for net
income and as COG for asset figures
• provide relevant measures of COG
only for asset figures
Alternative accounting models
Three models of accounting reflect
changes in the general price level:
• general price-level-adjusted
• general price-level-adjusted
replacement-cost accounting
• general price-level-adjusted net-
realisable value accounting
General price-level-adjusted
• This type of accounting is characterised
primarily by four aspects:
1. the use of historical cost as the attribute of
2. the use of general purchasing power as the
unit of measure
3. the matching principle
• Accordingly, it is the difference between
realised revenues and their corresponding
historical costs, both expressed in units of
general purchasing power
historical-cost financial
statements
General price-level-adjusted historical-
cost financial statements:
• contain no measuring-unit errors
• are interpretable
• provide relevant measures of COG
only for cash figures (and monetary
assets and liabilities)
replacement-cost accounting
General price-level-adjusted replacement-cost
accounting is characterised primarily by five
aspects:
1. the use of replacement cost as the attribute
of the elements of financial statements
unit of measure
4. the dichotomisation of operating income and
real realised holding gains and losses
5. the dichotomisation of real realised and real
unrealised holding gains and losses
replacement-cost financial
statements
General price-level-adjusted,
replacement-cost financial statements:
• provide relevant measures of COG in
the input market
net-realisable-value accounting
This type of accounting is characterised primarily
by five aspects:
1. the use of net-realisable value as the attribute
of the elements of financial statements
unit of measure
3. the abandonment of the realisation principle
4. the dichotomisation of operating income and
real holding gains and losses
5. the dichotomisation of real realised and real
unrealised gains and losses
net-realisable-value financial
statements
General price-level-adjusted net-
realisable-value financial statements:
• contain no timing errors
• provide relevant measures of COG in
the output market
The current-value accounting
tradition in Australia
The 1970s was a particularly active period
in Australian accounting, fuelled by:
• high inflation rates
• a growing body of Australian and
international literature recommending
abandonment of the historical-cost
model
• movement towards a system of current-
value accounting by international
standard-setting bodies
Exposure drafts on current-
value accounting
Three exposure drafts (EDs) were
released by the AARF between 1974 and
1978:
1. ED 7 „Accounting for Changes in the
Purchasing Power of Money‟
2. ED 9 „A Method of Current Value
Accounting‟
3. ED 10 „The Recognition of Gains and
Losses on Holding Monetary Resources
in the Context of Current Value
Accounting‟
SAP 1 „Current Cost
Accounting‟
• A Statement of Provisional Accounting
Standards, DPS 1.1 „Current Cost
Accounting‟, was issued by the
professional bodies in 1977 and
accompanied by DPS 1.2 „Explanatory
Statement: The Basis of Current Cost
Accounting‟
• In 1980, the ED 15 „Current Cost
Accounting‟ omnibus exposure draft was
issued, and suggested an expansion to
the Provisional Accounting Standard
SAP 1 „Current Cost Accounting‟
(cont‟d)
• This provisional standard was issued
as SAP 1 in November 1983
• A nationwide survey by Jones and
Love indicates that the number of
companies adopting SAP 1 in
Australia has significantly increased
since the mid-1980s
Conclusion
• Of the models compared, general price-
level-adjusted, net-realisable-value
accounting is the only model to meet each
of the four criteria set forth
• SAP 1 does not adopt this model
• Australia has opted for a predominantly
replacement-cost-based model
• Preferences for exit-value and present-
value-based models have, however,
manifested in recent accounting regulations
Chapter 15
The context of the
contemporary
accounting
professional
Environmental changes
Changes in environmental conditions can
be characterised by the following trends:
1. technical and ideological
proletarisation of accountants in public
and private sectors
2. the institutional capitalism of the new
governing class
3. the assimilation of academic
accountants into a flawed universal
class
4. the manufactured consciousness of
users
Genesis of emerging structural
changes
• Societies are constituted by groups of
protagonists competing for economic and
social power and political authority
• Dominant modes of interaction
consistently favour one category over
another and result in exploitation of
others
• At every societal level, groups of
protagonists face each other over the
contradictions that separate them
Genesis of emerging structural
changes (cont‟d)
• The emerging structural changes in the

accounting environment are
contradictions created by the global
conflicts and the emergence of new
protagonists in the accounting and
other environments
Technical and ideological
proletarianisation of accountants
• The first element in the new-era conflict is
the emergence of new class differences
among accountants
• Accountants have become proletarianised,
working according to a division of labour
conceived and monitored by management,
following procedural rules and repertoires
created by administrative processes and/or
fiat
Technical proletariansation
• Has reflected a shift of control towards
employers or management and a loss of
the creative freedom accountants enjoyed
as self-employed professionals
• In the process, as theorised by Marx, they
have lost control of both the means and
ends of labour, a phenomenon labelled as
technical proletarianisation
Ideological proletarianisation
• In addition to technical proletarianistion, the
emergence of the „new working class‟ or
„professional managerial class‟ has led also
to an ideological proletarianisation, which
refers to the appropriation of control by
management for capital, over the goals and
social purposes to which work is put
• The accountant has lost control of the
nature of the total product and may be
indifferent to the outcome of the activities
he or she is involved in
Results of the proletarianisation
• May lead to the accountant losing the knowledge
base as „capital‟ restructures through
management the specification of the product
and management restructures the organisation
of work
• Renders the accountant a mere technician of
functionaries, separate from the major social,
moral and technological issues of his or her
profession
• These changes have led to a decrease in the
number and quality of people going into
accounting programs; the profession lacks
„glamour‟
Effects on the accountant
• The accountant may respond by either
ideological desensitisation or ideological
cooperation:
– ideological desensitisation is a denial or
separation of the self from ideological control
of the job, disclaiming either interest or
responsibility for the social uses to which
one‟s work is put
– ideological cooperation is a redefinition of
one‟s goals to make them consistent with
institutional imperatives
• In either case, there is a high likelihood of the
accountant being alienated from his or her work
Alienation
• Alienation in the domain of work has a fourfold
aspect:
1. a human being is alienated from the objects
he/she produces, and
2. from the process of production, and
3. from him or herself, and
4. from the community of his or her fellows
• In this condition, the mindset of accountants,
their consciousness, is to a large extent only
the reflection of the conditions in which they
find themselves and of the position in the
process of production
Institutional capitalism
The second element in the new conflictual
order concerns the nature of the governing
class in corporations and accounting firms:
• the corporate community is characterised
by a socially cohesive national upper class
• according to Westergaard and Resler, this
governing class is composed of „those who
own and those who control capital on a
larger scale … they have a common stake
in one overriding cause: to keep the
working rule of society capitalist‟
Class-wide rationality
• This assumes that the corporate elite is
largely capable of identifying and
promoting its common political objectives
• Although corporate rationality still
characterises much of the internal
organisation of accounting firms, class-
wide rationality now characterises its
highest circles. Old school ties and
kindred signs of proper breeding greatly
facilitate access to the highest circles of
the CPA firms
Academic accountants
• The third element in the new conflictual order
is a new class of academic accountants
• Gouldner advanced two propositions regarding
this flawed universal class:
1. the rise of a „new class‟ comprising
humanistic intellectuals and technical
intelligentsia, whose universalism is badly
flawed
2. the growing dominance of this class as a
cultural bourgeoisie and having monopoly
over cultural capitalism and professionalism
from which it gains its power
Academic accountants (cont‟d)
• This new class forms one „speech community‟,
sharing a „culture of critical discourse‟. This
concept is defined as:
– „a historically evolved set of rules, a
grammar of discourse which:
1. is conceived to justify its assertions,
2. whose mode of justification does not
proceed by involving authorities and
3. prefers to elicit the voluntary consent
of those addressed solely on the basis
of arguments addressed‟
Academic accountants: a
flawed class
• This new class is flawed because it is considered
elitist and self-seeking and uses its special
knowledge to advance its own interests and power
• Gouldner suggests that the new class uses cultural
reproduction to maintain its power just as
economic reproduction is used to serve the
interests of the holders of economic capital
• Academic accountants are motivated by self-
interest and the pressing need to publish
• Academic accountants have gained a power
associated with their monopoly over the cultural
accounting capital
Capitalist domination of
information
The capitalist domination of information can be
expressed in three propositions:
1. the class rule of management appropriates the
information product they create
2. such domination is maintained by the state‟s
enforcement of contractual arrangements,
protection of property rights and maintenance
of public order
3. information tools at the disposition of
management, such as annual reports and
press releases, allow management to
disseminate information useful for the
preservation of its interests
The manufactured
consciousness of users
• The three propositions amount to three forms
of domination:
1. market exploitation
2. legal coercion
3. ideological domination
• They allow management to convey its beliefs
to the users and, in the process, shape users‟
consciousness about the firm
• The users acquire a manufactured
consciousness compatible with the
expectations of management
Manufacturing of consciousness
• The manufacturing of consciousness is an
obstacle to the expansion of data that is
relevant to the users
• The proper task is to announce the truth,
expose the error, and identify all the
constraints that can impede enquiring,
comprehension and efficient action
• A similar approach, the ethical approach to
financial accounting, rests on concepts of
fairness, justice, equity and truth
Manufacturing of consciousness
(cont‟d)
• A user needs to be informed of the wide
dissemination of accounting reports
• A better strategy with the attribute of better
informing the user is to expose the user to
various accounting reports from various
sources
• What may result is a shift in the user‟s
expertise: an expansion of the breadth of
knowledge, that the user may acquire a
better sense of what is useful and what is
not, and an evaluation of the different
preparers of accounting information
Chapter 16
International
accounting
Definitions of international
accounting
Weirich and others identify three
major concepts:
1. parent-foreign subsidiary
accounting or accounting for
subsidiaries
2. comparative international
accounting
3. universal or world accounting
World accounting
• Directs international accounting to the
formulation and study of a universally
accepted set of accounting principles
• Weirich and others define it as follows:
– „international accounting is
considered to be a universal system
that could be adopted in all countries.
A world-wide set of generally
accepted accounting principles
(GAAP) … would be established‟
Concept of comparative or
international accounting
This concept involves:
• an awareness of the international
diversity in corporate accounting and
reporting principles
• an understanding of the accounting
principles and practices of individual
countries
• the ability to assess the impact of
diverse accounting practices on
financial reporting
A second concept of
international accounting
• This concept involves a descriptive and
informative approach
• Within this concept, international accounting
includes all varieties of principles, methods
and standards of accounting of all countries
• This concept includes a set of generally
accepted accounting principles established
for each country … no universal or perfect
set of principles would be expected to be
established
Parent-foreign subsidiary accounting
• This reduces international accounting to a process
of consolidating the accounts of the parent
company and its subsidiaries and translating
foreign currency into local currency
• The definition, from Weirich and others, is:
– „refers to the accounting practices of a parent
company and a foreign subsidiary. A reference
to a particular country or domicile is needed
under the concept for effective internal financial
reporting. The accountant is concerned mainly
with the translation and adjustment of the
subsidiary‟s financial statement. Different
accounting problems arise … depending upon
which country is used as a reference for
translation and adjustment purposes‟
Amenkhienan‟s list of
concepts and theories
1. Universal or world theory
2. Multinational theory
3. Comparative theory
4. International transactions theory
5. Translation theory
Each of these theories provides some
grounds for the development of a
conceptual framework for international
accounting
Issues relevant to
international business
Private sector accounting
1. Comparative analysis:
a. national accounting, reporting and
auditing practice
b. national accounting theory
2. Policy at the international level
3. Accounting for multinational operations:
a. financial accounting
b. managerial accounting
4. Taxation
Issues relevant to international
business (cont‟d)
Public sector accounting

1. Comparative analysis of national
systems
2. Accounting for government agencies and
public not-for-profit organisations
Differences in financial
reporting practices
1. Basis of presentation
2. Consolidation reporting practices
3. Business consolidations, the two most
common methods being:
a. the purchase method
b. the pooling-of-interests method
4. Minority ownership, two alternative
methods being:
a. the equity method
b. the cost method
Differences in financial reporting
5. Valuation of fixed assets
6. Goodwill
7. Inventory costing
8. Contingency reserve policy
9. Deferred income taxes, the different
methods being:
a. the deferral method
b. the liability method
10.Pension disclosure
11.Research and development costs, these
practices including either:
a. capitalisation then amortisation, or
b. expensing
12.Foreign currency translation, these
methods including:
a. the non-current method
b. the monetary-non-monetary method
c. the current-rate method
d. the temporal method
13.Long-term leases, methods being
either:
a. capitalise then amortise
b. expense
Determinants of national
differences
Mueller identifies four elements of
differentiation:
• state of economic development
• state of business complexity
• shade of political persuasion
• reliance on some particular system of
law
Mueller‟s 10 distinct sets of
business environments
1. USA/Canada/the Netherlands
2. Australia and British Commonwealth (excluding
Canada)
3. Germany/Japan
4. Continental Europe (excluding Germany, the
Netherlands and Scandinavia)
5. Scandinavia
6. Israel/Mexico
7. South America
8. The developing nations of the Near and Far East
9. Africa
10.Communist nations
Environmental conditions
The following environmental conditions
are likely to affect the determination of
accounting standards:
1. cultural relativism
2. linguistic relativism
3. political and civic relativism
4. economic and demographic
relativism
5. legal and tax relativism
Harmonisation of accounting
standards
• The first step to harmonisation consists
of recognising national idiosyncrasies
and attempting to reconcile them with
other countries‟ objectives
• The second step is to correct or
eliminate some of the barriers, in order
to achieve an acceptable degree of
harmonisation
Advantages of harmonisation
1. Many countries still lack adequate codified
standards. Internationally accepted standards
would eliminate set-up costs and allow them
to immediately become part of the
mainstream of accepted international
2. The growing internationalisation of the
world‟s economies and the increasing
interdependency of nations in terms of
international trade and investment flows is a
major argument for some form of
internationally accepted standards
Advantages of harmonisation
(cont‟d)
3. The need for companies to raise outside

capital given the insufficiency of retained
earnings to finance projects and the
availability of foreign loans has increased
the need for harmonisation
Limits to harmonisation
• Tax collections in all countries are a great
source of demand for accounting services.
Because the systems vary internationally, this
will lead to diversity in the accounting principles
and systems used
• Accounting policies are sometimes fashioned to
achieve either political or economic goals
compatible with the economic or political
system espoused by a given country
• Some obstacles are created by accountants
themselves through strict national licensing
requirements
Actors involved in harmonisation
• Accountants International Study Group:
– formed as a three-nation group to
study practices in the USA, the UK
and Canada
– terms of reference were to institute
comparative studies as to accounting
thought and practice in participating
countries, and to make reports
• The International Federation of
Accounting Committee was formed in
1976
The International Federation of
Accounting Committee (IFAC)
12-point program
1. Develop statements that would serve as
guidelines for international auditing
practices
2. Establish a suggested minimum code of
ethics to which it hoped member bodies
would subscribe
3. Determine the requirements and develop
programs for the professional education and
training of accountants
4. Evaluate, develop and report on financial-
management and other management-
accounting techniques and procedures
The IFAC 12-point program (cont‟d)
5. Collect, analyse, research and disseminate
information on the management of public
accounting practices to assist practitioners in
conducting their practices more effectively
6. Undertake other studies of value to accountants
such as (possibly) a study of the legal liability of
auditors
7. Foster closer relations with users of financial
statements, including preparers, trade unions,
financial institutions, industry, government and
others
8. Maintain close relations with regional bodies and
explore the potential for establishing other
regional bodies as well as for assisting in their
organisation and development
The IFAC 12-point program (cont‟d)
9. Establish regular communication among
members of the IFAC and with other
interested organisations through the medium
of a newsletter
10. Organise and promote the exchange of
technical information, educational materials
and professional publications and other
literature
11. Organise and conduct an International
Congress of Accountants every five years
12. Seek to expand the membership of the IFAC
The International Accounting
Standards Committee (IASC)
• The IASC was founded in 1973, its objectives
being:
– to formulate and publish in the public interest
accounting standards to be observed in the
presentation of financial statements, and to
promote their worldwide acceptance and
observance
– to work generally for the improvement and
harmonisation of regulations, accounting
standards and procedures relating to the
presentation of financial statements
• Translates into a goal of developing a common
international approach to accounting standards-
setting aimed at worldwide harmonisation
Non-compliance with IASC
standards
Sir Henry Benson has attributed
noncompliance to the following factors:
• some countries take the view that they
cannot require compliance locally until
they are satisfied that the standards are
internationally acceptable
• some countries see local legislation as
an obstacle to the introduction of
international standards
Non-compliance with IASC standards
(cont‟d)
• some accounting bodies do not have
the power of discipline over their
members and therefore cannot
impose compliance with either
national or international standards
• some countries have not yet
overcome stubborn local resistance
from the business community
Group of Experts on
International Standards of
Accounting and Reporting
Created upon the recommendation of the
United Nations in 1976, with the following
objectives:
• to review the existing practice of reporting
by transnational corporations and
reporting requirements in different
countries
• to identify gaps in information in existing
corporate reporting and to examine the
feasibility of various proposals for
improved reporting
Group of Experts on International
Standards of Accounting and
Reporting (cont‟d)
• to recommend a list of minimum items,
together with their definition, that should
be included in reports by transnational
corporations and their affiliates
Results of the Group of
Experts
• The Group issued a report that included a 34-
page list of recommended items to be
disclosed by the „enterprise as a whole‟
• Following issuance, an Intergovernmental
Working Group of Experts on International
Standards of Accounting and Reporting was
formed with the objective of contributing to
the harmonisation of accounting standards
• International reaction was mixed: the USA
resigned its position on the Intergovernmental
Working Group in 1986
The Organization for
Economic Co-operation and
Development (OECD)
• The OECD includes 24 relatively
industrialised countries
• The OECD issued a Declaration on
International Investment and
Multinational Enterprises in 1976,
including a list of information that
should be disclosed
The European Union (EU)
• The EU has been active in achieving
regional harmonisation of accounting
principles through a series of directives
within the Treaty of Rome
• These directives are not as binding as
regulations, and leave the mode and
means of implementation to member
countries
Directives of the EU
The Fourth, Fifth and Seventh directives are
the most relevant to international accounting:
• the Fourth Directive deals with the annual
financial statements of public and private
companies, other than banks and insurance
companies
• the proposed Fifth Directive deals with the
structure, management and external audit of
limited-liability corporations
• the Seventh Directive addresses the issue of
consolidated financial statements and offers
some guidelines for more standardisation of
accounting reporting
Standard-setting strategies
for developing countries
Four strategies may be identified:
1. the evolutionary approach
2. the development through transfer of
accounting technology
3. the adoption of international accounting
standards
4. the development of accounting
standards based on analysis of
accounting principles and practices in
the advanced nations against the
backdrop of their underlying investment
The evolutionary approach
• Consists of an isolationist approach to
standard-setting whereby the
developing country defines its own
standard without any outside
interference or influences
• The learning process comes from local
experience, and it assumes that foreign
partners will adapt to its own
idiosyncratic rules
The transfer-of-technology
approach
• This approach may result from either the
operations and activities of international
accounting firms, multinationals and academicians
practising in the developing countries, or from
various international treaties and cooperative
arrangements calling for exchanges of information
and technology
• National goals combine with the social, political
and economic environment and general resources
and constraints to influence the overall economic
plan
Costs of transfer of
accounting technology
• Transfer of a wrong or inapplicable
technology
• Lack of appropriate infrastructure for the
correct application of the technology
• Increased dependence on outside experts
• Lack of incentives for developing local
standards
• Considerable loss of pride by some culture
groups
Adopting international
Adopting international accounting
standards consists of joining the IASC or
some other international standards body,
the rationale perhaps being to:
• reduce the setup and production costs of
• join the international harmonisation drive
• facilitate the growth of foreign
investment that may be needed
Adopting international accounting
standards (cont‟d)
• enable the accounting profession to
emulate well-established professional
standards of behaviour and conduct
• legitimise professional status as a
fully-fledged member of the
international community
The situationist strategy
• Calls for a consideration of the
diagnostic factors that determine the
development of accounting in
developing countries
• Based on cultural relativism, linguistic
relativism and legal-and-tax relativism,
the accounting concepts and the
reporting-and-disclosure systems in any
given country rest on the varying
aspects of that country
Diversity of judgement
The diversity of judgement in an
international accounting context may
be examined by reference to:
1. cognitive relativism
2. cultural relativism
3. linguistic relativism
4. organisational-culture relativism
5. contractual relativism
Cognitive relativism in
accounting
• This approach assumes the presence of
a cognitive process that guides the
• All accounting and auditing phenomena
involve the cognitive use of a
knowledge structure or schema,
developed by individuals through
experience, learning and prior
knowledge
Cultural relativism in
accounting
• Again, this approach assumes the presence of a
cognitive process that guides the
• Individuals from different cultures may invoke
different knowledge structures or schema
when faced with an accounting or auditing
phenomenon
• This approach implies that accounting and
auditing knowledge is organised in a culturally
standardised and hence familiar event-
sequence that tells the individual how to react
to a particular accounting and/or auditing
phenomenon
Linguistic relativism in
accounting
• This approach assumes the presence of
a linguistic process that guides the
• The basis of the linguistic-relativity
hypothesis in accounting is that the
characteristics of the accounting
language, lexical or grammatical
characteristics have a marked influence
on the cognitive processes preceding
the judgement/decision process in
accounting
Organisational-culture
relativism in accounting
• Organisational cultural efficiency requires the
sharing of frameworks, language and
referents that shape the schemata individuals
use when faced with an accounting and/or
auditing phenomenon
• This approach implies that the organisational
culture gives the individual faced with an
accounting and/or auditing phenomenon
categories, processing routines and schemas
that help solve the problems in the best
interests of the culture
Contractual relativism in
accounting
• According to this model, contracts define
permissible behaviour and actions that ultimately
determine the judgement/decision process in
accounting
• The importance of these contracts results from
the assumptions and implications inherent in the
four models of agency theory:
1. stewardship/accountability model
2. transaction-cost economies model
3. principal-agent model
4. positivist agency model
Judgement in international
accounting
The judgement/decision process in accounting and
auditing is determined by a cognitive process that
is itself uniquely shaped by:
• the national culture of the individual faced by
the accounting and/or auditing phenomenon
• the individual‟s linguistic repertoire
• the organisational culture of the entity of which
the individual considers himself/herself a
dedicated and loyal member
• the covenants and requirements of the
contracts that bind the individual to a set of
norms and allegiances to the firm

Teori Akuntansi Keuangan - Jones

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Teori Akuntansi Keuangan - Jones

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Chapter 1

Significant influences of the period

Arguments for improvement in

„The process of identifying,

• Accounting measures can be classified

Type 2: Causal double-entry

 Non-current assets can be revalued to

• A major issue of interpretation with the

FASB defines a public company as:

• The primary users of public

• Competitive market mechanisms that

„The problem is not accidental but

• Auditors prefer these rules for client

• Balance sheets and income statements

– members of the accounting

• Funded jointly by the ASCPA and the

• Each board consults with members of

• Section 226(1) of the Corporations Law

not clear-cut, thus mitigating the

3. The legal concept of property may

• Other parts of paragraph 10 obscure the issue

• Because efficient resource allocation is

• users are defined as those having a

5. that the FASB‟s conceptual framework

• This postulate holds that the business

• This postulate holds that financial

• According to Coughlan, the entity is the

• This theory views the entity as

• Under the fund theory, the basis of

• This principle holds that similar

• This principle holds that no information

• There is no comprehensive definition of

• Nozick‟s is a libertarian theory of

Step 2: The value-added equation can be

• Equation 2 expresses the gross value-added

According to Jung, four personality types

• The Particular Humanist, a sensing-feeling

5. Epistemological differences: Although

• There is an established school of thought

• Use of both methods can:

• Six features characterise the mechanistic type

6. Secondary laws characterise the stable

• Like formism, contextualism is dispersive,

• Most empirical research in accounting,

• The scheme consists of four distinct

• Good theory is practice-created, and

• Their analysis shows that the choice of

• These researchers are also in complete

• Theories confirming the market behaviour

• Accounting meets Buzzell‟s criteria, in

The value school, also called the use-

– the statement of cash flows is better

• The overall conclusions of these studies were

where H1 and H2 are the alternative

• Pre-decisional behaviour is generally

• The essence of cognitive relativism in

3. although variables are often generally

• Income is a basis for the taxation and

Accounting income is operationally

• A host of authors have observed that,

• The reliance of accounting income on

• The present-value income is the total pure-

– that depreciation is a current cost of

3. specific price movements in a period