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Chapter 1 Introduction to

Accounting Theory

Slides created by Zaid Zghoul based on Contemporary Issues in Accounting


book by Rankin ©
The following are dictionary
definitions of what a theory is:
 a belief or principle that guides actions or behavior

 an idea or set of ideas that is intended to explain


something (such as Darwin’s theory of evolution)

 the set of principles on which a subject is based or


of ideas that are suggested to explain a fact or event
(such as economic theory or the theory of relativity)

 more generally, a conjecture or an opinion.


Accounting theory :

 ‘A description, explanation or a prediction [of


accounting practice] based on observations and/or
logical reasoning’

 ‘Logical reasoning in the form of a set of broad


principles that

 (1) provide a general framework of reference by


which accounting practice can be evaluated and

 (2) guide the development of new practice and


procedures’.
Why is theory helpful?
 Theories describe and explain what is
happening.
 make predictions about what will happen.
 theories will also make suggestions or
guide action (i.e. say what should happen).
Different Accounting Theories

Describe Predict

Guide Improve
Different Accounting Theories
1. Describing and explaining current
accounting practices. For example: − Capital
market theory

2. Predicting accounting practice. For


example: − Agency or contracting theory
(Ch.5)
Different Accounting Theories
3. Providing principles to take into account( or
to be guided with) when taking action or
making decisions. For example:
− Theories of capital budgeting
− A theory of asset recognition

4. Helping to identify problems and


deficiencies with current accounting practice
and improve accounting practice.
For example: − The conceptual framework.
TYPES OF THEORIES

Picture by:- Kullabs.com


Positive theories

 Positive theories are used to represent


theories that are about the world as it is.
 Positive theories
• describe what is actually happening
• explain what is happening
• make predictions about what will happen.
Positive theories

 Examples of positive theories are:

• theories of how contagious diseases are


spread

•theories that explain why managers prefer


or choose particular accounting methods
or policies over others.
Positive theories
 Positive theories are often referred to as
‘empirical’ theories.

 ‘Empirical’ means ‘derived from or guided


by experience or experiment’
Positive theory
 Most positive theories are developed
from observation and by the process of
induction and deduction.
Normative theories
 Normative theories do not describe,
explain or predict what is happening, but
rather make suggestions or
recommendations as to what should
happen or what ‘ought to be’.
 they prescribe.
 The prescriptions or recommendations of
these theories aim to achieve some goal
or objective.
Normative theories example 1
There are theories about what should be
done to reduce greenhouse gas emissions
with the aim of reducing the rate of global
warming and the environmental damage it
results in.
Example 2
 There are theories in accounting that
propose that fair values should be used to
measure assets in the financial statements
with the aim to ensure that more relevant
information is provided to users of
financial statements.
Evaluating and testing theories
There are a number of reasons theories
might be accepted without ‘first hand’ or
direct knowledge. These include: −
 the authority of the source of the theory
 whether the theory makes sense and fits
with personal experiences and beliefs
 whether other people accept the theory.
Evaluating and testing theories
A researcher or professional in a particular
discipline would be expected to apply more
legitimate, independent and justifiable methods
in assessing and evaluating theories. These
include:

 examining the logical construction of the


theory

 considering evidence that confirms or


refutes the theory.