GODFREY

HODGSON
HOLMES
TARCA

CHAPTER 2
ACCOUNTING THEORY
CONSTRUCTION
Pragmatic theories
Descriptive pragmatic approach:
• based on observed behaviour of accountants
• theory developed from how accountants act in
certain situations
• tested by observing whether accountants do
act in the way the theory suggests
• is an inductive approach

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Pragmatic theories
• Criticisms of descriptive pragmatic approach:
– does not consider the quality of an accountant’s
action
– does not provide for accounting practices to be
challenged
– focuses on accountants’ behaviour not on
measuring the attributes of the firm

3
Pragmatic theories
Psychological pragmatic approach:
• theory depends on observations of the
reactions of users to the accountants’ outputs
• a reaction is taken as evidence that the outputs
are useful and contain relevant information

4
Pragmatic theories
• Criticisms of the psychological pragmatic
approach:
– some users may react in an illogical manner
– some users might have a preconditioned response
– some users may not react when they should

• Theories are therefore tested using large

samples of people

5
Syntactic and semantic theories
• Semantic inputs are the transactions and
exchanges recorded in vouchers, journals and
ledgers

• The inputs are then manipulated on the basis

of the premises and assumptions of historical
cost accounting

6
Syntactic and semantic theories
• Criticised because there is no independent
empirical verification of the calculated outputs

• The outputs may be criticised for poor syntax

inaccurate e.g. different types of monetary
measures are added together

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Syntactic and semantic theories
• The outputs may be syntactically accurate but
nevertheless be valueless due to a lack of
semantic accuracy (a lack of correspondence
with real-world events, transactions or
values)

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 example
• When a company reports better prospects
than previously, investors force that
company’s share price to increase
• Metcash is a company that has reported
better earnings per share than previously
• Investors forced Metcash share prices to
increase

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Syntactic and semantic theories
• Historic cost accounting may produce
‘accurate’ outputs but which nevertheless
have little or no utility
• That is, they are not useful for economic
decision making except to verify accounting
entries

10
Normative theories
• 1950s and 1960s ‘golden age’
– policy recommendations
– what should be
– concentrated on deriving:
• true income (profit)
• practices that enhance decision-usefulness
– based on analytic and empirical propositions

Financial
Financial statements
statements should
should mean
mean what
what
they
they say
say

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Normative theories
• True income:
– a single measure for assets
– a unique and correct profit figure

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Normative theories
• Decision usefulness:
– the basic objective of accounting is to aid the
decision-making process of certain ‘users’ of
accounting reports by providing useful accounting
data

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Normative theories
The decision process

Accounting
Accounting Prediction
Prediction Decision
Decision
system
systemof
of model
modelofof model
model of
of
company
companyXX user
user user
user

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Positive theories
• Expanded during the 1970s
• Based on ‘experiences’ or ‘facts’ of the real
world
• Explain the reasons for current practice
• Predict the role of accounting information in
decision-making

15
Positive theories
• The main difference between normative and
positive theories is that
– normative theories are prescriptive
– positive theories are descriptive, explanatory or
predictive

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Different perspectives
• Scientific approach:
– has an inherent assumption that the world to be
researched is an objective reality
– is carried out by incremental hypotheses
– has an implied assumption that a good theory
holds under circumstances that are constant
across firms, industries and time

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Different perspectives
• Criticism of the scientific method:
– large-scale statistical research tends to lump
everything together
– it is conducted in environments that are often
remote from the world of or the concerns of
accountants

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Different perspectives
• Naturalistic approach:
– implies that there are no preconceived
assumptions or theories
– focuses on firm-specific real-world problems
• Naturalistic research starts from specific real-
world situations; the main intention is to
answer the question “what is going on here” ,
not to provide generalisable conditions for
wide segments of society
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Different perspectives
• Alternative ways of looking at the world:

CATEGORY
CATEGORY ASSUMPTION
ASSUMPTION
1.
1. Reality
Realityas
asaaconcrete
concretestructure
structure
2.
2. Reality
Realityas
asaaconcrete
concreteprocess
process
3.
3. Reality
Realityas
asaacontextual
contextual field
fieldof
of information
information
4.
4. Reality
Realityas
asaasymbolic
symbolicdiscourse
discourse
5.
5. Reality
Realityas
asaasocial
socialconstruction
construction
6.
6. Reality
Realityas
asprojection
projectionof
of human
humanimagination
imagination

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 Category 1
• Researchers assume that all managers aim to
maximise their personal wealth and that they
are aware of how they can use accounting
techniques to do so
• Researchers predicts that all managers behave
in the same manner because they have shared
a view of the world and of the outcomes of
their actions and because they share
preferences for particular outcomes
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 Category 6
• Humans are not expected to behave according
to a set of behavioral rules that apply to
everyone equally
• Although individuals may behave rationally
according to their personal understanding of
the world and of the outcomes of particular
actions, they do not share a common
understanding of how the world works, and
they have different preffered outcomes from
their decisions 22
Different perspectives
• For categories 1 – 3 it is more appropriate to
use the scientific approach

• For categories 4-6 the naturalistic approach is

more appropriate

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Different perspectives

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Scientific approach applied
to accounting
Misconceptions of purpose
• Make scientists out of accounting practitioners
• Researchers = practitioners
• The desire for ‘absolute truth’

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Scientific approach applied
to accounting
• The scientific method does not claim to
provide ‘truth’
• It attempts to provide persuasive evidence
which may describe, explain or predict

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 Issues for auditing theory
construction
• Auditing is a verification process that is
applied to the accounting inputs and
processes

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 Issues for auditing theory
construction
• Auditors provide an opinion on
– whether the financial statements accord with the
applicable reporting framework
– whether the statements give a true and fair view

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 Issues for auditing theory
construction
• The normative era of accounting coincided
with a normative approach to auditing theory
• The positive ere of accounting has led to a
positive approach to auditing theory

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Summary
• Many different approaches to theory
formulation in accounting
• Evolution of accounting theory
– positive v. normative
– scientific v. naturalistic

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Key terms and concepts
• Descriptive pragmatic approach
• Psychological pragmatic approach
• Syntactic and semantic theories
• Historical cost accounting
• Normative theories
• Positive theories
• Scientific approach to theory
• Naturalistic approach to theory
• Auditing theory

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