BFA715 Accounting Perspectives and Theory

Semester 1 -2020

Workshop/Tutorial One/Two
1.8 Deegan 4e
What is the difference between developing a theory by induction and
developing a theory by deduction?
•The main difference between inductive and deductive approaches to research is that whilst a deductive approach is aimed and testing theory, an
inductive approach is concerned with the generation of new theory emerging from the data. A deductive approach usually begins with a
hypothesis, whilst an inductive approach will usually use research

•Induction – theory is developed as a result of undertaking a series of observations of particular events (for example, activities being undertaken in an
accountants office), and on the basis of these observations, a theory is developed (for example, expectations about what we might expect to see in an
accountants office). Early theories of accounting (for example, in the 1960s) were often developed by observing what accountants were actually
doing in practice. This led to the formulation of certain conventions and doctrines of accounting which were considered to be theories and indicative
of expected behaviours – historical cost convention, monetary convention, going concern convention, entity convention, accounting period
convention, accrual concept, matching concept, conservatism, disclosure, materiality, consistency. Most of these are embedded in standards and
generally accepted accounting principles rather than being considered theories as such. [that is, specific to general]

•Developing theory on the basis of observation typically does not allow us to address the issue of what would be the most appropriate behaviour in
particular circumstances (and determining ‘appropriate behaviour’ will in turn be influenced by particular assumptions or value judgments made by
the researcher). That is, it does not encourage us to evaluate what accountants are doing.
1.8 Deegan 4e
What is the difference between developing a theory by induction and
developing a theory by deduction?
• Deduction - By contrast, developing theory on the basis of deduction does not rely upon observation. It
relies upon the use of logic to develop arguments and related theory. Deductive reasoning works from the
more general to the more specific. [that is, general to specific]

• Some theories developed through deduction—such as positive accounting theories which are developed and
then used to predict particular behaviour—can be tested (but not initially developed) through subsequent
observation.

• Other theories developed through deduction—such as Chambers’ theory of accounting (Continuously

Contemporary Accounting)—should not be evaluated through subsequent observation as he was prescribing
a particular approach to accounting that was in stark contrast to what accountants were doing at the time.
1.11 Gray, Owen and Maunders (1987, p.66) make the following statement in relation to research based on the inductive
approach:
“studying extant practice is a study of ‘what is’ and by definition does not study ‘what is not’ or ‘what should be’. It therefore
concentrates on the status quo, is reactionary in attitude and cannot provide a basis upon which current practice may be
evaluated or from which future improvements may be deduced.”
Do you consider research based on induction is useful for improving the practice of financial accounting?

• Undertaking research based on observing actual practice provides an understanding of what is being done.

• Key Point: what we actually observe to be happening, and what we record, might be influenced by our own values and biases that we
have prior to undertaking the research.

• This means that researchers with different ‘views of the world’ (perhaps they work from quite different research paradigms) might
actually see things differently; ask different questions and record different events than would other researchers.

• Inductive researchers need to be careful that their own biases do not overly influence the data they are collecting if they are attempting to
develop a theory based on actual practice.

• With the above in mind we might nevertheless argue that it is important to understand current practice and therefore inductive research
provides an important basis for subsequently providing suggestions for improvement to practice.
• However, if we restrict our research to describing what currently occurs, this in itself does not allow us to evaluate the practice or to
prescribe improvements. For example, just because most accountants do things in a certain way – which would be identified by inductive
research – this does not in itself mean that it is the best way to do things.
1.12 Explain the meaning of the following paragraph and evaluate the logic of the perspective described:
“In generating theories of accounting that are based upon what accountants actually do, it is assumed (often implicitly) that what is
done by the majority of accountants is the most appropriate practice. In adopting such a perspective there is, in a sense, a perspective
of accounting Darwinism – a view that accounting practice has evolved, and the fittest, or perhaps ‘best’ practices have survived.
Prescriptions or advice are provided to others on the basis of what most accountants do, the logic, being that the majority of
accountants must be doing the most appropriate thing.

Just because the majority of accountants do something, this does not necessarily mean there is not a better, unknown approach
(unless we start adopting all sorts of assumptions about the high level of efficiency of accountants in determining what methods best
reflect the underlying performance and position of particular entities).

The other point that must be appreciated is that the longer the time that particular accounting methods have been used then
arguably the greater will be the resistance of accountants to change. Accounting practices can effectively become ‘institutionalised’
across time, despite the possibility that the practices are not longer the most efficient way to do something.

A change in accounting methods means that accountants and users of financial statements need to retrain and, realistically, there
may be some opposition to this. Also, there could be many contractual arrangements in place that use accounting numbers (for
example, borrowing agreements with banks or accounting-based bonus schemes negotiated with employees) and hence there could
be all sorts of social and economic consequences if the accounting rules, and hence, the ultimate accounting numbers, change.

There is also an argument by some researchers, identified as critical theorists (covered in Chapter 12 of the textbook), that financial
accounting practices tend to provide results that favour people with control over capital at the expense of those without capital.
These ‘powerful’ people will tend to argue against reform if it appears that new rules will favour those who have traditionally had
limited wealth.
 
1.12 Explain the meaning of the following paragraph and evaluate the logic of the perspective described:
“In generating theories of accounting that are based upon what accountants actually do, it is assumed (often implicitly) that what is done by the
majority of accountants is the most appropriate practice. In adopting such a perspective there is, in a sense, a perspective of accounting
Darwinism – a view that accounting practice has evolved, and the fittest, or perhaps ‘best’ practices have survived. Prescriptions or advice are
provided to others on the basis of what most accountants do, the logic, being that the majority of accountants must be doing the most
appropriate thing.

1.10 It can be argued that before we can seek to improve the practice of financial accounting we need to know which methods
of accounting are currently being used. Research which describes what is currently being done as well as describing the generally
accepted conventions is therefore useful to the overall process of improving financial accounting.

What might not be constructive, however, is where theories are developed through observing current practice and these
observations/theories are then used to prescribe what all other people should do. Just because the majority of people are doing
something does not necessarily mean that it is the best or most efficient thing to do.

Studying what is does not mean the same thing as studying what should be.

As Gray, Owen and Maunders (1987, p. 66) indicate, an approach to developing theories on the basis of observing what is
‘concentrates on the status quo, is reactionary in attitude, and cannot provide a basis upon which current practice may be
evaluated or from which future improvements may be deduced’.
 
Research that provides prescription on the basis of what is already being done does not tend to be very controversial (for
example, the work of Grady, 1965) and will not tend to generate opposition from the accounting profession. But again, assuming
that what is being done is the best approach (perhaps on the basis that only the ‘fittest’ survive) is not really logical.
1.15 As Watts and Zimmerman (1986, p.7) state, Positive Accounting Theory “is concerned with explaining (accounting)
practice. It is designed to explain and predict which firms will and which firms will not use a particular accounting method …
but it says nothing as to which method a firm should use.” Do you t6hink that this represents ‘abrogation’ of the accademics’
duty to serve the community that supports them?

•  A matter of opinion.

• There are many people (such as Howieson, 1996, from whom this quote is taken) who consider that the role of an academic is to provide guidance as to what
practitioners should be doing—because practitioners do not typically have the time to do the research that improves practice in the same way as academics (with
academics typically having their salaries paid by way of community-based taxes).

• Positive accounting theorists (particularly those that apply Positive Accounting Theory) are typically reluctant to provide prescription (that is, to use the ‘should’
word) and this has, in turn, been the cause of much criticism of this theory (for example, by researchers such as Sterling and Chambers).

• Positive theory is theory that describes and/or predicts particular phenomena and does not tend to prescribe particular activities.

• Researchers such as Watts and Zimmerman considered that ‘good, scientific’ research was research which was free of the researchers own values and biases and
that by restricting one’s attention to describing and predicting one was not taking the value-based step of saying what people should do.

• As we would appreciate however, no research can be value free (for example, Positive Accounting theorists accept the theoretical economics-based assumption
that all people are self-interested wealth maximisers—accepting such an assumption is obviously a value judgement).

• While positive accounting theorists might not elect to provide prescription, their research, which provides information about the possible implications of
particular accounting approaches and the potential motivations that drive managers to select particular accounting methods, could provide the resources and
knowledge that others might use to develop prescription. Hence, positive theory can arguably provide benefits to ‘the community’, just as normative theory can.
1.20 In your opinion, can accounting research be ‘value free’? Explain.

• Accounting research cannot really be considered to be value-free.

• Many value judgements must be made in the research process.

• For example, selecting a theory to use from among competing alternatives

can be based on a value judgement.
• We might dismiss a theory because in our view its assumptions about what motivates
human behaviour do not tie in with our own views.
• Determining what is important or interesting enough to research in the first place can
be a value judgement.
• What I think is worthwhile research might be dismissed by others as a waste of time.
1.33 In this chapter we provided quotes from Gray, Owen and Adams (2010) in which they discuss an apparent herding
phenomenon that seems to be occurring in respect of the selection and use of particular theories. They state ‘there has been a
strange herding tendency, especially around legitimacy theory’, as well as stating that they ‘also have a sneaking feeling that
institutional theory may be coming up fast as the next theory around which to herd’. What do we mean by the apparent
practice of ‘herding’ and what are some possible advantages and disadvantages that are related to this practice?

• When referring to ‘herding’ they are referring to the fact that it is common that researchers in a particular discipline tend to adopt theories that are used
by many other people within that discipline.

• That is, it is not uncommon for many researchers to adopt particular theories because the majority of people researching the particular topic also adopt or
use the theory – what some people might call as ‘running with the herd’.

• Whilst this is not necessary a bad or wrong thing to do, just because the majority of people might be applying the theory does not mean it is necessarily
the best theory available to fulfil whatever aims or objectives the researcher is hoping to achieve. Adopting something because ‘everybody else does it’
can also potentially be considered as intellectually lazy. Embracing a theory should be based on an assessment that it is the best available theory.

• Advantages with using a commonly used theory,

• one benefit would be that it will save time for the researcher. If a logical and coherent theory has already been developed then we do not have to replicate the work that others
have already done to develop the theory.
• If a theory has become accepted within a paradigm and is used by leaders in the field (who would also conceivably act as journal paper reviewers and editors), the less resistant
path to publication is deemed to be one that embraces the apparently accepted theory of the day. Generating publications is a key performance requirement of university
researchers.

• Disadvantage in using theories

• Our contribution to the literature would not be as significant as it would be if we were responsible for developing a theory.
• Whilst it is generally considered a risky exercise to develop new theory (for example, it might be relatively more difficult to get the work published relative to research which
applies accepted theories) if the work is published, despite the hurdles, it will tend to command high citation rates.
• Also, if we simply use theories that everybody else is using then we will never potentially be considered as a ‘leader’ within our field.
Q. 2.1 What expectations do accounting standard setters have about the accounting
knowledge of financial statement readers?

• Accounting standard-setters do not specifically address the expected accounting knowledge of financial
statement readers

• There is an expectation that the readers of general purpose financial reports have a ‘reasonable
knowledge’ of business and economics.

• Specifically, the IASB Conceptual Framework for Financial Reporting states that ‘financial reports are
prepared for users who have a reasonable knowledge of business and economic activities and who review
and analyse the information diligently’.

• Hence, there appears to be an implied expectation that financial statements are not tailored to meet the
needs of people who have not, in some way, studied financial accounting.

• Consider …. IS this expectation is in itself ‘reasonable’.

Q.2.3 Do you believe that the media portray accounting numbers, such as profits, as
some sort of ‘hard’ and objective performance indicator? Why do you think they
might do this? And, if they do, what are some of the implications that might arise as
a result of this approach?
Do you believe that the media portray accounting numbers, such as profits, as some sort of ‘hard’ and objective performance
indicator?

In making this judgement consider the various articles that frequently appear in newspapers and various discussions that occur on
television and radio in relation to an organisation’s profits.

Rarely is any mention made of the accounting methods used, even though the profits ultimately reported are directly a product of
the many decisions that would have been made regarding how particular items should be accounted for (if possible, direct reference
should be made to a number of articles which discuss organisations’ reported profits).

Hence, it does appear as if profits are often held out as some form of ‘hard’, objective measure of organisational performance.

Rarely, is any comment made in regard to the choices that are made in putting the various parts of ‘profit’ reports together and the
reason for these ‘subjective’ choices.

Consider – does this mean the ‘profit’ result may not mean the same for all entities and in some way defeat our ability to
compare?
Q.2.3 Do you believe that the media portray accounting numbers, such as profits, as
some sort of ‘hard’ and objective performance indicator? Why do you think they
might do this? And, if they do, what are some of the implications that might arise as
a result of this approach?
Why do you think they might do this?

• Why the media might behave in this manner:

• One possibility is that those responsible for writing the stories are ignorant that financial accounting relies upon a great deal of
professional judgement and they might believe that every decision made by accountants is clearly mapped out by a
comprehensive system of rules.

• The writers might consider that people simply do not want to be ‘bogged down’ in the fine detail.

• The accounting profession, through such vehicles as conceptual frameworks, may have successfully cultivated an impression (with
the people in the media, and others) that the practice of accounting is objective, and the output of the accounting system is
highly comparable between different entities—meaning that one organisation’s profits can appropriately be compared to
another.

• Consider – is this truly ‘good/best practice’? Should we be doing better?

Q.2.3 Do you believe that the media portray accounting numbers, such as profits, as
some sort of ‘hard’ and objective performance indicator? Why do you think they
might do this? And, if they do, what are some of the implications that might arise as
a result of this approach?
And, if they do, what are some of the implications that might arise as a result of this approach?

• The implications of this approach to reporting profits in the media:

• Is that one entity’s performance as represented by its profit might simply be compared to another, and that the entity with the higher reported
profit might be considered to be more successful, and therefore to represent a better investment.
• Its management might also be considered in a more favourable light than the management of the entity with the lower reported profits.
• Implications such as this however, assume that readers and media listeners do not appreciate that profits are directly related to the various
accounting choices made.
• Advocates of an efficient market perspective might however, argue that as long as the information about accounting method selection is made
public somewhere, such as in the annual report, then the market (for example, the capital market) on average, will be able to understand how
the adoption of particular accounting methods affected reported profits and hence the market will not simply fixate on the final numbers
reported. There are differences in opinion about the efficiency of markets, such as the capital market.

• A further point that could be raised in relation to this question is that accounting ‘profits’ are not a comprehensive measure of
organisational performance, given that accounting profits typically disregard many of the social and environmental implications
of a reporting entity.

• Consider – Are social and environmental issues of equal importance to financial/economic issues? Or should they be?
Q.2.5 What is ‘creative accounting’ and why does it occur?

What is ‘creative accounting’?

• Creative accounting can be defined as an approach to accounting wherein objectivity is not employed, but rather refers to a situation where those
responsible for the preparation of accounts select accounting methods that provide the accounting result desired by the preparers.

Why does it occur?

• There can be a number of reasons why creative accounting might be employed.

• Perhaps it might be undertaken to hide some fraud.

• It might also be undertaken because the organisation has negotiated various contractual arrangements with various stakeholders.
• For example, the organisation might have borrowed funds from certain lenders, and as part of the lending agreement the organisation might have signed a contract that included
various covenants that used accounting numbers and which have the aim of reducing the risks of the lenders. This also would have reduced the costs that the organisation would
have paid for the finance.
• In this regard, the organisation might have agreed to restrict its total level of debt by means of a stipulation that its debt to asset ratio is not to exceed a pre-specified upper limit
(often referred to as a debt-to-asset covenant), or it might have agreed to maintain a certain interest coverage ratio, for example, that its profits (perhaps before interest and taxes)
was to exceed/cover interest expense by a minimum number of times.
Q.2.5 What is ‘creative accounting’ and why does it occur?

Why does it occur?

• When an organisation has agreed to certain accounting-based debt covenants, a failure to comply with these
covenants/restrictions means that the organisation would enter what is commonly referred to as ‘technical default’.
• Being in technical default can be costly for an organisation and can potentially lead to the company being discontinued.
• To avoid this, the accountant might be encouraged to ‘creatively’ increase reported income and assets, both actions of
which would lead to a reduced probability of technical default (to the extent that the creativity remained undetected).

• Also, organisations often pay key people within an organisation rewards that are tied to the performance of the
organisation. These management bonuses might pay a bonus based on reported profits, return on assets or perhaps sales.
Such bonus schemes are common. When people’s bonuses, and therefore wealth, are linked to accounting numbers there
will be pressure on the accountant to be ‘creative’ with the accounting numbers.

• The above discussion has been far from exhaustive. There can be many reasons that creative accounting can occur. Not all
accountants will respond to the various pressures to be ‘creative’, but to believe that accountants are always objective
(and never ‘creative’) would be very naïve.
MC Wells ‘A Revolution in Accounting Thought’. The Accounting Review. V.LI.
No.3. July 1976. pp471-82. The article does not have an abstract – write an abstract
of no more than 400 words. A short guide to writing an abstract is provided.

The word abstract - a condensed form of a longer piece of writing.

How do I write an abstract?

• First re-read your paper/report for an overview. Then read each section and condense
the information in each down to 1-2 sentences.
• Next read these sentences again to ensure that they cover the major points in the
paper.
• Ensure you have written something for each of the key points.
• Check the word length and further reduce your words if necessary by cutting out
unnecessary words or rewriting some of the sentences into a single, more succinct
sentence.
• Edit for flow and expression.
MC Wells ‘A Revolution in Accounting Thought’. The Accounting Review. V.LI.
No.3. July 1976. pp471-82. The article does not have an abstract – write an abstract of
no more than 400 words. A short guide to writing an abstract is provided.

What makes a good abstract?

• uses one well-developed paragraph that is coherent and concise, and is able to stand alone as a unit
of information
• covers all the essential academic elements of the full-length paper, namely the background, purpose,
focus, methods, results and conclusions
• contains no information not included in the paper
• is written in plain English and is understandable to a wide audience, as well as to your discipline-
specific audience
• often uses passive structures in order to report on findings, focusing on the issues rather than people
• uses the language of the original paper, often in a more simplified form for the more general reader
• usually does not include any referencing
• in publications such as journals, it is found at the beginning of the text, while in academic
assignments, it is placed on a separate preliminary page
MC Wells ‘A Revolution in Accounting Thought’. The Accounting Review. V.LI.
No.3. July 1976. pp471-82. The article does not have an abstract – write an abstract of
no more than 400 words. A short guide to writing an abstract is provided.

How is an abstract different to an introduction?

Abstract Introduction

The essence of the whole paper Introduces the paper

Covers the following academic elements: Covers the following academic elements:
 background  background
 purpose and focus  purpose
 methods  proposition
 results (also called ‘findings’) (also called ‘point of view’ or ‘thesis’ statement)

 conclusions  Outline of key issues

 recommendations  Scope (not always relevant)

(or ‘implications’, not always relevant)

Summarises briefly the whole paper including the conclusions. Introduces the paper and foregrounds issues for discussion.
Kuhn (2006 summary by Pajares) talks of ‘scientific revolution’. What does he
mean? Do you think this makes sense? Is this linked to increased sophistication of
the business world and the needs that accounting is asked to address? Do we
construct our social world? Do accountants create their world?
What does he mean?

•A shift in professional commitments to shared assumptions takes place when an

anomaly undermines the basic tenets of the current scientific practice

•These shifts are what Kuhn describes as scientific revolutions - "the tradition-
shattering complements to the tradition-bound activity of normal science"

•New assumptions –"paradigms" - require the reconstruction of prior assumptions

and the re-evaluation of prior facts. This is difficult and time consuming. It is also
strongly resisted by the established community.
Kuhn (2006 summary by Pajares) talks of ‘scientific revolution’. What does he
mean? Do you think this makes sense? Is this linked to increased sophistication of
the business world and the needs that accounting is asked to address? Do we
construct our social world? Do accountants create their world?
• Do you think this makes sense?

• It is a way of developing news ways of thinking, of applying a new way

of thinking about what we know – usually because we believe the old
way of thought is not valid or is lacking in some way

• Take – description to positive theory to systems theory

Kuhn (2006 summary by Pajares) talks of ‘scientific revolution’. What does he
mean? Do you think this makes sense? Is this linked to increased sophistication of
the business world and the needs that accounting is asked to address? Do we
construct our social world? Do accountants create their world?
Is this linked to increased sophistication of the business world and the needs that accounting is asked to address?
• When they first appear, paradigms are limited in scope and in precision. But more successful does not mean completely successful with a
single problem or notably successful with any large number.

• Initially, a paradigm offers the promise of success. Normal science consists in the actualisation of that promise. This is achieved by
extending the knowledge of those facts that the paradigm displays as particularly revealing, increasing the extent of the match between
those facts and the paradigm's predictions, and further articulation of the paradigm itself.

• In other words, there is a good deal of mopping-up to be done. Mop-up operations are what engage most scientists throughout their
careers. Mopping-up is what normal science is all about! This paradigm-based research is "an attempt to force nature into the pre-formed
and relatively inflexible box that the paradigm supplies".
• No effort is made to call forth new sorts of phenomena, no effort to discover anomalies. When anomalies pop up, they are usually
discarded or ignored. Anomalies are usually not even noticed and no effort is made to invent a new theory (and there’s no tolerance for
those who try).
• Those restrictions, born from confidence in a paradigm, turn out to be essential to the development of science.
• By focusing attention on a small range of relatively esoteric problems, the paradigm forces scientists to investigate some part of nature in
a detail and depth that would otherwise be unimaginable" and, when the paradigm ceases to function properly, scientists begin to behave
differently and the nature of their research problems changes.
Kuhn (2006 summary by Pajares) talks of ‘scientific revolution’. What does he
mean? Do you think this makes sense? Is this linked to increased sophistication of
the business world and the needs that accounting is asked to address? Do we
construct our social world? Do accountants create their world?
• Do we construct our social world?

• When scientists disagree about whether the fundamental problems of their field have been solved, the search for rules gains a function that it does
not ordinarily possess .

• Nonetheless, new and unsuspected phenomena are repeatedly uncovered by scientific research, and radical new theories have again and again
been invented by scientists . Fundamental novelties of fact and theory bring about paradigm change. So how does paradigm change come about?
There are two ways: through discovery - novelty of fact - or by invention – novelty of theory.
• Discovery begins with the awareness of anomaly - the recognition that nature has violated the paradigm-induced expectations that govern normal
science. The area of the anomaly is then explored. The paradigm change is complete when the paradigm has been adjusted so that the anomalous
become the expected. The result is that the scientist is able "to see nature in a different way“
• The emergence of a new theory is generated by the persistent failure of the puzzles of normal science to be solved as they should. Failure of
existing rules is the prelude to a search for new ones . These failures can be brought about by observed discrepancies between theory and fact or
changes in social/cultural climates Such failures are generally long recognised, which is why crises are seldom surprising.

• Crises provide the opportunity to retool.

• In responding to these crises, scientists generally do not renounce the paradigm that has led them into crisis. Rather, they usually devise numerous
articulations and ad hoc modifications of their theory in order to eliminate any apparent conflict.
Kuhn (2006 summary by Pajares) talks of ‘scientific revolution’. What does he
mean? Do you think this makes sense? Is this linked to increased sophistication of
the business world and the needs that accounting is asked to address? Do we
construct our social world? Do accountants create their world?
•Why should a paradigm change be called a revolution? What are the functions of scientific
revolutions in the development of science?

•A scientific revolution is a non-cumulative developmental episode in which an older paradigm is replaced in whole or in part by an
incompatible new one .
•A scientific revolution that results in paradigm change is analogous to a political revolution.
•Political revolutions begin with a growing sense by members of the community that existing institutions have ceased adequately to
meet the problems posed by an environment that they have in part created.
•The dissatisfaction with existing institutions is generally restricted to a segment of the political community. Political revolutions
aim to change political institutions in ways that those institutions themselves prohibit.
•As crisis deepens, individuals commit themselves to some concrete proposal for the reconstruction of society in a new institutional
framework.
•Competing camps and parties form. One camp seeks to defend the old institutional constellation. One (or more) camps seek to
institute a new political order. As polarisation occurs, political recourse fails. Parties to a revolutionary conflict finally resort to the
techniques of mass persuasion.
Kuhn (2006 summary by Pajares) talks of ‘scientific revolution’. What does he
mean? Do you think this makes sense? Is this linked to increased sophistication of
the business world and the needs that accounting is asked to address? Do we
construct our social world? Do accountants create their world?
• Do accountants create their world?

• Yes
• Think about standard setting
• Think about theory adoption