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Accounting theory 3

Accounting theory 3







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    Accounting theory 3 Accounting theory 3 Presentation Transcript

    • Financial Accounting Theory Craig Deegan, 3 rd edition Prepared by: Dewan Mahboob Hossain, Assistant Professor; Department of Accounting & Information Systems; University of Dhaka; Dhaka; Bangladesh
    • Chapter 1: Introduction to financial accounting theory
      • Theory
      • Why is accounting theory important?
      • Overview of theories of accounting.
      • Can we prove a theory?
      • Logic and evidence.
    • Theory
      • A coherent group of general propositions used as principles of explanation for a class of phenomena.
      • Theories impose cohesion and stability.
      • Whenever life is ambiguous people will work at confronting these ambiguity through theorizing.
    • Theories of accounting
      • Examples:
      • Prescribes how assets should be valued for external reporting purposes?
      • Predicts that managers paid bonuses on the basis of profit will adopt those accounting methods that lead to an increase in reported profits.
      • Seeks to explain how an individual cultural background will impact on the types of accounting information that the individual seeks to provide to people outside the organization.
    • Why important?
      • Exposure to issues like:
      • How the various elements of accounting should be measured?
      • What motivates managers to provide certain types of accounting information?
      • What motivates managers to select particular accounting methods in preference to others?
      • What motivates individuals to support and perhaps lobby regulators for some accounting methods in preference to others?
      • How and why capital market reacts to particular kind of information?
    • Theories of accounting: overview
      • Many theories of financial accounting.
      • No universally accepted theory.
      • *Explain and predict
      • *Prescribe (as opposed to describe)
    • Induction
      • Early theories  used induction.
      • Development of ideas or theories through observation.
      • 3 conditions:
      • -large number of observations.
      • -observations repeated under wide variety of conditions.
      • -no accepted observation should conflict with the derived universal law.
    • 1920s to 1960s: based on observations
      • Theories of accounting were developed on the basis of observation of what accountants actually did in practice  induction.
      • Still popular.
      • Accounting Darwinism: ‘accounting practice has evolved, and the fittest, or perhaps ‘the best’ practices have survived.
      • No prescription because, rarely have regulatory bodies accepted suggestions.
    • 1960s and 1970s
      • Prescribe particular accounting procedure  not driven by existing practices.
      • Normative period  what accountants should do?
      • Deductive reasoning.
    • Mid to late 1970s
      • Major aim shifted to  explaining and predicting accounting practices.
      • Positive theories.
      • Positive Accounting Theory (PAT) was developed by Watts and Zimmerman. It seeks to predict and explain why managers/accountants elect to adopt particular accounting methods in preference to others.
      • PAT embraced the assumption of self interest.
    • PAT
      • PAT 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 about which method a firm should use.
    • Can we prove a theory?
      • An acceptable theory might admit exceptions.
      • While we might use observations to support a theory, it would generally be inadvisable to state that we have proved a theory on the basis of observations.
      • Karl Popper  falsification  knowledge develops through trial and error.
      • Knowledge develops as a result of continual refinement of a theory.
    • Logic and evidence
      • Logical deduction:
      • All surfers over the age of 35 ride long boards.
      • Jack is a surfer over the age of 35.
      • Jack therefore rides a long board.
      • If we accept the above premises, we might accept the conclusion. It is logical.
    • Logical deduction
      • A lot of surfers over 35 ride long boards.
      • Jack is a surfer over 35.
      • Therefore, Jack rides a long board.
      • Not logical .
    • Logical deduction
      • Self-interest tied to wealth maximization motivates all decisions by individuals.
      • Manager X is paid on the basis of reported profit.
      • Accounting method Y is an available method of accounting that will increase reported profits relative to other methods.
      • Manager X will adopt accounting method Y.
      • Logical. If the premises are both logical and true, then the conclusion will be true.