Financial Accounting Theory Deegan

1. Types of Accounting Theories
EXTRACTS: CHAPTER 01
SOURCE: FINANCIAL ACCOUNTING THEORY, 4TH ED (DEEGAN, C., 2014)
PREPARED BY: MD TAPAN MAHMUD (D2)
SHIOSAKI SEMINAR
GRADUATE SCHOOL OF ECONOMICS, KYUSHU UNIVERSITY

2. Throwback to the development of
Accounting Theories…
 1920 to 1960s: Inductive Accounting Theories
 1960 to 1970s: Prescriptive (Normative) Accounting Theories
 Mid to late 1970s: Predictive (Positive) Accounting Theories

3. Throwback to the development of Accounting
Theories (1920 to 1960s: Inductive )
 Induction: Development of ideas or theories based on observations
 Reflecting what accountants did in practice; common practices were then codified in the
form of doctrine or conventions
 ex: conservatism
 Ex: ignoring inflation-impact in financial reporting)

4. Throwback to the development of Accounting
Theories (1920 to 1960s: Inductive )
 Criticisms:
 Study of ‘what is’; not ‘what is not’ or ‘what should be’(future directions)
 Concentrates only on the ‘status quo’ and only reactionary
 Can’t provide a basis upon which current practices can be evaluated
 Assumes that common practice by majority of accountants are right practice
 Avoids ‘radical’ or ‘controversial’ research-ideas, preferring ‘idea-acceptability’
(GAAP) of regulatory bodies
 Supports Accounting Darwinism: accounting practices has evolved and the ‘fittest’ or
perhaps the ‘best’ practices only have survived

5. Throwback to the development of Accounting
Theories (1960 to 1970s: Normative )
 Sought to Prescribe (as opposed to describe) and not driven by existing practices
 Based on norms/values
 Many theories were developed in this era which were based on the development of
arguments (deductive reasoning) regarding what the researchers considered accountants
should do

6. Throwback to the development of Accounting
Theories (1960 to 1970s: Normative )
 Researchers were critical of ‘historical cost accounting’ (due to inflation) and vouched
for other alternatives (replacement cost, net realizable value, present value). However,
since it was difficult to resolve the differences in opinion (subjectivity) ‘historical cost
accounting’ continued to be used
 It should not be evaluated on whether they reflect actual accounting practice or not
 Rather the prescriptions might reflect radical departure from existing practices

7. Throwback to the development of Accounting
Theories (1960 to 1970s: Normative )
Examples
 Continuously Contemporary Accounting: most useful information about an
organizations asset is ‘current cash equivalents’
 In recent years the use of ‘market values’ (more specifically fair value) for asset valuation
has gained popularity with the IASB
 Conceptual Framework of Accounting / Financial Reporting: It provide guidance on:
 How the elements of financial statements should be defined
 When they should be recognized
 How they should be measured

8. Throwback to the development of Accounting
Theories (1960 to 1970s: Normative )
Criticism:
 It is not based on observation, rather on personal opinion, hence it is not scientific
 Normative theorists impose their personal opinions on others

9. Throwback to the development of Accounting Theories (Mid
to late 1970s: Predictive /Positive/Explanatory)
 Aim of ‘explaining’ and ‘predicting’ rather than ‘prescribing’
 It tries to ‘make sense’ of what is currently happening in the real-world
 Positive theory is mostly ‘If…Then…’ phrasing based (ex: if certain conditions are met,
then particular accounting practices will be observed)

10. Throwback to the development of Accounting Theories (Mid
to late 1970s: Predictive /Positive/Explanatory)
 Through logical argument, make predictions (Hypothesis)
 Test the predictions/hypothesis through actual ‘real-world’ observations
 Modify the theory, if necessary, based upon the real world observations
Developing Process of Positive Theories:
 Researchers might firstly identify a number of key assumptions
 ex: that individuals are driven by self-interest, that capital markets are efficient, and so forth

11. Throwback to the development of Accounting Theories (Mid
to late 1970s: Predictive /Positive/Explanatory)
Example of Positive Accounting Theory:
 Developed by Watts and Zimmerman
 It seeks to predict and explain why accountants elect to adopt particular accounting
methods in preference to others
 It is based on ‘rational economic person’ assumption
 individuals motivated by self-interest tied to wealth-maximization
 challenges the view that accountants will be ‘objective’

12. Throwback to the development of Accounting Theories (Mid
to late 1970s: Predictive /Positive/Explanatory)
Criticisms:
 When there is no data, there is no way of building a theory
 Do not seek to tell us regarding the evaluation (i.e., what is the most efficient or
equitable process)
 Do not tell us what we should do (i.e., which method a firm should use); no prescriptions
available
 No prescription means there is nothing (almost) to offer for the professional
accountants, which is a dilution of academic responsibility