WEEK2: SCOPE AND ROLE OF ACCOUNTING THEORY

1.​ Definition of Accounting Theory

●​ A coherent set of principles forming a framework for understanding accounting
●​ Provides logical reasoning to evaluate and guide accounting practices
●​ Helps explain current practices and suggest improvements
2.​ Purpose of Accounting Theory
●​ Explain why and how current accounting practices evolved
●​ Provide a basis for developing new accounting practices
●​ Guide decision-making in accounting
●​ Predict and explain accounting phenomena
3.​ Development Stages of Accounting Theory
●​ Pre-theory period (1400-1800): No formal theory
●​ General Scientific Period (1800-1960): Inductive approach
●​ Normative Period (1960-1970): Prescriptive theories
●​ Specific Scientific/Positive Era (1970-present): Explanatory and predictive
theories
4.​ Theory Formulation Approaches
●​ Inductive: From specific observations to general conclusions
●​ Deductive: From general principles to specific conclusions
5.​ Types of Accounting Theories
●​ Normative Theories: Prescribe what should happen
●​ Positive Theories: Explain and predict accounting practices
●​ Behavioral Theories: Explore broader sociological implications
6.​ Theory Evaluation Criteria
●​ Explanatory power
●​ Predictive accuracy
●​ Constructive approach
●​ Correspondence to real-world events
7.​ Modern Developments
●​ Influenced by corporate collapses
●​ Increased legislative reporting
●​ Accounting standards convergence
●​ Technology integration

Key Takeaway: Accounting theory provides a systematic approach to understanding, evaluating,

and improving accounting practices by offering theoretical frameworks and explanatory models.

Reading Material: Additional slide

1. Introduction to Accounting Theory

The document starts by introducing the concept of accounting theory and its importance in
shaping accounting practices.

●​ What is Accounting Theory?

○​ Accounting theory refers to a systematic set of principles that guide accounting
practice. Unlike natural sciences, accounting theory is rooted in human behavior,
economics, and decision-making processes.
●​ How Accounting Theories Relate to Accounting Practices?
○​ Accounting theory is closely related to accounting practice, as it provides the
framework and rationale behind accounting methods, standards, and
approaches. This relationship helps practitioners make informed decisions and
apply accounting rules consistently across different contexts.

2. Formulation of Accounting Theory: Inductive vs. Deductive Approaches

The document explains two methods of formulating accounting theory:

●​ Inductive Approach:
○​ The inductive method involves deriving general principles from observations
or empirical data. In this approach, accountants look at real-world accounting
practices and build theories based on these practices.
●​ Deductive Approach:
○​ The deductive method begins with general assumptions or principles and
applies them to specific cases. Theories are developed starting from a broad
framework and are then applied to real accounting scenarios.

Both approaches contribute to the development of accounting theory, but they do so in different
ways. The inductive approach focuses on observation, while the deductive approach
emphasizes theoretical foundations.

3. Development of Accounting Theory

The document discusses the evolution of accounting theory through four periods:

1. Pre-Theory Period:

●​ In the early stages, accounting was more about practical tasks like record-keeping,
and there was little systematic theory behind these practices. Accounting was simply a
method to track transactions, with no formal theory to back up decisions.

2. General Scientific Period:

●​ During this period, accounting began to evolve from a purely practical task into a more
scientific discipline. Efforts were made to apply scientific methods and theories to
 accounting practices. This was the beginning of accounting as a formalized field, with
emerging guidelines and principles that attempted to standardize practices.

3. Normative Period:

●​ The normative period focused on establishing standards and norms for accounting
practices. This period saw the development of accounting theories that attempted to
prescribe how accounting should be done, rather than just describing what was
happening. Theories in this period aimed to establish best practices and ethical
guidelines for accountants.

4. Specific Scientific Theory Period:

●​ The final stage in the development of accounting theory is the specific scientific theory
period. During this phase, accounting theory became more specialized and technical.
Specific accounting practices, such as financial reporting, cost accounting, and
auditing, were developed as distinct fields within accounting. The theories during this
period are based on empirical research and data-driven analysis.

4. Nature of Accounting

The document emphasizes that accounting is not like the "hard" sciences (e.g., physics or
chemistry), where there are clear, universally applicable laws. Instead, accounting is a practical
discipline that requires theories and frameworks to guide decision-making.

●​ Accounting Rules:
○​ While accounting relies on rules and guidelines, it is important to recognize that
theory is necessary to provide a solid foundation for these rules. Without theory,
accounting practices would be inconsistent and potentially unreliable.
●​ Theory's Role in Decision-Making:
○​ Accounting theory is crucial for providing a rational basis for decisions in the
field. It helps accountants and organizations make informed choices about how
to measure, report, and interpret financial data.

5. Conclusion

The document concludes by reinforcing the idea that accounting theory is essential for the
coherent and consistent application of accounting practices. It serves as the foundation
for developing accounting standards and ensures that accountants can apply practices that are
both ethical and reliable.

Key Takeaways:

●​ Accounting theory provides a systematic framework that guides accounting practice.

 ●​ There are two primary ways to formulate accounting theory: inductive (based on
observation) and deductive (based on general principles).
●​ The development of accounting theory can be divided into four periods: Pre-theory,
General Scientific, Normative, and Specific Scientific.
●​ Accounting is a practical discipline, but it requires theory to provide consistency and
rational decision-making.
●​ Accounting rules are influenced by theory, which ensures ethical and reliable
practices in the field.

This document outlines the importance of accounting theory in structuring and guiding the
practice of accounting, and how it has evolved over time to become a fundamental aspect of
modern accounting.

Reading material 1: The scope and role of accounting theory (Glautier)

1. The Construction of Accounting Theory

Accounting theory is not just a set of rules or principles, but it also involves justifying or
refuting existing accounting practices. The goal is to develop a conceptual framework for
understanding what accountants do and what they are expected to do.

●​ Traditional Approach: In the traditional approach to accounting theory, the

construction and verification of a theory were considered synonymous. This meant
that theory development was seen as a process of verifying existing practices and
constructing new ideas that fit those practices.
●​ New Approach: In the past decade, a new approach has emerged in accounting theory.
This approach distinctly separates verification from construction. The idea is to test
and verify accounting practices against real-world data and evidence, leading to more
empirical validation.

Despite these changes, the underlying objective of both approaches remains the same: to
create a conceptual framework that helps understand and guide accounting practices.

2. The Nature of Theories

Accounting theory is different from theories in natural sciences (such as physics or biology).
While natural sciences deal with universal laws and objective truths, accounting theory is
more subjective and contextual.

●​ Contextual Nature: Accounting theory deals with human-made rules and standards,
which are shaped by economic, legal, and social factors. Therefore, the development of
 accounting theory is influenced by the cultural context and economic environment in
which it is applied.
●​ Normative vs. Positive Accounting Theories: The chapter likely touches on the
distinction between normative theories (which prescribe how accounting should be)
and positive theories (which describe how accounting is actually practiced).

3. Challenges in Developing a General Theory of Accounting

The chapter addresses a significant issue in accounting: the lack of progress toward a
general theory of accounting.

●​ Lack of Universality: Unlike in natural sciences, where universal laws can apply
everywhere, accounting practices vary greatly between different countries, industries,
and organizations. As a result, developing a universal theory that fits all situations is
challenging.
●​ Diverse Accounting Standards: Accounting theory must account for different
systems such as GAAP (Generally Accepted Accounting Principles), IFRS
(International Financial Reporting Standards), and other national standards. These
differences make it difficult to create a single, overarching theory that applies globally.

4. Different Approaches to Accounting Theory

The chapter describes various approaches to the development of accounting theory,

emphasizing that there is no single, universally accepted methodology.

●​ Empirical Approach: This approach relies on empirical data to test and verify
accounting practices. It focuses on real-world observations and data, making it more
practical.
●​ Conceptual Approach: The conceptual approach focuses on developing a
framework of ideas or concepts that help in understanding accounting practices. This is
often theoretical and abstract, aiming to develop guiding principles or general theories.
●​ Positivist vs. Interpretivist Approaches: The chapter may also mention the debate
between positivist approaches (which focus on observable, quantifiable data) and
interpretivist approaches (which focus on understanding the context and meaning
behind accounting practices).

5. The Importance of Concepts and Standards in Accounting Theory

Construction

A major part of constructing accounting theory involves understanding and applying key
concepts and standards.

●​ Concepts: In accounting, concepts such as assets, liabilities, revenue, and expenses

serve as the building blocks of accounting theory. These concepts guide how
accountants record and report financial information.
 ●​ Standards: Accounting standards like GAAP or IFRS are based on these concepts and
provide the rules and guidelines that accountants follow to ensure consistency and
comparability in financial reporting. The construction of accounting theory requires a
deep understanding of these standards and the concepts that underpin them.

6. Relevance of Conceptual Frameworks

The chapter concludes by emphasizing the relevance of a conceptual framework for

accounting theory construction.

●​ Conceptual Framework: A conceptual framework in accounting helps ensure that

accounting practices are consistent and reliable. It provides a foundation for developing
new standards and adapting existing ones, ensuring that the theory behind accounting
practices evolves in line with changes in the business environment.
●​ Guiding Principles: The development of accounting theory is essential to ensuring that
accounting remains relevant in the face of changing economic realities. A strong
conceptual framework helps to interpret and apply accounting standards in ways that
meet the needs of businesses, regulators, and other stakeholders.

Key Takeaways:

1.​ Accounting theory seeks to justify and improve existing accounting practices through
the development of a conceptual framework.
2.​ Unlike natural sciences, accounting theory is influenced by contextual and social
factors, making it more subjective.
3.​ There has been little progress in developing a universal theory of accounting due to
the diversity in practices across countries and industries.
4.​ Various approaches, including empirical and conceptual approaches, are used to
develop accounting theory.
5.​ Key concepts like assets and liabilities, as well as accounting standards like GAAP
and IFRS, are crucial for constructing a reliable accounting theory.
6.​ A conceptual framework is essential for developing new standards and ensuring that
accounting practices remain relevant and consistent.

This chapter provides an in-depth exploration of accounting theory, its importance, and the
challenges faced in its development. It also highlights the need for conceptual frameworks
and the crucial role that accounting standards play in shaping theory and practice.

Reading material 2 (Godfrey)

1. Introduction to Accounting Theory

The chapter starts by emphasizing the importance of understanding accounting theory and
its evolving role over time. It highlights key concepts, such as the nature of accounting theory
and its purpose in guiding accounting practice.

●​ Definition of Accounting Theory: Accounting theory refers to a systematic set of

principles and concepts that guide the preparation, presentation, and interpretation of
financial information. It helps explain why accounting practices exist and provides the
foundation for accounting standards and rules.
●​ Purpose of Accounting Theory: The purpose of accounting theory is to provide logical
explanations and frameworks that support accounting practices, ensuring consistency
and reliability across different situations.

2. The Evolution of Accounting Theory

The chapter traces the historical development of accounting theory and how views on
accounting have changed over time. It examines the shift in perspectives from practical
record-keeping to a more conceptual approach.

●​ Early Accounting: In the early stages, accounting was primarily about record-keeping
and the management of resources, often for taxation or trade. It was seen more as a
technical skill rather than a theoretical discipline.
●​ Development of Theories: As the scope and complexity of businesses grew, the need
for formal theories emerged. Accounting became more structured, with theories aiming
to provide rational foundations for practices like valuation, measurement, and
reporting.

3. Theories in Other Fields and Their Relation to Accounting

The chapter makes an analogy to highlight the importance of theory in accounting by

referencing theories in other fields, such as gravity in physics and evolution in biology. These
theories help explain phenomena in the natural world and provide a framework for
understanding complex systems.

●​ Theory's Authority: The chapter questions the authority of theory and why theories
are respected in disciplines like physics and biology. Similarly, accounting theory holds
authority in explaining accounting practices and ensuring their consistency across
different regions and time periods.
●​ Relevance of Accounting Theory: Accounting theory provides theoretical
justification for accounting practices. Just as scientific theories explain natural
phenomena, accounting theory helps explain why financial transactions are reported in
particular ways.

4. The Need for Published Accounting Reports

The chapter discusses the role of published accounting reports in a perfect financial
world—a scenario where information would be readily available and understandable without the
need for accounting reports. However, in the real world, these reports are necessary because:

●​ Complexity: Businesses and organizations operate in environments with complex

financial structures and activities.
●​ Decision-Making: Accounting reports provide crucial information for decision-makers,
including investors, creditors, and management.

Accounting theory ensures that these reports are consistent, reliable, and transparent,
making them useful for all stakeholders involved.

5. The Structure of the Book

The chapter briefly outlines the structure of the book and how it logically sequences
discussions on accounting theory. The chapters are designed to take readers through a
historical perspective, exploring the development of accounting theory and introducing
various approaches to accounting practices.

●​ The book discusses how accounting theory relates to standard-setting, regulations,

and professional practices.

Key Takeaways:

1.​ Accounting theory is a set of principles and concepts that guide accounting practices.
2.​ The development of accounting theory over time has helped shape the field, moving
from basic record-keeping to more complex and conceptual frameworks.
3.​ Just like theories in other scientific fields (e.g., gravity, evolution), accounting theory
provides explanations and justifications for accounting practices.
4.​ Published accounting reports are essential for decision-making in the business world
and are guided by accounting theory to ensure their accuracy, reliability, and
consistency.
5.​ The book is structured to trace the historical development of accounting theory, providing
a logical sequence of how it has evolved and how it informs modern accounting
practice.

This chapter provides a foundational understanding of accounting theory, its historical

development, and its relevance to modern accounting practices. By positioning accounting
theory alongside other scientific theories, it illustrates the importance of theory in ensuring
consistency and reliability in accounting.
Reading material 3: Accounting theory construction (Godfrey)

1. Pragmatic Approaches to Theory Development in Accounting

The chapter introduces pragmatic approaches to accounting theory, which are based on
practical experience and real-world observations rather than purely theoretical constructs.

●​ Pragmatic approaches emphasize the usefulness and practicality of accounting

theories in real-world settings. They are concerned with what works in accounting
practices rather than abstract principles.
●​ Application to Accounting: The chapter highlights how pragmatic approaches can help
accountants and organizations choose and apply accounting methods that are most
effective in specific situations, even if these methods are not strictly aligned with
traditional or theoretical frameworks.

2. Criticisms of Historical Cost Accounting as a Theoretical Model

The chapter discusses the criticisms of historical cost accounting as a theoretical model.
Historical cost accounting involves recording assets and liabilities at their original purchase
price, which may not reflect their current market value.

●​ Limitations: Critics argue that historical cost accounting is outdated and does not
reflect the true value of assets, especially in periods of high inflation or volatile markets.
This leads to a mismatch between financial statements and the actual economic
position of a business.
●​ Theoretical Issues: The reliance on historical cost accounting has been challenged by
proponents of fair value accounting, which suggests that assets and liabilities should
be measured at their current market value to better reflect the financial condition of an
organization.

3. Normative True Income Theories and the Decision-Usefulness Approach

The chapter introduces normative true income theories and discusses the
decision-usefulness approach to accounting theory.

●​ Normative True Income Theories: These theories attempt to define a “true” or

“accurate” income for an entity, based on idealized assumptions about how income
should be measured. They are normative because they prescribe how accounting
should be done rather than describing actual practices.
●​ Decision-Usefulness Approach: This approach to accounting theory focuses on
providing information that is useful for decision-making by users of financial reports.
 The emphasis is on how accounting information helps stakeholders (such as investors,
creditors, and management) make informed decisions about the entity’s future.

4. Positive Theories and Their Construction

The chapter explores positive accounting theories, which aim to describe and explain actual
accounting practices, rather than prescribe what should be done.

●​ Positive Theories: These theories are grounded in empirical research and focus on
understanding how accounting decisions are made in practice. They attempt to
explain the behavior of accountants, the choice of accounting methods, and the impact
of accounting on the real world.
●​ Construction of Positive Theories: The chapter discusses how positive accounting
theories are constructed based on observations of accounting practices in the field and
the data collected from these observations.

5. Naturalistic Approaches and the Importance of Ontology

The chapter also introduces naturalistic approaches to accounting theory and discusses the
importance of ontology (the study of being and existence) in theory development.

●​ Naturalistic Approaches: These approaches focus on understanding accounting in

its natural context. They rely on studying real-world accounting practices without
attempting to impose rigid theoretical frameworks. They emphasize the importance of
the social and economic environment in shaping accounting practices.
●​ Ontology: Ontology plays a significant role in understanding what accounting is and
how accounting phenomena exist in the real world. Different ontological assumptions
can lead to different approaches to accounting theory.

6. Misconceptions in Scientific Approaches to Accounting Research

The chapter addresses several misconceptions associated with scientific approaches to

accounting research and why these are often incorrect.

●​ Scientific Approach Misconceptions: The chapter discusses how scientific methods in

accounting research are often misunderstood. For example, some believe that
accounting theory should always be objective and value-neutral, but accounting is also
influenced by subjective judgments and social factors.
●​ Importance of Recognizing Subjectivity: The chapter suggests that it is crucial to
recognize that accounting practices are not always scientific in the strict sense. They
are shaped by human judgment, regulatory environments, and economic conditions.

7. Issues for Auditing Theory Construction

The chapter briefly touches on the development of auditing theory and the issues that arise in
constructing theories related to auditing.

●​ Auditing Theory: The development of auditing theory is influenced by public interest

and accountability. Auditing theories aim to explain how auditors assess and verify the
truthfulness and fairness of financial statements.
●​ Key Issues: The chapter likely explores conflicts of interest, ethical considerations,
and the role of auditors in ensuring the integrity of financial reporting.

Key Takeaways:

1.​ Pragmatic approaches to accounting theory focus on practical, real-world applications

rather than abstract theoretical models.
2.​ Historical cost accounting is criticized for failing to reflect the true value of assets,
leading to calls for fair value accounting.
3.​ Normative true income theories prescribe how income should be measured, while the
decision-usefulness approach focuses on providing relevant information for
decision-making.
4.​ Positive theories aim to explain actual accounting practices based on empirical data
and observations.
5.​ Naturalistic approaches emphasize the importance of context in accounting and the
ontology of accounting phenomena.
6.​ Misconceptions in scientific approaches to accounting research highlight the need to
recognize the subjective nature of accounting.
7.​ Auditing theory is concerned with the role of auditors in ensuring accuracy and
accountability in financial reporting.

This chapter delves into various approaches to accounting theory, offering insights into the
different methodologies and critical issues that shape how accounting is understood and
practiced. It emphasizes the importance of context, real-world applicability, and empirical
research in constructing accounting theory.