Chapter 3

Traditional approaches to the formulation of an accounting theory

Traditional approaches to accounting theory

• Non-theoretical approaches• Deductive approach• Inductive approach• Ethical approach• Sociological approach• Economic approach

The nature of accounting: various images

Accounting as:– language– historical record– current economic reality– information system– commodity– ideology

Accounting as an ideologyAccounting has been perceived as:• a means of sustaining and legitimising the

current social, economic and political arrangements:– Karl Marx maintained that accounting

perpetuates a form of false consciousness and mystifies rather than reveals the true nature of social relationships

– accounting has been perceived as a myth, symbol and ritual that permits the creation of a symbolic order within which social agents can interact

• an instrument of economic rationality and a tool of the capitalistic system

Accounting as a language

• Accounting is perceived as the language of business

• According to Hawes, a language has two components, being symbols and grammatical rules:– numerals and words and debits and

credits are examples of the symbols unique to accounting

– in accounting, grammatical rules refer to the general set of procedures used

Accounting as a historical record

• Accounting records provide a history of the manager’s stewardship of the owner’s resources

• Measurement of the stewardship concept has evolved over time, in the following periods:– pure custodial period– traditional custodial period– asset-utilisation period– open-ended period

Accounting as a current economic reality

• Balance sheets and income statements should both be based on economic reality rather than on historical costs

• The main objective of this image of accounting is the determination of true income

Accounting as an information system

• Accounting links an information source or transmitter (usually the accountant), a channel of communication and a set of receivers (external users)

• This view of accounting: – assumes that the accounting system is

the only formal measurement system in the organisation

– raises the possibility of designing an optimal accounting system capable of providing useful information

Accounting as a commodity

• Accounting exists because specialised information is in demand and accountants are willing and capable of producing it

• There is a market for accounting information with its derived demand and supply

The nature of accounting theory

• The primary objective of accounting theory is to provide a basis for the prediction and explanation of accounting behaviour and events

• No single comprehensive theory of accounting exists at present

Definitions of accounting theory

Hendriksen defines accounting theory as ‘a set of broad principles that:

1. provides a general frame of reference by which accounting practice can be evaluated

2. guides the development of new practices and procedures’

Definitions of accounting theory (cont’d)

McDonald argues that a theory must have three elements:

1. encoding of phenomena to symbolic representation

2. manipulation or combination according to rules

3. translation back to real-world phenomena

How accounting meets these criteria

Accounting employs:1. symbols (debit and credit)2. translation rules3. rules of manipulation

The two methodologies

• Descriptive methodology:– attempts to describe accounting

practices that exist and are deemed useful

• Normative methodology:– attempts to justify what ought to be

rather than what is

Non-theoretical approaches

• The pragmatic approach:– consists of the construction of a

theory that conforms to real-world practices and suggests practical solutions

• The authoritarian approach:– consists of issuing pronouncements

for the regulation of accounting practices

The deductive approachSteps used to derive the deductive

approach

1. Specifying the objectives of financial statements

2. Selecting the ‘postulates’ of accounting

3. Deriving the ‘principles’ of accounting

4. Developing the ‘techniques’ of accounting

The inductive approachFour stages

1. Recording all observations2. Analysing and classifying these

observations to detect recurring relationships

3. Inductive derivation of generalisations and principles of accounting from observations that depict recurring relationships

4. Testing the generalisations

Comparing deductive and inductive approaches

• In the inductive approach, the truth or falsity of the propositions does not depend on other propositions, but must be empirically verified

• In the inductive approach the truth of the propositions depends on the observation of sufficient instances of recurring relationships

• Accounting propositions that result from inductive inference imply special accounting techniques only with high probability

• Accounting propositions that result from deductive inference lead, on the other hand, to specific accounting techniques with certainty

The ethical approach• The basic core consists of the concepts of

fairness, justice, equity and truth• In general, the concept of fairness implies

that accounting statements have not been subject to undue influence or bias

• The committee on auditing procedures refers to ‘fairness of presentation’ as:

1. conformity with GAAP2. disclosure3. consistency4. comparability

The sociological approach

• Emphasises the social effects of accounting techniques

• According to this approach, a given accounting principle or technique is evaluated for acceptance on the basis of its reporting effects on all groups in society

• Implies that accounting data will be useful in making social welfare judgements

The economic approach• Emphasises controlling the behaviour of

macroeconomic indicators that result from the adoption of various accounting techniques

• The choice of different accounting techniques depends on their impact on the national economic good

• Accounting policies and techniques should reflect ‘economic reality’, and the choice of accounting techniques should depend on ‘economic consequences’

Eclectic approach

In general, the formulation of accounting theory and the development of accounting principles have followed an eclectic approach (a combination of approaches), rather than just one school of thought