** Introduction:

Attempts to formulate a generally accepted accounting theory have not succeeded so

far because of different assumptions, methodologies and users. Rather, there are many theories
and frameworks for accounting. A theory should either justify or refute the existing practices.
This should apply to accounting theory as well. Accounting theory should be the result of both a
process of theory construction and a process of theory verification.

** Approaches to the Formulation of Accounting Theory:

Modern Accounting is a mode of thought, a manifestation of our Charismatic
thinking and evaluating, a tool designed to help master our economic struggle. It unfolded in its
full breadth during the last hundred years and cannot be regarded as having exhausted its
potential of technical as well as intellectual growth. Such intellectual growth of accounting is
amply manifested in the numerous approaches that relate to the attempts to accord theoretical
support for this discipline. Two approaches have been used: the traditional approach and the new
approach.

** Traditional Approaches:

In the traditional approaches to accounting theory construction, accounting practice

and verification are considered synonymous. Traditional approaches cover:
 Non-theoretical
 Theoretical.

** Non-theoretical approaches:

Non-theoretical approaches to accounting theory are concerned with developing a

theory or accounting techniques and principles that will be useful to users, particularly decision
makers. This approach can be developed in a pragmatic or authoritarian way.

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 (1) Pragmatic Approach:

The pragmatic approach is also referred to as the practical approach, though it does
not fully employ the formal rule of the pragmatic school of logicians. Yet, this approach
constitutes an important part of theory in accounting because .it enables the theory to have
operational utility, based on an understanding of relations between business phenomena, of
constraints on the measurement system, and of the needs of users of accounting information. The
pragmatic approach is essentially a problem solving approach. Its primary objective, as can be
seen from the most of the .generally accepted accounting principles, is to find a workable
solution to a problem. As a result, any solution obtained through this approach should be viewed
as a tentative solution to problems. The pragmatic approach consist of the construction of a
theory characterized by its conformity to real – world practices that is useful in terms of
suggesting practical solutions.

(2) The Authoritarian Approach:

The authoritarian approach to the formulation of an accounting theory which is

employed primarily by professional organizations consists of issuing pronouncements for the
regulation of accounting practices. This approach is sometimes equated with the practical
approach because of the common methodology its theoretical grounding based on operational
utility under the stamp of approval of the regulatory bodies. .The role of authoritarianism is to
discriminate between well-founded but conflicting theories (given on the state of knowledge at
the time). A practice which appears appropriate in given circumstances should be authorized for
use by practitioners.
Both the approaches assume that accounting theory and the resulting accounting
techniques must be predicted on the ultimate uses of financial reports if accounting is to have a
useful function.

** Theoretical approaches:
Theoretical approaches to the development of an accounting theory are many. The
approaches which are discussed below are-
Deductive, Inductive, Ethical, Sociological, Economic, and Eclectic.

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 (1) The Deductive Approach:

This approach involves developing a theory from basic propositions, premises and
assumptions which results in accounting principles that are logical conclusions about the subject.
The theory is tested by determining whether its results are acceptable in practice. Historical cost
accounting was derived from a deductive approach. Under this approach accounting techniques
and practices are linked to the objective of accounting which is derived from the accounting
environment. Development of specific accounting practice and techniques would be the last step
in the ladder of deductive approach, as shown in diagram below:

Postulate
Principles
Standards
Practices

Instructions Activities

Rules Procedures

Directives Methods
Society

Figure- Deductive approach to the formulation of Accounting Theory

As can be seen from the diagram, in a deductively derived accounting theory, the
techniques and procedures of accounting are related to the principles, postulates and objectives in
such a logical sequence that if they are true the techniques and procedures must also be true.
Theory cannot be kept in isolation. It has to be put to practice to determine to what extent the
practices are in conformity with the theory. A proper testing of deductive theories is, therefore,
very necessary.

(2) The Inductive Approach:

For this approach we start with observed phenomena and move towards generalized
conclusions. The approach requires empirical testing, i.e. the theory must be supported by
sufficient instances/observations that support the derived conclusions. Quite often the deductive
and inductive approaches are mixed as researchers use their knowledge of accounting practices.
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This approach in consequence depends on observations to reach conclusions. Here, unlike the
deductive approach, the process is .going from the specific to the generalization. In other words,
some specific observations about financial transactions will be made. If recurring relationships
are found among the transactions, generalization and principles can be formulated as shown in
diagram below-

Problems Problems

Induction

Procedures

Generalization

Principles

Figure- Inductive approach to the formulation of accounting theory

Inductive approach is backward looking; it depends on the past accounting practices

to seek solution for emerging problems. In that sense, this is pragmatic or practical approach, as
most of the current generally accepted accounting principles are. They have not been derived
from the accounting environment, objectives and basic features of financial accounting.

(3) The Ethical Approach:

The ethical approach to accounting theory places emphasis on the concepts of justice,
truth, and fairness. Interestingly, every one of these concepts has found its way into the
Conceptual Framework created by the FASB. Considerations such as the absence of bias and
representational faithfulness are both considered necessary characteristics of a reliable
accounting system. Neutrality, meaning that information should not be colored so as to influence
behavior in a particular direction, is an essential feature of standard setting. Ethical
considerations, in other words, have a pervasive influence on all of accounting. The ethical
approach does not constitute a major theoretical underpinning, though it certainly reflects a
paradigmatic change in the accounting objective that was taking place in the world. F. J. Imke
Opined that, Accounting exists to serve society by recording, interpreting, and otherwise
effectively utilizing financial and other economic data. According to him, accounting, therefore,
should be based on the following three criteria:
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(i) The practice of accounting must provide equitable treatment of all interests concerned,

(ii) Accounting information must be truthful.

(iii) Accounting must reflect an impartial and unbiased representation of the economic facts.

The ethical approach has instantaneous appeal, but the principal limitation of the approach is that
though no one would argue against the concepts of truth, fairness and justice as a desirable
feature of accounting theory; these are subjective value judgments having no definite yardstick to
measure them.

(4) The Sociological Approach:

This is actually an ethical approach that centers on social welfare. In other words,
accounting principles and techniques are evaluated for acceptance after considering all effects on
all groups in society. Thus within this approach we would need to be able to account for a
business entity’s effect on its social environment. The centre of gravity of the sociological
approach to accounting theory is reflected in the proposition that accounting has the
responsibility to transcend the internal viewpoint of a private firm and develop information
which portrays a private firm’s role in and contribution to society. The plank of this approach is
further strengthened by this argument that business being a subsystem of the wider social system,
ultimate usefulness of accounting depends on the good it can do to the society and not in the
services rendered to individuals. In short, under this approach the techniques of accounting
should be directed to the development of information for decisions that result in the efficient
utilization of resources, the conservation of the environment and equitable allocation of business
income as an effective means of maximization of social well-being. The sociological approach to
the formulation of accounting theory is believed to be the precursor to the evolution of societal or
socio-economic accounting, an important sub discipline of accounting that emerged during the
1960s. The main objective of socioeconomic accounting is to assess the impact of the economic
activities of the private firms on the society at large by developing indices for the measurement,
internalization and disclosure in the financial statements the ultimate social costs which are not
included in the traditional cost structure of the firms. The techniques of socio-economic
accounting are yet to reach its stage of maturity and the traditional accounting measurements are
found insufficient. It has been suggested that to solve the problem, accounting techniques should
be flexible and it should encompass other nonmonetary measurements which are presently
beyond the scope of traditional accounting.

(5) The Economic Approach:

This approach focuses on general economic welfare. Thus accounting principles and
techniques are evaluated for acceptance depending on their impact on the national economy.
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While the ethical approach focuses on the concept of fairness and sociological approach on the
concept of .social welfare, the economic approach to the formulation of accounting theory
emphasizes the macro and micro economic welfare of the affected parties arising from the
proposed accounting technique. Such considerations were, however, given little attention in the
formulation of accounting theory under the traditional approaches discussed above. In fact,
accounting techniques in different countries remained neutral to economic impact. For example,
the current discussion on accounting for leases focuses on the effect that a standard requiring the
capitalization of all leases, whether finance or operating, might have on the economy or business
in general. Traditionally, accounting standards have been set without considering economic
consequences but lobby pressures from groups who perceive themselves as being affected can be
strong. The general criteria used by the macro-economic approach are-

(a) Accounting policies and techniques should reflect economic reality,

(b) The choice of accounting techniques should depend on “economic consequences”

Many FASB statements on standards reflect the concepts of economic consequences

and economic reality. A conference on economic consequences of financial accounting standards
was held by the FASB in 1978.

(6) The Eclectic Approach:

This is perhaps our current approach where we have a combination of all the
approaches already identified appearing in our accounting theory. This approach has come about
more by accident than as a deliberate attempt, due to the interference in the development of
accounting theory by professionals, governmental bodies (including the EU) and individuals.
This eclectic approach has also led to the development of new approaches to accounting theory.
While in a purely deductive approach the objective is to develop a statement of basic accounting
theory based on “cohesive set of hypothetical, conceptual and pragmatic principle” to form a
general frame of reference for the study and practice of accounting. Eclectic approach does not
profess commitment to any particular methodology; it is mainly the result of numerous attempts
by individuals, professionals and other agencies [AICPA, AAA and the like] to remove the
deficiencies of other approaches. Such an approach is particularly useful in the absence of a
universally accepted accounting theory.

But an accounting theory needs confirmation before it is accepted. One great

weakness in traditional approaches is that accounting practice and verification are considered
synonymous. No attempt is made to logically verify the theory. In the new approaches to
accounting theory construction, attempts are made to logically or empirically verify the theory.

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** New Approaches:
New approaches have been developed or revised recently, the aims of which are
not yet generally accepted by the various interest groups or by the accounting profession in
particular. They represent new streams of accounting research that use both conceptual and
empirical reasoning to formulate and verify a conceptual accounting framework. The new
approaches include the following;

 The Events approach

 The Decision model approach

 The Behavioural approach

 The Predictive approach

 The Information-Economics approach

(1) The Events Approach:

The events approach was developed in 1969 by George Sorter and was defined as
‘providing information about relevant economic events that might be useful in a variety of
decision models’. The events approach leaves the user to aggregate and assign weights and
values to the event. The accountant would only provide information on the economic event to the
user; he would not assume a decision model. Thus, for example, the event approach income
statement would not indicate financial performance in a period but would communicate events
that occurred during the period without any attempt to determine a bottom line. The limitations
of the events approach, however, are the following:

(i) Events approach presupposes that the users are sophisticated enough to be able to classify and
aggregate accounting data for their own use.

(ii) Events approach does not explicitly mention which data are to be selected for the financial
statements.

(iii) There is definite limit to the amount of data a person can handle at a time. The expansion of
data may cause information overload to the users.
(2) The Decision Model Approach:

In this approach, an appropriate decision model is developed based on the

hypothesized needs of financial statement users. The theorist establishes a set of normative
assumptions about the goals, decisions and the information needs of the users, and given these
assumptions, derives the accounting principles and methods best suited for meeting these needs.
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In this model, it is acknowledged that different information may be needed for different users of
the financial statements or for different kinds of decisions.

(3) The Behavioural Approach:

Most traditional approaches to the construction of an accounting theory have

failed to take into consideration user behaviour in particular and behavioral assumptions in
general. The behavioral approach to the formulation of an accounting theory is concerned with
human behavioural, as it relates to accounting information and problems. In this context, the
choice of an accounting technique must be evaluated with references of the objectives and
behavior of the users of financial information. Given that financial reporting is about
communicating information to users to enable them to make decisions, a lack of consideration of
how that information influences their behaviour is indeed unforgivable. Studies in this area have
tended to concentrate on:

 the adequacy of disclosure

 usefulness of financial statement data
 attitudes about corporate reporting practices
 materiality judgments
 decision effects of alternative accounting practices.

In one of these areas, materiality, it was discovered that users’ assessment of materiality was
individualistic and that the provider of the information was not in the best position to determine
materiality for a user. There is much work still to do within the behavioural approach.

(4) The Predictive Approach:

This approach attempts to formulate an accounting theory by focusing on the predictive

nature/ability of a particular method of reporting an event that would be of use to the user. Such
approaches are most prevalent in what could be regarded as management accounting. The
predictive approach is directly related to the .predictive ability. of financial data and is purported
to provide a purposive criterion to relate the function of collecting financial data to the task of
decision-making. This predictive ability of accounting information has been considered by the
SFAC No. 2 of the FASB as an explicit criterion of the quality of accounting information.

(5) The Information-Economics Approach:

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 This approach suggests that all accounting-reporting decisions should be evaluated within
the cost-benefit framework.

** Conclusion:
The new approaches are still in a developing stage. It will take time before they are
accepted by the accounting world. Due to changes in environment and the evolution of advanced
techniques of analysis and interpretation, old approaches, if necessary, will be replaced by the
new ones in course of time.

References
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 Accounting Theory by L. S. Porwal, 3rd Edition
 http://www.mdudde.net/books/Mcom/Mcom-f/Accounting
%20Theory-final.pdf
 http://faculty.ksu.edu.sa/Eman-Aqeel/Documents/traditional
%20approach.pdf
 www.redbrick.dcu.ie/~scruff/projects/acctheory.doc
 www.jstor.org/stable/10.2307/244119

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