TUTORIAL 1 (WEEK 2)

Question 1

Briefly explain what is meant by the term ‘theory’.

A theory is concerned with predicting or explaining some phenomena or with prescribing

a course of behaviour. It is a collection of propositions and conclusions which are
designed to illustrate the principles of a subject. Other terms such as ‘hypothesis’ or
‘supposition’ are often used instead of theory. The simplest form of a theory is a
statement of a belief expressed in a language such as written language or mathematical
language.

One definition of a theory is a deductive system of statements of decreasing generality

connected together logically. Other definitions emphasise the empirical nature of
theories (see the definition by Popper). Theory formulation is usually the first stage of
the scientific method.

There are three recognised parts to a theory: the syntactic, semantic and pragmatic
relations.
 Syntactics
 logical r/ship
 evaluating the syntactics of a theory involve evaluating the validity
(logic) of the argument
Premise 1: All a/c’s relating to assets have Dr balances.
Premise 2: The accumulated dep’n a/c relates to assets.
Conclusion: The accumulated dep’n a/c has a Dr balance.

 Semantics
 r/ship of a word, sign or symbol to a real-world object or event
Premise 1: All liab a/c’s have cr balances.
Premise 2: The purchase returns a/c is not a liab a/c.
Conclusion: The purchase returns a/c has a cr balance.

 Pragmatic
 consists of the construction of a theory characterised by its conformity
to real-world practices
 effect of words or symbols on people
 Eg pragmatic approach: Decision model
 Accounting should provide useful information for decision making to
certain interested parties
 Observe that people react to the same message in different ways
For example theories of accounting can be described and classified as:

(i) an historical record-keeping activity (pragmatic or syntactic theory)

(ii) political theories (pragmatic theories)
(iii) communication — decision making (pragmatic, syntactic and semantic
theories)
(iv) accounting as an economic good (pragmatic)
(v) accounting as magic or mythology (pragmatic)
(vi) accounting as a social commodity to exploit or aid policies or as a social club
for accountants (pragmatic)

Question 2.

(a) What is the difference between a fact and a theory?

A fact is a piece of information about circumstances that exist or events that have
occurred, and it contains a concept whose truth can be proved.

A theory, on the other hand, is a logical flow of argument leading from

fundamental assumptions and connected statements to final conclusions. It is a
collection of propositions and conclusions that are designed to illustrate the
principles of a subject.

Unlike a fact, a theory may not always be true until proven otherwise, but it is
aimed to explain some phenomena/facts or to prescribe a course of behaviour.
For example, it is a fact that all things that are thrown to the sky will fall down.
This fact/phenomenon can be explained by the theory of gravity, which contains
arguments as to why that happens.

(b) What role(s) can theory play in relation to accounting? Give an example.

There are several theories that have evolved in accounting and which reflect the
different ‘views of the world’ or the way accountants see problems as individuals.
For example, theories of accounting can be described and classified as:
 historical record-keeping activity
Example: firms use accounting principles to keep record of their
transactions so that they can advise how resources have been used.
 a language
Example: financial statements are used by management to communicate to
shareholders how well they have performed in running the business.
 political theories
Example: management use accounting reports to allocate resources among
different divisions within the firm, or different levels of employees.
  magic or mythology
Example: Enron management used accounting techniques to hide the
losses it suffered from transactions with its special purpose entities.
 communication — decision making
Example: a local bank decided to give loans to a small business after
analysing the business’ financial position.
 an economic good
Example: there are costs involved in producing financial reports (not free).
Accounting information is demanded to make economic decisions, but
there is a cost to its supply since accounting information is a scarce
commodity itself.
 a social commodity
Example: government uses accounting numbers (such as profits or
research expenditure) to decide whether to give grants to particular firms.
 ideology and exploitation
Example: firms cut down jobs in their unprofitable divisions.

Question 3

In your opinion, does the theory of accounting as communication for decision

making usually dominate the theory of accounting as magic, or vice versa?

The original purpose of preparing financial statements is to provide users with

information useful for decision making (theory of accounting as communication for
decision making). In reality, however, management sometimes acts to maximise their
own interest when those interests vary from shareholders’. One way to do this is to distort
financial statements so that they indicate that they have been doing a good job in
managing the firm’s business. This can involve manipulation of financial statements,
where management causes the financial statements to reflect something that is not real
(theory of accounting as magic).

Thus, the theory of accounting as magic dominates the theory of accounting as

communication for decision making in some instances.