AF301

Accounting Theory & Applications

Semester 2, 2020
Discussion Questions
1. Identify at least one theory you know
 From accounting; or
 From other subjects/disciplines

2. Briefly summarise the theory

 i.e. what does the theory say?

3. Explain how this theory can help you and/or others

 Learning Outcomes are the broad
items you need to learn in a unit.
Learning Outcomes Test and exam questions are based
on the Learning Outcomes.

On successful completion of this unit, you should be

able to :
1.Explain the importance of theories
2.Discuss the chronological development of accounting
theory
3.Distinguish between induction and deduction
4.Describe and critique pragmatic approaches to theory
construction
5.Explain the importance of syntactics and semantics
and differentiate between them
 Learning Outcome 1

IMPORTANCE OF THEORIES
 Learning Outcome 1

Importance of Theories
A critical aspect of academic disciplines
1.Help us to make sense of the world we live in
 e.g. gravity, markets, mathematics
2.Have general applicability
 Different from facts & observations
3.Can be challenged & disproven
 e.g. people once thought the sun travelled
around the earth, based on their assumption
that earth is the centre of the universe [in fact,
the earth travels around the sun]
 Learning Outcome 2

CHRONOLOGICAL
DEVELOPMENT OF
ACCOUNTING THEORY
 Learning Outcome 2

Time Line of Accounting Thought

7
Theories in Accounting
Can be divided into 3 main branches
 Pragmatic, Normative, Positive
 We will consider each in more details

Theories can also be divided into specialised areas

 Social & Environmental Accounting
 Behavioural Accounting
 Theories of Regulation
 Theories of Culture etc.
Pragmatic Theory
Accounting is regarded as a practice
 Like a trade or apprenticeship
Theories are based on observation & repetition of
Accounting Practice
 Historical cost (accountants were observed to
record items at cost)
 Conservatism (accountants were observed to be
conservative)
Lack of critical thought or reflection
Normative Theory - Prescribes
Accounting is regarded as an academic discipline?
Critical of historical cost
Seeks to identify ‘best practice’ in accounting
How should we account for various items?
Search for ‘true income’ including valuation of
assets e.g. CPP, CCA, CoCoA
No agreement on best alternative to historical cost
at least during the 1970s and 1980s
Led to development of conceptual framework
a structured theory of accounting
Positive Theory – Explains & Predicts
Accounting is regarded as a science?
 Involves hypothesis testing
 Use of large data sets, facilitated by advances in
computing
No value judgement or ethical considerations
 (Initially) focused around 3 key hypotheses i.e.
bonus-plan, debt and political cost
 Assumption of rational wealth maximisation
 Assumes efficiency of markets
 Learning Outcome 3

INDUCTION & DEDUCTION

Reaching Logical Conclusions
Induction and Deduction both involve logical reasoning
or arguments

1.What is induction?
 Provide an example

2.What is deduction?
 Provide an example
Induction & Deduction
Induction
 Using (many) specific observations to build a general
theory
 e.g. reaching broad conclusions about Pacific
Islanders, accountants etc.
Deduction
 Using a general theory to make (one) specific
prediction
 e.g. Chand and White used Hofstede & Gray to make
predictions about accountants in Fiji
 Learning Outcome 4

PRAGMATIC APPROACHES
Pragmatic Theory
Accounting is viewed or seen as a practice
Like a trade or apprenticeship

Involves observation & repetition of Accounting

Practice
e.g. Historical cost, Conservatism

Lacks critical thought or reflection

Descriptive Pragmatic Approach
Inductive Approach
Build a general theory from (numerous) specific
observations
Observe how accountants behave
 e.g. they use historical cost accounting
Test if other accountants behave in the same way
Descriptive Pragmatic Approach
Criticisms

1 Fails to analyse correctness/appropriateness

of accountants’ behaviour
2 Provides no scope for change
i.e. upholds the status quo
3 Focuses on accountants’ behaviour rather
than accounting phenomena
Compare this to astronomy, biology,
mathematics
Psychological Pragmatic Approach
Inductive Approach
Observe how users respond to accounting outputs
 e.g. movement in share price following release of
financial reports (demand and supply)
 Good news and bad news
Any reaction is regarded as evidence of relevance,
usefulness etc.
Use of conservatism
Favoured by lenders
Psychological Pragmatic Approach
Criticisms

1 Users may react in illogical ways

Including preconditioned responses
2 Users may fail to react
E.g. less experienced users
3 Herding behaviour
Follow the crowd
 Learning Outcome 5

SYNTACTICS & SEMANTICS

Syntactics & Semantics
Syntactics Semantics
Based on Based on
Assumptions or Observation of
premises phenomena
Logical reasoning
Involves abstract Involves observation
thinking occurs in the real world
occurs in the brain (concrete)

Both are important aspects of any theory

Historical Cost
Uses
1.semantic inputs
 e.g. source documents
2.logical processes (syntactics)
 e.g. addition, double entry accounting
However, output may lack semantic value
 What does historical cost mean in the ‘real world’?
e.g. for a building acquired 10 years ago
 How is historical cost relevant for decision making?
 AF301
Accounting Theory & Applications

Semester 2, 2020