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Chapter 2 - Lecture Notes

This document discusses different approaches to accounting theory construction, including pragmatic, normative, and positive theories. Pragmatic theories include descriptive approaches that observe accountant behavior and psychological approaches that observe user responses. Normative theories from the 1950s-60s focused on deriving true income or discussing useful decision-making information. Positive theories since the 1970s empirically test assumptions and explain or predict the role of accounting in economic decisions. The key difference is that normative theories prescribe what should be done, while positive theories descriptively explain what is done.

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107 views5 pages

Chapter 2 - Lecture Notes

This document discusses different approaches to accounting theory construction, including pragmatic, normative, and positive theories. Pragmatic theories include descriptive approaches that observe accountant behavior and psychological approaches that observe user responses. Normative theories from the 1950s-60s focused on deriving true income or discussing useful decision-making information. Positive theories since the 1970s empirically test assumptions and explain or predict the role of accounting in economic decisions. The key difference is that normative theories prescribe what should be done, while positive theories descriptively explain what is done.

Uploaded by

anisulislam asif
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Faculty: FZC Chapter 2- Accounting Theory ACT 4173

PRAGMATIC THEORIES:

1. Descriptive pragmatic approach


The descriptive pragmatic approach to accounting theory construction is an inductive
approach - it is based on continual observation of the behavior of accountants in order
to copy their accounting procedures and principles. Hence, a theory can be developed
from observations of how accountants act in certain situations. The theory can be tested
by observing whether accountants do, in fact, act in the way the theory suggests.
Sterling called this method the 'anthropological approach'

The descriptive pragmatic approach is probably the oldest and most universally used
method of accounting theory construction. Until quite recently, it was a popular way of
learning accounting skills - future accountants were trained by being apprenticed or
articled to a practicing accountant. However, there have been several criticisms of this
approach to accounting theory construction: The descriptive pragmatic approach does
not include an analytical judgment of the quality of an accountant's actions; there is no
assessment of whether the accountant reports in the way he or she should. This
approach does not provide for accounting techniques to be challenged, hence it does
not allow for change. For example, we observe practicing accountants' methods and
techniques and teach those methods and techniques to students. Those students will
become practicing accountants whom we will observe in the future to learn what to
teach, and so on. The descriptive pragmatic approach focuses attention on accountants'
behavior, not on measuring the attributes of the firm, such as assets, liabilities and
profit. In taking a descriptive pragmatic approach, we are not concerning ourselves with
the semantics of accounting phenomena.

2. Psychological pragmatic approach


Faculty: FZC Chapter 2- Accounting Theory ACT 4173

In contrast to descriptive pragmatic approaches where theorists observe accountants'


behaviors, psychological pragmatic approaches require theorists to observe users'
responses to the accountants' outputs (such as financial reports). A reaction by the user
is taken as evidence that the financial statements are useful and contain relevant
information. A problem with the psychological pragmatic approach is that some users
may react in an illogical manner, some might have a preconditioned response, and
others may not react when they should. This shortcoming is overcome by concentrating
on decision theories and testing them on large samples of people, rather than
concentrating on the responses of individuals.

SYNTACTIC AND SEMANTIC THEORIES


One theoretical interpretation of traditional historical cost accounting is that it is largely a
syntactic theory. This interpretation may be described as follows: the semantic inputs of
the system are the transactions and exchanges recorded in the vouchers, journals and
ledgers - of the business. These are then manipulated (partitioned and summed) on the
basis of the premises and assumptions of historical cost accounting.
For example, we assume that inflation is not to be recorded and market values of
assets and liabilities are ignored. We then use double-entry accounting and the
principles of historical cost accounting to calculate profit and loss and the financial
position. The individual propositions are verified every time the statements are audited
by checking the calculations and manipulations.

Some accounting theorists are critical of this approach. They argue that the theory has
semantic content only on the basis of its inputs. There is no independent empirical
operation to verify the calculated outputs,
For example, 'profit' or 'total assets'. These figures are not observed; they are simple
summations of account balances, and the auditing process is, in essence, simply a
recalculation.

Theories based on historical cost conventions lead to cautious hypotheses. The


hypotheses therefore are unable to be tested and, as per the falsifications approach (in
Faculty: FZC Chapter 2- Accounting Theory ACT 4173

which a hypothesis is not informative and does not add to scientific progress if it is not
worded or proposed so that it is falsifiable), they are not useful for financial decision
making except to verify accounting entries. Hence, they are uninformative and do not
add to knowledge or progress in accounting. The above criticisms of historical cost are
essentially criticisms about measuring current values and were the forerunner of the
current move of International Financial Reporting Standards (IFRS) towards 'fair value'
accounting.

In defense of the historical cost system, accountants argue that there is no requirement
that accounting outputs should have any semantic content (correspondence with current
real-world events, transactions, or values) or be subject to falsification rules. They
counter by using the argument that the role of accounting is to allocate the historical
cost of resource usage against revenue - the matching concept - to determine the
surplus secured from economic activity. In this case, assets, liabilities and equity are
residuals from this process; they are not meant to measure or say anything about entity
value or about the entity's financial state of affairs. If we adopt this allocation approach,
the definition of depreciation is then in accordance with the matching concept.

NORMATIVE THEORIES
The 1950s and 1960s saw what has been described as the 'golden age' of normative
accounting research. During this period, accounting researchers became more
concerned with policy recommendations and with what should be done, rather than
with analyzing and explaining the currently accepted practice. Normative theories in this
period concentrated either on deriving the 'true income' (profit) for an accounting period
or on discussing the type of accounting information which would be useful in making
economic decisions.
Faculty: FZC Chapter 2- Accounting Theory ACT 4173

True income:
True income theorists concentrated on deriving a single measure for assets and a
unique (and correct) profit figure. However, there was no agreement on what constituted
a correct or true measure of value and profit. Much of the literature during this period
consisted of academic debate about the merits and demerits of alternative
measurement systems.

Decision-Usefulness:
The decision-usefulness approach assumes that the basic objective of accounting is to
aid the decision-making process of certain 'users' of accounting reports by providing
useful, or relevant, accounting data; for example, to help investors (current and
potential) decide whether to buy, hold or sell shares.

In science, this decision-usefulness approach is referred to as either financial


instrumentalism or realism. The suggestion that alternative accounting systems
should be assessed according to their predictive ability is an extension of logical
positivism and is termed 'instrumentalism' - that is, a theory has no utility except as an
instrument for prediction. According to Friedman, theories cannot be tested by the
realism of their assumptions; they can be judged only by their predictive value.
On the other hand, realism stresses the explanatory role of science; in essence,
prediction in reverse. This methodological point of view stresses the feedback role of
accounting. The 'realism' approach to accounting means that for an accounting theory
to be valid it must be more than an instrument for forecasting; it must also hold as a
description of the reality that underlies the accounting phenomena.
Faculty: FZC Chapter 2- Accounting Theory ACT 4173

POSITIVE THEORIES
During the 1970s, accounting theory saw a move back to empirical methodology, which
is often referred to as positive methodology. Positivism or empiricism means testing or
relating accounting hypotheses or theories back to experiences or facts of the real
world. Positive accounting research first focused on empirically testing some of the
assumptions made by the normative accounting theorists.
For example, by using questionnaires and other survey techniques, attitudes to the
usefulness of different accounting techniques were determined. Today, the greater bulk
of positive theory is concerned mainly with 'explaining' the reasons for current practice
and 'predicting' the role of accounting and associated information in the economic
decisions of individuals, firms and other parties that contribute to the operation of the
marketplace and the economy.

Differences between Normative and Positive Theories


The main difference between normative and positive theories is that normative theories
are prescriptive, whereas positive theories are descriptive, explanatory or predictive.
Normative theories prescribe how people such as accountants should behave to
achieve an outcome that is judged to be right, moral, just, or otherwise a 'good'
outcome.
Positive theories do not prescribe how people (e.g. accountants) should behave to
achieve an outcome that is judged to be 'good'. Rather, they avoid making value-laden
prescriptions. Instead, they describe how people do behave (regardless of whether it
is 'right'); they explain why people behave in a certain manner.

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