Accounting Theory and Research Quiz

Lecture 1: Introduction to Accounting Theory

• The lecture is an introduction to accounting theory
• Recommended textbooks include:
  • Deegan, C., and Unerman, J. (2011). Financial Accounting Theory. (2nd ed.). European Edition. McGraw-Hill. (D&U) [Main text I]
  • Rankin, M., Stanton, P., McGowan, S., Ferauto, K., and Tilling, M. (2022). Contemporary Issues in Accounting. (3rd ed.). Wiley. (R) [Main text II]
  • Godfrey, J., Hodgson, A., Holmes, S., and Tarca, A. (2010). Accounting Theory. (7th ed.). Wiley. (GHHT) [additional reading]
• Additional journal articles are available for download on blackboard
• Background reading for Lecture 1 includes:
  • D&U Chapter 1
  • Rankin et al. Chapter 1; Chapter 5, pp. 131-134
  • GHHT Chapters 1 & 3

Overview of Lecture 1

• Defining accounting theory
• Types of accounting theories
• Development of accounting theory over time
• Relationship between theory and research
• Evaluation of theories

What is a theory?

• An organized way of thinking about a subject
• A set of ideas that explains something
• A scheme or system of ideas (Oxford English Dictionary)
• A statement of concepts and their interrelationships that explains how/why a phenomenon occurs (Corley & Gioia, 2011: 12)

What is the purpose of theories?

• To make sense of the world (physical, social, psychological phenomena) and communicate understanding to others.
• To make sense of financial accounting information (financial statements, reports)
• Accounting information is compiled and interpreted by people.

Types of Theory

• Common-sense theory: Used by lay people based on personal experience. Example: "It is not what you know, but who you know." [Example link referenced in slides]
• Working theory: Used by experts like managers, investors, and auditors. [Example link referenced in slides] Example: Crisis communication should prioritize key stakeholders.
• Scholarly theory: Used by academics. Example: Accounting choice is driven by managerial factors. Example of accounting theory discussed is positive accounting theory.

Scholarly Theory

• Undergoes systematic research
• Provides more thorough explanations for financial accounting than common-sense or working theories

Purpose of Theories

• Descriptive theories: Describe what people do. Based on common practice. Example: Common ways to avoid high COVID-19 infection rates. Common practice of accounting for fixed assets.
  • Advantage: Commonly accepted.
  • Disadvantage: Doesn't allow for change or critical evaluation.
• Prescriptive theories (normative theories): Suggest the best way to deal with human behavior. Example: Prescribing particular accounting practices. What people should do
  • Advantage: Improves accounting practices
  • Disadvantage: Assumes that there is only one "best way".
• Predictive theories (positive theories): Explain and predict human behavior. Example: Explain why managers choose particular accounting methods [Example of theory]. -Concerned with explaining reasons for outcomes and predicting future outcomes. Example: Predicting effect of a change in social behaviour on infection rates. Explaining the characteristics of companies that revalue assets.

Comparison of Theories

• Descriptive: "What is." Non-value laden. No empirical methodology.
• Prescriptive: "What should be." Value laden. No empirical methodology.
• Predictive: "Why it is," and "What will happen." Non-value laden (generally). Empirically based.

Examples of Uses of Theories

• Prescribing how assets should be valued
• Predicting why managers choose specific accounting methods
• Explaining how cultural background impacts accounting information
• Prescribing accounting information for stakeholders
• Predicting the effect of stakeholder power on accounting information, and why accounting information is used to present legitimacy.

Accounting Theories

• Accounting is a human activity.
• Accounting theories explain human behaviour within and outside organisations regarding accounting information.
• Accounting theories consider why people in organisations elect to provide specific information, people's behaviour towards accounting information, needs of people for accounting information.

Accounting Theories (cont'd)

• Accounting is a social phenomenon
• Accounting theories draw on disciplines studying human behavior, such as psychology and sociology.

Why do we need accounting theories?

• Accounting is viewed practically, focusing on applying accounting rules.
• Theories help understand the social world we live in.
• Theories provide a basis for decisions, such as the decision of whether to include an item in financial statements [example: materiality and recognition criteria].

Why do we need accounting theories (cont'd)

• Theories help make better predictions and decisions.
• Theories help clarify accounting and reporting issues.
• Accounting theories help to understand the many possible reasons behind accounting methods and reporting.

Why study accounting theories?

• Understanding motivating factors for supporters/lobbyists of accounting methods in preference to others. Example of theories considered are regulatory theories.
• How capital markets react to accounting information. Example of theories considered are positive accounting theories
• Evaluating if there is a true measure of income [Example theories considered are asset valuation theories].

Overview of Theories of Accounting

• Multiple financial accounting theories exist.
• No single universally accepted accounting theory.
• Different perspectives on the central objective, role, and scope of financial accounting exist.
• Different researchers have different perspectives on the role of accounting theory.

Accounting Theory Timeline

• Shows the development periods in accounting theory and practices.
  • Example: 1750-1920s: Formalization of practice (e.g., general scientific explanations of practice development).
  • Example: 1970s-2000s: Positive accounting theory.
  • Examples: pre-theory, normative period, mixed period

Early Development of Accounting Theories

• Descriptive theories used induction reasoning from observations.
  • Relied on the observation of existing practice to drive theory.

Criticisms of Inductive Approach

• Focuses solely on "status quo"
• Doesn't provide a means to evaluate practice for future improvement.
• Assumes what is done by the majority is the best approach

Example of Inductive Approach

• Grady's research for the AICPA on basic accounting principles and concepts.

Theory Development - 1960s and 1970s

• Normative theories sought to prescribe ideal practices.
• Often critical of existing historical cost accounting.
• Sought to improve asset valuation approaches during times of inflation.

Example of Prescriptive Theory

• Moonitz and Sprouse studies advocating for current values as accounting measurement.

Theory Development - Mid-to-Late 1970s

• Shift towards positive theories to explain and predict accounting practice rather than prescribing.

Positive Theories

• Seek to explain and predict phenomena (accounting behaviours) through logical deduction or assumptions.
  • Example of deductive logic: If assumption is true, then deduction(s) follow (predictions are made).
• If predictions hold up in real-world observations, support is provided.

Testing a Theory in Research

• Steps involved in testing accounting theories. [Flow diagram/steps shown in the lecture slides]

Relationship between Theory and Research

• Research is driven by implicit or explicit theories of the phenomenon being investigated.

Evaluation of Theories

• Accounting theories are abstractions of reality.
• Choice of theory is based on value judgements.
• Theories cannot provide perfect explanations of human behaviour or discern what types of information users need.

The Role of Assumptions

• Logical arguments might be accepted if critical assumptions are acceptable.
• Example: The assumption that people are rational and are driven by money. (Is this a good assumption?)

Evidence

• Evaluating theories requires enough evidence.
• Conflicting evidence should be considered.

### Any Questions?

• Participate in discussions on the blackboard.
  • Discuss why we need accounting theories.

Test your understanding of the relationship between accounting theories and research. This quiz explores key concepts, recommended readings, and the implications of theory in the field of accounting. Prepare to deepen your knowledge of how theory shapes research outcomes in accounting.