Assessing different forms of accounting theory Essay

The systematic recording, coverage, and analysis of fiscal minutess of a concern. The individual in charge of accounting is known as an comptroller, and this person is typically required to follow a set of regulations and ordinances, such as the Generally Accepted Accounting Principles. Accounting allows a company to analyse the fiscal public presentation of the concern, and expression at statistics such as net net income.

The definition suffices to demo, loosely, what comptrollers do ( i.e. , maintain records of fiscal minutess ) and why they do it ( i.e. , to enable people to analyze an administration ‘s fiscal public presentation. It besides indicates that there are by and large accepted accounting rules. However, the usage of the phrase by and large accepted suggests that some governments do non accept them. In other words, sentiments differ. Hence there are different theories of accounting.

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All theories of accounting draw upon economics-accounting is about money. However, some theories besides draw on political scientific discipline, psychological science, and sociology. There can besides be an ethical component to theories of accounting.

This essay describes some of these theories, and explains how and why they differ. First, nevertheless, it explains what is meant by the term theory.

What is theory?

The Encarta Dictionary ( English UK ) provides five definitions of theory, three of which are irrelevant to this essay ( 2: guess ; 3: thought formed by guess ; 4 ; conjectural fortunes ) , viz. :

1: Rules and techniques. The organic structure of regulations, thoughts, rules, and techniques that applies to a topic, particularly when seen as distinguishable from existent pattern.

5: Scientific rule to explicate phenomena. A set of facts, propositions, or rules analysed in their relation to one another and used, particularly in scientific discipline, to explicate phenomena.

The first Encarta definition, as respects accounting theory, suggests that an accounting theory should depict what comptrollers should make. Such a theory would be both normative and proscriptive, and as such should pull mostly from economic sciences, and possibly moralss. The 5th Encarta definition suggests an accounting theory should explicate what comptrollers really do. Such a theory would be ethically impersonal, and would pull on economic sciences and whatever other subject the theoretician believed relevant-psychology, sociology, political scientific discipline, for illustration.

The 5th Encarta definition of theory is near to Popper ‘s ( 1963 ) position of theories. Popper argued that theories evolve to work out jobs. They are ne’er shown to be “ right ” . They are merely shown to be incorrect. The best theories hence are the 1s that explain the most yet are ne’er shown to be incorrect, despite many people seeking to demo they are incorrect. Good theories, said Popper, are capable of being falsified.

Types of theory of accounting

As indicated, there are two definitions of theory relevant to accounting-those that are normative and those that seek to explain-and these different definitions give rise to different types of theory. In accounting the former are called normative theories, the latter positive ( Gaffikin, 2005 ) . There is a major job with normative theories: it is impossible, in rule, to find the best normative theory.

This is non a theory. It is a theorem. It comes from Demski ( 1973 ) . Stated informally, it states:

No set of criterions exists that will ever rank options in conformity with penchants and beliefs-no affair what these penchants and beliefs are, every bit long as they are consistent in acknowledging to the expected public-service corporation word picture. ( p. 721 )

The theorem therefore demands that, even if one had a individual, absolutely rational, supremely intelligent comptroller, the comptroller could non invent any rule of accounting in which it could be shown that some chosen method of clerking ( e.g. , FIFO ) was ever preferred, by the comptroller ‘s ain standards of what was preferred, to some alternate method. Thus the theorem suggests, non merely that any organic structure ( e.g. the IASB ) that tries to enforce cosmopolitan criterions will neglect to fulfill some users of the criterions on at least some occasions, but besides that the organic structure will, on juncture, fail to fulfill itself.

Consequently, this essay looks merely at positive theories. It describes two: positive accounting theory ( PAT ) and Legitimacy theory.

Positive accounting theory ( PAT )

PAT was developed by Watts and Zimmerman ( 1978 ) . Gaffikin ( 2005 ) describes its chief characteristics:

In PAT the house. . . is described as a aggregation of contracts-a link of contracts. Contracts are necessary in order to acquire self seeking persons to hold to collaborate. . . . However, there will be undertaking costs associated with the contracts. . . . PAT holds that houses will seek to minimise the catching costs and this will impact the policies adopted, including the accounting policies. ( p. 9 ; accent master )

The theory, in that it aims to explicate how comptrollers behave, besides makes anticipations. Thus the theory, in that it can be tested ( i.e. , falsified ) , is “ scientific ” in Popper ‘s ( 1963 ) sense of the term. The anticipations of PAT are based on three hypotheses: the fillip program, the debt compact, and the political cost hypotheses ( see, e.g. , Gaffikin, 2005 ) .

The fillip program hypothesis

The fillip program hypothesis derives from bureau theory ( Jensen and Meckling, 1976 ) . Agency theory provinces that agents have different involvements from those that employ them. Therefore, for illustration, company managers ( agents ) have different involvements from stockholders ( their employers ) . Stockholders are interested in high dividends and high monetary values of the portions they own. Company directors are interested in other things-high wages, comfy offices, “ position ” , and so forth. The theory is non new. In kernel, as Jensen and Meckling admit, it was appreciated by Adam Smith, composing in the eighteenth century. Adam Smith observed that people in places of authorization tend, to greater or lesser extent, to “ rip off ” the system. The fresh portion of bureau theory is that rip offing carries costs, and patroling cheating carries costs, excessively.

Some signifiers of rip offing are elusive. Gaffikin ( 2005 ) notes, for case, that stockholders might favor some bad activities, because, on norm, they may be extremely profitable. However, managers will be given to dislike bad activities because, if they fail ( which some, by definition, will ) the managers will acquire the incrimination, and therefore lose their occupations or, at lower limit, their fillips.

The debt compact hypothesis

The fillip program hypothesis suggests non merely that directors will prefer activities that maximise their fillips, but besides that they will prefer accounting patterns that maximise their fillips. One manner of making this is to travel earning from the hereafter to net incomes from the present. This is the debt compact hypothesis ( Gaffikin, 2005 ) ..

The political cost hypothesis

The political cost hypothesis states that administrations are sensitive to the political deductions of their public presentation. For illustration, when oil companies make record net incomes, there may be calls for lower gasoline monetary values, or higher revenue enhancements on oil companies. Therefore, in the aftermath of high oil company net incomes in 2004 and 2005, oil companies in some states switched their accounting patterns to LIFO ratings, which tend to understate net incomes ( Gaffikin, 2005 ) .

Criticisms of PAT

There are three major unfavorable judgments of PAT. First, it assumes all participants in organisational behaviors are rational. This is non needfully the instance. Second, although PAT purports to be nonsubjective, it can non through empirical observation warrant its pick of premises. Therefore it is non genuinely nonsubjective ( Gaffikin, 2005 ) . Third, despite its claim to be an empirical theory, grounds in support of it is light. Therefore, for illustration, Sterling ( 1990 ) writes:

Although it would non be proper for me to deduce anything from zero informations, I must squeal the intuition that the absence of a study is due to failure to happen even one case of support for PAT. Until something beyond W & A ; Z ‘s ipse dixit is forthcoming, I will stay massively doubting that such support exists. ( p. 126 )

In this connexion, Mouck ( 1992 ) argues that PAT, despite its claims to be scientific, lacks substance.

Systems-oriented theories

Systems-oriented theories are like PAT in that they aim to depict and explicate the behavior of comptrollers. However, unlike PAT, they do non presume comptrollers, company directors, or stockholders are rational. Alternatively, they seek to explicate corporate behaviors, including that of accounting, in socio-political footings. Thus some systems-oriented theories are political, others are more societal ( Godfrey et al. , 2003 ) . Legitimacy theory is more societal

Legitimacy theory

Legitimacy theory takes as a get downing point that corporations wish to be perceived as ethical-as “ legitimate ” -even if they are non. The theory makes no claim as to what, finally, is “ legitimate ” , because ethical criterions alteration. Thus, for illustration, many corporations boast about being environmentally “ cognizant ” . Such a self-praise, nevertheless, appears recent.

Related to these unfavorable judgments, it arguably does non depict how administrations behave. Legitimacy theory suggests, in contrast to PAT, that administrations are preponderantly concerned with being perceived as legitimate-that is, honest. In this, legitimacy theory suggests that corporations exist, non so much to do money, but to alter the universe for the better. Corporations have a “ mission ” .

Legitimacy uses Max Weber ‘s thoughts of substantial reason. Weber ( 1864-1914 ) was a pioneering sociologist and political philosopher who argued that societies are formed mostly as a effect of the establishments that comprise them. In this respects, ethically, establishments may take from a scope of values and actions and may seek to do them consistent. Of class, different societies, or the same 1s over clip, may take different values.

Legitimacy theory impacts upon accounting because, in seeking to look legitimate, corporations can describe on the “ good ” things they do. Thus, Deegan and Unerman. ( 2006 ) study of a figure of accounting surveies that have tried to prove legitimacy theory by look intoing company accounting patterns that do advertise the “ good ” things that companies engage in. Thus, for case, Cadbury ‘s Get Active run publicized Cadbury ‘s philanthropic gift to schools. Similarly, environmental impact studies are used as standard by FTSE 100 companies. ( Godfrey, 2006 )

Criticisms of legitimacy theory

The major job with legitimacy theory is that it makes anticipations that are identical from those of the political cost hypothesis in PAT. Another job is that, in that it makes no premises of market efficiency, it is even less unfastened to refutation than PAT. A 3rd unfavorable judgment is that it is one thing to demo that companies seek to look legitimate. It is another thing to demo that they truly are legitimate.

A concluding unfavorable judgment, one that can be made against any positive theory of accounting, is that such theory has had small impact on how comptrollers really pattern their trade. As Inanga and Schneider ( 2005 ) study, academic research workers have different involvements from those of rehearsing comptrollers. Therefore much accounting theory-including legitimacy theory-may sum to little more than abstract research, little related to the existent universe.

Decision

Accountancy theory seeks to make two things: supply guidelines to practicians and to depict and explicate what practicians do. The former, in an absolute sense, can non be done, for it is a theorem that no individual system of accounting suits all fortunes. The latter appears debatable because there does non look to be an in agreement frame of mention for accounting theory. That is why there are many theories of accounting.

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