Accounting

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What is a theory?
In this book we consider various theories of financial accounting. Perhaps, there¬fore, we should start by considering what we mean by a 'theory'. There are various perspectives of what constitutes a theory. The Oxford English Dictionary provides various definitions, including: A scheme or system of ideas or statements held as an explanation or account (description) of a group of facts or phenomena. Explanation or Account (description)

of a group of facts or phenomena.
Any theory consists of two elements: explanation & Phenomena The accounting researcher Hendriksen (1970, p. 1) defines a theory as: A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.

The definition provided by Hendriksen is very similar to the US Financial Accounting Standards Board's definition of their Conceptual Framework Project (which in itself is deemed to be a normative theory of accounting), which is defined as 'a coherent system of interrelated objectives and fundamentals that can lead to consistent standards' (FASB, 1976). What the above definitions imply is that a theory should be based on logical (1. systematic and 2. coherent) reasoning i.e. explanation and account. As we will see, some accounting theories are developed on the basis of past observations (empirically based) of which some are further developed to make predictions about likely occurrences (and sometimes also to provide explanations of why the events occur). That is, particular theories may be generated and subsequently supported by undertaking numerous obser¬vations of the actual phenomena in question. Such empirically based theories are said to be based on inductive reasoning and are often labelled 'scientific', as, like many theories in the 'sciences', they are based on observation. Alternatively, other accounting theories which we also consider do not seek to provide explanations or predictions of particular phenomena, but rather, prescribe what should be done (as opposed to describing or predicting what is done) in particular circumstances. Llewelyn (2003) points out that the term 'theory' in accounting not only applies to 'grand theories' which seek to tell us about broad generalizable issues (like the theory of gravity in physics), but also applies to any framework which helps us make sense ( a meaning conveyed or intended : IMPORT, SIGNIFICATION) of aspects of the (social) world in which we live, and which helps provide a structure to understand our (social) experiences. We stress that different theories of accounting often have different objectives. Because accounting is a human activity (you cannot have 'accounting' without accountants), theories of financial accounting (and there are many) will consider such things as people's behaviour and/or people's needs as regards financial accounting information, or the reasons why people within organizations might elect to supply particular information to particular stakeholder groups. For example, we consider, among others, theories which: *Theories which prescribe how, based upon a particular perspective of the role of accounting, assets should be valued for external reporting purposes (we consider such prescriptive or normative theories in Chapters 5 and 6); *Theories which predict that managers paid bonuses on the basis of measures such as profits will seek to adopt those accounting methods that lead to an increase in reported profits (we consider such descriptive or positive theories in Chapter 7); *Theories which seek to explain how an individual's cultural background will impact on the types of accounting information that the individual seeks to provide to people outside the organization (we consider such a theory in Chapter 4); *Theories which prescribe the accounting information that should be provided to particular classes of stakeholders on the basis of their perceived...
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