Name: SHWETA NAGPAL
Due date: 26/08/2011
Q 1-Explain why theories need to be evaluated. Identify and justify the factors you would consider before deciding that a theory appears sound. Apply the factors you have identified to an accounting theory of your choice (e.g., Normative, Positive etc.).
There are various definitions of theory:
A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry’ (Hendriksen 1970) A scheme or system of ideas or statements held as an explanation or account of a group of facts or phenomena’ (The Oxford English Dictionary)
There are many theories of financial accounting that is there is no universally accepted theory of accounting, or indeed, any universally agreed perspective of how accounting theories should be developed. This is because different researches have different perspective of the role of accounting theory and/or what the central objective, role and scope of financial accounting should be.. (Deegan, 2009, p. 7)
Why theories need to be Evaluated?
Early development of accounting theory Relied upon the process of induction, development of ideas or theories through observation Normative accounting theories and Positive Accounting Theory represent two fundamentally different approaches to accounting theory. Theory development—1960s and 1970s Known as the ‘normative period’ of accounting research Theory development—mid to late 1970s Known as positive theories (Deegan, 2009, p. 7) Normative Theory: In relation to the purpose of the theories, explained by (Abdullah, 2011) the purpose of Normative Accounting theories is to provide guidance for practitioners. Normative theorists identify the role of accounting (for example, the provision of information for investment decisions), the goal of firms (for example, to maximise profits), the characteristics of firms that are important to measure (for example with Cocoa this is a firms ‘adaptive capacity’) and prescribe methods of accounting that best meet these roles. In the case of Cocoa, the prescription is for the use of exit prices. Normative theories are almost always developed via the use of deductive logic. This means that a number of general ‘axioms’ are first identified and these are used to make specific prescriptions. For example, the Conceptual Framework begins by identifying general matters such as the qualitative characteristics of accounting and the users of accounting and then moves onto to more specific matters such as definitions of components of financial statements and measurement methods
Positive Theory: The goal of Positive Accounting Theory is to explain and predict accounting practice. By (Abdullah, 2011) PAT does not see any need to recommend specific methods to practitioners. PAT instead aims to inform users of circumstances when particular accounting methods will be used. These accounting methods are generally discussed in relation to their ability to either understate or overstate assets/liabilities/expenses/revenues PAT on the other uses a mixture of both induction and deduction. Induction/observation was used to create generalisations such as efficient market hypothesis and agency theory. These generalisations were then used deductively to create the three hypotheses (the bonus plan hypothesis, debt covenant hypothesis and political cost hypothesis). These three hypotheses can then be examined inductively by further empirical testing
Criticism (Abdullah, 2011)
Both theories have received a degree of criticism. Normative theories are criticised for being too full of individual opinions to be of any use to a broad community (accountants). They are also criticised for not being adopted by accountants on a widespread basis. Positive Accounting Theory has also received much criticism. These criticisms begin with the assumption of...