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The approach has attracted criticisms which are largely based on the seemingly narrow approach that concentrated on agency theory and assumptions about the efficiency of markets. The potential role of positive accounting theories in explaining and predicting behaviour is illustrated in theory in action 1.

The Bank of France announced an enquiry by the Banking Commission. SocGen declined to name the trader, but said he had been suspended pending dismissal after confessing to his actions.

He now faces legal action from Societe Generale, which is in turn already being sued by a group of angry shareholders. The bank accused the trader of taking "massive fraudulent" positions in and on European equity market indexes, meaning he was gambling on broad movements in share prices. When the bank discovered the concealed trades, it decided to close the positions in the market as quickly as possible, but this coincided with a sharp market sell-off, and the bank's losses on the deals spiraled to 4.

Like Leeson before him, the trader apparently benefited from knowledge of the bank's control systems after working in the back office of its trading rooms, according to SocGen. It said he had used a "scheme of elaborate fictitious transactions" to try to cover up his mistakes, but did not accuse him of profiting personally from his actions.

The announcement sent a shiver through the world banking industry, which is suffering a credit crunch as high-risk U. Lehman Brothers chief executive and chairman Richard Fuld called it "everyone's worst nightmare" in a comment from the World Economic Forum in Davos, Switzerland.

It seems incredible that the Societe Generale can lose 5 billion through one operator", said Alain Crouzat, a portfolio manager at Montsegur Finance. Other said the crisis at SocGen, one of the top 10 banks in the eurozone by market value, could spell trouble elsewhere.

In the light of this, what we've done is to downgrade banks that are very linked to trading income or whose capital base i s weak.

Several said the bank, which has for years been coveted by larger French rival BNP Paribas, could face a battle to remain independent. SocGen said it expected a net profit of between and million euros, well below its profit figure.

Excerpts from Reuters, 24 January ; published online, Financial Post, www.

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Questions 1. Given this definition, who is ultimately responsible for the rogue trading outlined in the Societe Generale scandal - the trader directly involved; management, who are responsible for the high-risk framework in which the trader operated; or a combination of both? Discuss the role played in the SocGen case by each of the following three elements: How could Societe Generale have been unaware of the activity of its trader and of the environment that it had created for the trader to operate within?

Explaln your answer. Behavioural research is concerned with the broader sociological implications of accounting numbers and the associated actions of key participants such as managers, shareholders, creditors and the government as they react to accounting information.

An example is a theory that predicts that loan managers cannot process all the financial information they receive, so they assess firms' credit risk using the information that is most relevant to the background of the loan manager. If the loan manager had been involved with loans to firms that defaulted on their debt agreements because of poor cash flows, despite profitable activities, it is predicted that the manager will place more reliance on cash flow information than other information.

On the other hand, if the loan manager had been involved with loans to firms that defaulted because of unprofitable operations, it is predicted that the manager will place more reliance on the reported profit or loss and earnings prospects of prospective borrowers. Note that, although it had a resurgence in the s and continues to be important, behavioural research in accounting emerged in the early s and first appeared in the accounting literature in Many stakeholders shareholders, government, and creditors are concerned about the failure of accounting information to signal such financial catastrophes and the apparent manipulation of accounting information and of those meant to independently report on financial information auditors.

In fact, in some of these cases such as Enron in and the collapses in the financial sector in it appears that the auditors colluded with management to mislead the external stakeholders.

In one sense, this supports the positive view that at least one party was acting to maximise its wealth to the obvious detriment of others.

This leads to an alternative view - if theory focused on the impact of accounting on behaviour rather than or1 explanations after the event of observed behaviour, the current corporate and reporting failures could well have been predicted. Instead, as occurred in the aftermath of the s following the 'Great Crash' of the Wall Street exchange, the legislative reporting requirements have been increased significantly e. One view is that it is impossible to develop a single theory of accounting, as human greed, opportunism, future uncertainty, and a degree of naivety on the part of some stakeholders can never be captured in a theory of accounting per se.

Accounting standards and legislated reporting measures are the outcome of competing sets of interests and this may well be the place to begin developing a new theory of accounting behaviour. Either way, the current environment is one of increased disclosures and reporting requirements with legislated sanctions.

But the key question is will this advance the development of theories relating to accounting measurements and disclosures? Recent developments Both academic and professional interests in theory development have tended to be aligned in the past.

Whereas the academic research emphasis remains in the area of capital market, agency theory, and behavioural impacts, the profession has pursued a more normative approach. In particular, the profession has sought normative theories to unify accounting practice and make it more homogeneous, whereas academic researchers have sought to better understand the role and impact of different forms of accounting information.

These positive and normative approaches are not incompatible, since an understanding of the impact of accounting is a factor that accounting standard setters consider in developing prescriptions for practice.

In the mid to late s, the Australian accounting profession was heavily involved in the conceptual framework debate in an attempt to provide a definitive statement of the nature and purpose of financial reporting and to provide appropriate criteria for deciding between alternative accounting practices. It also included a detailed outline of the 'tentative building blocks of a conceptual framework for regulation of financial reporting'.

This was closely followed by ED 4GA-B in March , which outlined the concept of a reporting entity and provided definitions of the measurement and recognition of expenses. In , the AAR!? SAC 5, the controversial measurement statement, had not been released prior to the adoption of international financial reporting standards IFRS in The conceptual frameworks of the various countries are used in developing accounting standards and in attempting to reduce the inconsistencies arising from earlier fragmented theory and practice developments.

The need for a single, consistent framework has gained widespread acceptance in recent years. The IASB, in a joint project with the US Financial Accounting Standards Board, embarked on a new conceptual framework project in to update and improve the conceptual framework for standard setters and preparers of financial statements to use. The need for a single set of international accounting standards was acknowledged by the accounting profession in Australia with the adoption of IFRS in January International standards seek to harmonise practices across international reporting boundaries and to reduce the differences in reported information which are a direct consequence of different accounting choices.

This approach aims to eliminate accounting disclosures and techniques specific to one or a small group of countries which subsequently affects the comparability or integration of information, particularly for multinational and listed corporations. The assumption is that the same theoretical issues apply whether the standards are specific to one country or designed for global application. Figure 1. Pre-theory period ontinued development of practice 7.

General scientific period- lanations of practice and development of explanatory framework s: Normative period- s to Positive accounting nt of ideal practices and theory-a framework to explain r achieving such practices and predict behaviour to present: To reflect this, the book is divided into three parts: Part 1: Accounting theory chapters Part 2: Theory contributing to practice through accounting standards chapters Part 3: Accounting and research chapters Chapters 2 and 3 detail many different theory construction frameworks and then apply them to analyse examples from the accounting literature.

The 'parts' of a theory are detailed, the means of testing theories are considered and the chronological development of accounting theory is traced. Understanding the components of theory development is important for accountants, not just those who will become academics, but also those who need to understand the choice of alternative accounting methods and explain this to clients and stakeholders.

It is also important to distinguish between theory development as it relates to the natural versus human sciences. Accounting processes and information are the result of a complex set of human interactions and decisions which may not fit the traditional empirical or scientific process.

When it comes to interpreting human behaviour, completely rational and systematic approaches may not apply. To be a complete professional accountant one needs to understand the mainstream approaches to theory development, in order to specifically consider theories of accounting, the behaviours accounting information demands, and the advice needed by clients. Thus, these chapters set down the fundamentals of taking a scientific perspective. Chapter 4 describes how, over time, the different perspectives of the different users of financial statements have influenced the focus of accounting.

It covers issues such as whether the focus of accounting is on reporting the ownership interest in the firm or the financial affairs of the firm as a separate operating entity. Basically, a significant number of choices and decisions are made to ensure the accounting methods fit the reporting entity. It is important to appreciate that human decisions, preferences and objectives will affect the accounting viewpoint adopted, which in turn drives the accounting choices made in recording, measuring and reporting accounting information.

This is an important chapter in the context that the IFRS has adopted a shareholder perspective rather than an entity perspective when determining the focus of accounting.

Since measurement is fundamental to accounting, chapter 5 provides an introduction to some important technical issues in relation to measurement and to how it applies to accounting theory and practice. We learn that in fundamental measurement numbers can be assigned by reference to natural laws, but in accounting there is considerable debate over the nature of fundamental value. We also learn that accounting is derived measurement that depends on the previous measurement of two or more other quantities.

For example, we calculate income and expenses before profit is determined. Fiat measurements are those that relate numbers to properties of objects or events on the basis of arbitrary definitions. Chapter G provides an overview of the accounting measurement systems from which the principles of fair value accounting can be said to be derived. The first section describes conventional historical cost accounting and the theoretical bases, criticisms and defence of the system.

During the normative period, the historical cost system came under attack, and theories were developed to deal with the effects of changing prices on asset valuation and profit determination. These theories focused on either downloading prices current costs or selling prices exit prices. Thus, this chapter enables the student to place into perspective arguments about accounting measurement and the current debates about measurement in IFRS.

The definition and measurement of assets and liabilities are fundamental in determining the net value of the firm and, in many cases, the income and equity. Chapter 7 provides the definition of an asset and addresses measurement issues related to tangible, intangible and financial assets. The mixed measurement attribute model applied by IFRS is outlined as well as the concepts and methods behind different measurement methods.

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Chapter 8 is concerned with the credit side of the balance sheet - liabilities and equity. Liabilities are first defined and applications associated with applying the recognition and mixed measurement criteria to employee benefits, pension liabilities, provisions and contingencies are discussed. The chapter finishes with the definition of equity as the residual interest in assets, discusses the concept of capital, and outlines the difference between debt and equity.

The calculation of profit has been a key component in accounting measurement over many years and forms a fundamental component in many valuation models, capital market research, agency contracts, taxation issues, social issues and the behaviour of individuals.

Chapters 9 and 10 provide overviews of the issues faced in rhe two main components used to derive income - revenue and expenses. Discussion is provided about recognition criterion - from cash transactions through to more recent concepts such as the acquisition of a customer valued at exit price.

We also discuss the concept oC the comprehensive income. Expenses are defined and concepts such as economic benefits, expired costs and matching expenses and revenue are discussed in chapter One outcome of these two chapters is the ultimate consideration of the nature of profit and the alternative measurement rules that can give rise to quite different levels of reported profit. Positive empirical accounting theory has been at the forefront of the academic accounting research agenda for several decades.

Chapters 11 and 12 focus on the philosophy, scope and impact of positive theory on accounting theory development. Chapter 11 details the development of theories of accounting policy choice and revenue management. It focuses on contracting, agency and signalling theories, as a result of the divergence between managers and shareholders and debtors , that provide managers with incentives to manage accounting numbers to maximise the wealth of themselves or the firm.

Chapter 12 describes and explains the development of theories about the role of accounting information in the share market. It focuses on evidence of how share prices respond to accounting information, and why the information should influence either the price or amount of shares that are traded.

The role and development of behavioural accounting theory are described in chapter This chapter explains how relaxing some of the assumptions underlying positive accounting theory and focusing on individual behaviour rather than on aggregate market behaviour influences an understanding of the role of accounting reports and their significance, in various contexts, to various parties.

The final chapter, chapter 14, discusses some recent controversial issues in accounting theory and regulation. Issues covered are the use of XBRL - a system that enables users to extract accounting data at a micro less aggregated level, the impact of Sarbanes-Oxley on the accounting and auditing professions, the role of fair values in the global financial crisis of , the IASB and FASB convergence program, and the impact of IFRS on auditors.

Finally, the chapter ends by summarising a number of issues in sustainability accounting. This research area is a growing extension to the traditional focus of accounting theory on financial issues. It examines social and environmental issues in an accounting context. Topics coveled include the Global Reporting Initiatives, climate change issues and accounting for carbon emissions rights, assurance problems, and water accounting.

Overall, this book aims to assist students to develop the necessary skills to interpret, discuss, evaluate and criticise competing theories and concepts, and to apply the elements of these theories and concepts to current accounting issues.

More specifically, it aims to help students evaluate the current issues surrounding the introduction of IFRS on a scientific basis, using logic and empirical perspectives. Barry, P , Rich kids: Random House. Scott, W , Financial accounting theory, Toronto: An Arrow-Debreu economy is when 7. Jermakowicz, Abacus, vol. A detailed analysis of the conceptual 2. E Hendriksen, Accounting theory, p.

Richard D Irwin, RJ Chambers, 'Why bother with historic cost and conservatism This L Goldberg, An inquiry into the nature postulates? AAA, Research, vol. Henderson, Peirson and Brown S Henderson, G Peirson and R overstate assets and net income'.

Chapters 1 1 and 12 provide a Brown, Financial accounting theory 8. Two examples of such books are: Longman Cheshire, Philadelphia: University of For further detail, see chapter Pennsylvania, ; and H Sweeney, R Watts and J Zimmerman, Positive 5.

For a detailed discussion of the Stabilized accounting, New York: Prenticr Hall, See, for example, 0 Edwards and University research: A search for order', pp. Some of the classifications that have proven most useful are pragmatic, syntactic, semantic, normative, positive and naturalistic approaches. Pragmatic approaches are based on observing the behaviour of accountants or those who use the information generated by accountants.

Syntactic approaches rely on logical argument, based on a set of premises, and semantic approaches concern how theories correspond to real-world events. Normative theories rely on both semantic and syntactic approaches. Positive approaches test hypotheses against actual events, and naturalistic approaches consider individual cases and do not try to generalise.

This chapter provides some insight into how accountiilg theories in each of these classifications were formulated. We also note some of the weaknesses and criticisms of various theories. Later chapters consider the different types of theory in detail in relation to particular accounting issues. 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': If the accounting anthropologist sets forth the 'principle of diversity', then we can test this principle by observing whether or not accounting man does in fact record similar occurrences in different ways.

And so f0rth. Until quite recently, it was a popular way of learning accounting skills - future accountants were trained by being apprenticed or articled to a practising accountant. However, there have been several criticisms of this approach to accounting theory construction: The descriptive pragmatic approach does not include an analytical judgement 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 practising accountants' methods and techniques and teach those methods and techniques to students.

Those students will become practising accountants whom we will observe in the future to learn what to teach, and so on. The descriptive pragmatic approach focuses attention on accountants' behaviour, 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.

His conclusion is, of course, in relation to normative theories of how accounting should be conducted rather than pragmatic theories that describe real- world practices. Psychological pragmatic approach In contrast to descriptive pragmatic approaches where theorists observe accountants' behaviours, 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.

This interpretation may be described as follows: 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.

However, the accounts are rarely audited specifically in terms of whether and how people will use them a pragmatic test or in terms of what they mean a semantic test. In this way, historical cost theory has been confirmed many times. If we assume a Lakatosian research program, the principles of historical cost accounting form the negative heuristic and, in a Kuhnian viewpoint, the dominant paradigm.

Some accounting theorists are critical of this approach.

Accounting Theory 7th Edition Godfrey

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 ale simple summations of account balances, and the auditing process is, in essence, simply a recalculation. The auditing process verifies the inputs by examining underlying documents and checks mathematical calculations.

However, it does not verify the final outputs. This means that even if accounting reports are prepared using perfect syntax, they may have little, if any, value in practice.

Sterling comments: The inadequacy of this procedure to confirm a theory is immediately apparent. If one were to attempt to confirm a theory of astronomy, as exemplified by a particular planetarium, then one might begin by checking on the accuracy of the observational inputs and one might also check for errors in computation. One would look at the sky to see if the stars were in fact in the position indicated by the planetarium. In the absence of this last step, several absurdities could result.

First, the set of equations could describe any situation whatsoever, e. If one restricted the 'verification' procedure to a check on the accuracy of the inputs and a recalculation, then one would certify that this planetarium presents fairly the position of the stars. The only way to discover that the orbit ought or ought not to be rectangular is to perform a separate operation and compare the results of that operation with the outputs of the system.

If enough of these outputs were subjected to independent verification, the theory of rectangular orbits would be either confirmed or disconfirmed. Second, if there were two planetariums concerned with the same phenomena but with different sets of equations resulting in contradictory outputs, then the auditing procedure would require that both of them be certified as correct when at least one of them is necessarily wrong.

Do share prices rise when profit improves? Metcash increased earnings per share by The Australian Financial Review, 31 July , p. The article describes a market reaction to accounting news. This description provides an example of which approach to theory? Consider the following syllogism: When a company reports better prospects than previously, investors force that company's share price to increase. Metcash is a company that has reported better earnings per share than previously.

Investors forced Metcash share prices to increase. If so what is the flaw? The sum of two weights means nothing unless they are measured by the same rules. What, then, about the procedure of adding the amount of cash held by a company today to the amount of cash paid 20 years ago for a piece of freehold land which the company still holds today?

The impression one gains from the internal inconsistency of many of the arguments upon which the justification of conventional accounting is made to rest is strongly reminiscent of the underlying philosophy of the rulers of Oceania in George Orwell's Nineteen Eighty-Four.

The distinctive feature of this philosophy is doublethink. Doublethink means the power of holding two contradictory beliefs in one's mind simultaneously, and accepting both of them. Valuations are incorporated in balance sheets. Fixed assets should be carried at cost. In terms of a Popperian approach to science, many of the propositions of conventional accounting are not falsifiable.

Take, for example, the following criticism of a definition of depreciation: Definitionsare unacceptablewhich imply that depreciationfor the year is a measurement, expressed in monetaly terms, ofthe physical deterioration within the year, or the decline in monetary value within the year, or, indeed of anything thai actually occurs within the year.

For example, depreciation depends on allocation, which in turn depends on a future sale disposal value and the expected useful life of the asset. The same is true for profit. Under this logic, true profit cannot be determined until the firm has been liquidated. Theories based on historical cost conventions lead to cautious hypotheses. The hypotheses therefore are unable to be tested and, as per the falsificationist approach in 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 defence 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 niles. 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.

If we adopt this allocation approach, the definition of depreciation is then in accordance with the matching concept. Although it may be syntactic, this cost allocation assumption can conflict with normative theories about how we should account to provide information that is useful for decision making.

The assumption that accounting should be a measurement system, providing information useful for decision making, is a normative premise assumed by a large group of accounting theorists and regulators.

The criticism that there are many different and acceptable historical cost allocation systems can be explained within a 'positive accounting' framework which makes the assumption that accounting information is an economic good, subject to demand and supply forces. Under positive approaches to accounting theory development, diversity of accounting techniques exists because diversity is required. This is because different accounting techniques are needed to account for different business situations.

For example, where firms are regulated by agencies that allow them to charge prices only on a cost-recovery basis, historical cost could be useful for management accounting price setting and for informing outside users of financial statements about the firm's likely future profits, and also as a means of influencing price-regulation agencies regarding the appropriateness of their price-setting formula.

The allocation of costs used for price setting might involve accelerated cost recognition, such as diminishing-balance depreciation over a short period of time because this gives high costs and leads to high prices being set for the firm's products.

However, a slower cost allocation might better reflect to outside users the likely life and vdlue of the assets. Agency theory suggests that the accounting technique required to minimise the costs of contracting will often differ from situation to situation.

Moreover, different political and regulatory costs affect each firm. Since firms seek to minimise all costs, they will choose different accounting techniques and because historical cost allocation allows a substantial number of allocation techniques, then firms can simply choose the most efficient technique. During this period, accounting researchers became more concerned with policy recommendations and with what should be done, rather than with analysing 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. 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 rnerits and demerits of alternative measurement systems. 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 download, hold or sell shares. One test of usefulness already discussed is the psychological pragmatic reaction to data.

Others do not identify a particular group but argue that all users have the same requirement for accounting data. They usually make adjustments to historical cost measures to account for inflation or the market values of assets. They are, in essence, measurement theories of accounting. They are normative in nature because they make the following assumptions: These assumptions were rarely subjected to any empirical testing.

Their proponents usually described their derived accounting system as the 'ideal'. They recommended it to replace historical cost and prescribed its use by all and sundry.

Normative researchers labelled their approach to theory formulation scientific and, in general, based their theory on both analytic syntactic and empirical inductive propositions. Conceptually, the normative theories of the s and s began with a statement of the domain scope and objectives of accounting, the assumptions underlying the system and definitions of all the key concepts.

The domain of accounting was general. It was in relation to the entire income statement and balance sheet, not just specific accounting items such as accounting for doubtful debts only. Also, it was in relation to all users of financial statements and not confined to a specific user or user group. The normative theorists also made assumptions about the nature of a firm's operations based on their observations. Detailed and precise accounting principles and rules and a logical explanation of the accounting outputs were outlined.

The deductive framework was to be rigorous arid consistent in its analytic concepts. Financial statements should mean what they say; they should have semantic connections with the real world.

Although financial statements are abstractions and reductions of firms' economic affairs, since they summarise the stock and the movement of economic resources, they should be pragmatic only to the extent that they were surrogates for direct experience. An important question in this accounting research concerns the usefulness of accounting data. Are the quantitative data we derive from given sets of operations based on an overall theory of accounting useful to users of financial statements?

To find the answer, what was usually done was to take the output data of specific accounting systems and determine whether this data helped decision makers make the right financial decisions. This is a direct approach to testing accounting theory. Figure 2. The arrows signify the output of each model. Decision makers use accounting data to make predictions about the company. Based on these predictions, they decide what to do, such as sell shares in the company or download more.

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 power. First, if the prediction is verified, it verifies the prediction model of the user, not the accounting system. There are, of course, other variables besides accounting data that affect a financial prediction.

We do not know precisely how the accounting data were used. Second, if the decision turns out to be the right one, it verifies the decision model, not the accounting system. Therefore, it is difficult to interpret the validity of the accounting model based simply on decision making. 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. Accounting, under this approach, gains predictive ability cnly because it gives relevant feedback or descriptive explanation of what has occurred.

We can also question the logical validity of using prediction forecasting as a scientific test for an accounting theory in a dynamic environment where intervening variables cannot be controlled.

Prediction in science is more valid when we can control variables such as air pressure, heat, weight and so on. When we cannot control variables in the economic environment, such as inflation and interest rates or consumer confidence, we have to assess predictions statistically, according to how probable it is that the evidence supporting the prediction is representative.

The following article is a comment on the way accounting theory has evolved, become accepted and then implemented. Now, I'm not usually one of those who goes around suggesting the public sector is wasting money, largely because when all is said and done it seems to me no more prone to the frailty of human fallibility than the private sector, where I have witnessed waste on the most colossal scale.

But on this occasion I'm going to, and I'm going to point a finger at those imposing the waste. IFRS are completely and utterly inappropriate for use by local authorities.

The reason is simply stated: I question that, but for logical reason in this case. The IASB defines decision useful information as that needed by an investor to decide whether to download or sell shares in an entity. They do not consider there to be any other reason for financial reporting. This is no minor issue: UK GAAP was accruals accounting and sought to match transactions in a period to provide a measure of what had happened in that time scale.

Balance sheets are a residual measure in that process. So this GAAP was about stewardship, financial performance, delivery of value for money, and action over time.

The difference is the result for the period. So the balance sheet is predominant and the profit and loss account secondary because it is assumed that the investor in the entity will have a short time scale for involvement usually less than a year - the UK stock exchange changes hands entirely well over once a year now, on average and is therefore wholly uninterested in stewardship, performance over time or even delivery of results.

The IFRS belief is that the only issue of concern to the investors, who they believe to be the sole user of accounts, is in making a quick buck from dealing.

Now, let's get down to some basic facts here. No one invests in a local authority. They're not for sale. They do not provide an investment return. With rare exceptions and I regret this they do not even issue bonds to finance their capital projects.

So the user of the financial statements that IFRS assume to exist are not present in the case of local authorities. There are no investors. And the use for which the financial statements that IFRS assumes to exist, being the decision to download and sell shares, does not exist in the case of local authorities. There is nothing to download and sell. This alone, at this most obvious and basic level, makes it abundantly obvious that IFRS is the wrong accounting system for local authorities as it is for any unquoted company, incidentally, for much the same reason - an absence of any marketable security.

It's worse than that though: IFRS will not require accounting for stewardship of public funds entrusted, or for the supply of services, both of which are core to the management of local authorities. And we know that a failure to measure almost always means a failure to deliver in management terms. This means we have a potential disaster on our hands. And whose fault is this? Well firstly, the IASB's.

They do not act in the public interest, after all. They are a private cartel designed by and promoted for, in no small part, the benefit of their biggest sponsors - who are the Big 4 firms of accountants. Second, those firms have much to answer for. They have just made a fortune from the IFRS transition for first tier listed companies, now they're selling similar services to the secondary markets and after that there was a void. So they've persuaded the professional bodies which they dominate to move IASB into local authorities which will give their teams work for several more years.

You can call that cynical if you like - but actually, it's just a statement of fact. What I really hate i s when people say the public sector i s inefficient when the entire reason is that the public sector was sold a completely dud product by the private sector.

That's true of most of the IT debacles, for example. It will be true here. Someone needs to wake up, smell the coffee and realise that UK local authorities are being sold a dud reporting system designed from the outset to be unfit for their needs. This project must be cancelled now before it i s too late!

This is not just a waste of money. This i s a straightforward con. I am angry. And so should all local authority tax payers in the UK.

We're going to be taken for a ride unless we protest now. What are the differences and why is IFRS deemed inappropriate for local authorities? Based upon the arguments by Murphy should we have different accounting svstems?

For local authorities? For different countries? What approach is Murphy using when he addresses the question of accounting for local authorities? Why do you think IFRS has been adopted for local authorities? Is it scientific or unscientific? Australian equities are now about 40 per cent off bear-market lows. Ditto the Australian dollar. Commodity indices are at nine-month highs, while domestic interest rates are at year lows. I remain a bull - a true believer.

I'm still a supporter of the commodity supefr-cycle. So why in the world am I worried? I get the feeling we may be trading at interim highs on equities, the Australian dollar and commodities.. I can't shake the feeling that investors have already factored in most of the market's medium-term positives. This inevitably leaves them prone to short-term negative surprises. Commodities are a particular concern. I think Xstrata's Mick Davis caught the mood on Tuesday when he pointed to the "froth" that had accompanied the run-up in metal prices.

I'm also expecting a more pragmatic reading of the domestic interest rate outlook to soften the local currency. Equity investors appear to be searching for an excuse to take some profits. Many are still pinching themselves, as they come to terms with their recent good fortune.

So how should investors play this? As volatility returns, the market will inevitably wrong- foot many as it moves to find a new floor. Do you look to take advantage of gains that have accrued since the March lows and lock a little away?

Or do you grit your teeth and ride out any short-term volatility, before the expected fourth-quarter resumption of the dominant market trend? Whatever path you take, view any correction as an added opportunity. Forget selling rallies - it's time to download dips. The Australian Financial Review, 6 August , pp.

What is a bull market? What is a bear market? Why would high commodity prices and low interest rates help to maintain share prices? What is the theory underlying the advice to download the 'dips'? Is this a normative theory? 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 mzde by the normative accounting theorists. For example, by using questionnaires and other survey techniques, attitudes to the usefulness of different accounting techniques were determined. A typical approach was to survey the opinions of financial analysts, bank officers and accountants on the usefulness of different inflation accounting methods in their decision-making tasks such as predicting bankruptcy or deciding whether to download or sell shares.

Tests attempted to deternine whether inflation accounting increased the information efficiency of share markets; whether profit is an important determinant in share valuation; whether the cost of gathering 'finer' accounting data outweighed the benefits; or whether the use of different accounting techniques affected value. 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.

This research tests theories that assume that accounting information is an economic and political commodity, and that people act in their own self-interest.

Positive accounting theory in particular covers questions such as: Do firms substitute alternative ways of financing assets when the rules governing the accounting for leases change? Which firms are more likely to use straight-line depreciation rather than diminishing-balance depreciation, and why?

The theory used to answer these questions generally revolves around managers' incentives to maximise bonuses based on their companies' profits, their incentives to avoid breaching accounting-based debt covenants and thereby reducing the cost of debt, or their incentives to use accounting techniques to divert attention from their high profits if those profits would attract public or government scrutiny, and perhaps lead to higher taxes.

In this book, chapters 11, 12 and 13 focus on different types of positive accounting 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. 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, for example to achieve some objective such as maximising share values or their personal wealth regardless of whether that is 'right' ; or they predict what people have done or will do again, regardless of whether that is 'right' or 'best behaviour'.

Many positive theory researchers are largely dismissive of normative viewpoints. Similarly, many normative theorists do not accept the value of positive accounting research. In fact, the theories can coexist, and can complement each other. Positive accounting theory can help provide an understanding of the role of accounting which, in turn, can form the basis for developing normative theories to improve the practice of accounting.

We start with a theory based on prior knowledge or accepted 'scientific' theory constructions. When we observe real-world behaviour that does not concur with the theory, we treat that anomaly as a research issue and express it as a research problem to be explained. We develop a theory to explain the observed behaviour and use that theory to generate testable hypotheses that will be corroborated only if the theory holds. This approach has an inheren, assumption that the world to be researched is an objective reality capable of examination in terms of large-scale or average statistics.

This type of research is carried out by incremental hypotheses which are then combined to provide greater understanding, or better predictions, of accounting. The implied assumption is that a good theory holds under circumstances that are constant across firms, industries and time.

This approach to research is generally described as the 'scientific' approach and is the approach currently used by most researchers in accounting, and the approach that is published in most major academic accounting journals. This, in turn, influences the types of research problems posed and the hypotheses that are tested.

It is important for accounting researchers to clearly recognise the assumptions underlying their research and to consider whether alternative research approaches are more appropriate. There is a body of literature, loosely labelled naturalistic research, which is critical of the highly structured approach adopted by 'scientific' researchers.

We briefly review some of their criticisms in this section. Most researchers now accept that the most appropriate approach depends on the nature of the research question being considered.

The first criticism of the scientific method is that large-scale statistical research tends to lump everything together. Hypotheses based on the use of stock market prices or surveys render much of accounting research remote from the wcrld of practitioners. Also, they are not commensurate with the concerns of many individual accountants in their roles as accountants.

Some researchers advocate the naturalist research focus as being more appropriate for gaining a knowledge of accounting behaviour in its natural setting. The idea is that we undertake research as naturally as possible. This approach has two implications. First, we d o not have any preconceived assumptions or theories. Second, we focus on firm-specific problems. This is done by taking a flexible research approach using close observations and placing less emphasis on mathematical analysis, modelling, statistical tests, surveys and laboratory tests.

The usual way to undertake naturalistic research is to use individual case studies and more detailed fieldwork. This type of research is much more micro in its perspective because it is aimed at solving individual problems which may be firm-specific.

Therefore, results may be more difficult to generalise. The naturalistic approach can be compared with 'scientific' accounting research, which is more prone to aggregating the results from testing a number of hypotheses in order to form 'general theories of accounting'. Naturalistic research starts from specific real-world situations; the main intention is to answer the question 'What is going on here?

The case-study approach is seen by some researchers as best fulfilling the role of exploring or crystallising the research problem for naturalistic research. For example: They see the naturalistic research approach as being more appropriate to different ontological assumptions.

For example, we may view accounting as a social construction. We may wish to understand what self-images people hold, what underlying assumptions sustain that view, or what part this perception plays in controlling the way they perform their everyday role.

These are the types of questions that might be researched using a subjective ontology. First, they list a six-way classification of the nature of the social world see table 2. Categories are alternative ways of looking at the world. Category 1 is a strict objectivist viewpoint of the world, where behaviour will always conform to a set of behavioural rules, and outcomes of decisions and actions are highly predictable.

In relation to category 1, for example, researchers assume that all managers aim to maximise their personal wealth and that they are aware of how they can use accounting techniques to do so e. This enables researchers to predict what accounting methods managers will use if accounting choice is unregulated. Researchers will predict that all managers behave in the same manner because they have a shared view of the world and of the outcomes of their actions, and because they share preferences for particular outcomes.

When researchers view the world as a concrete structure category I , this enables them to use the scientific approach and statistical methods to test their predictions. Category Assumption 1. Reality as a concrete structure 2. Reality as a concrete process 3. Reality as a contextual field of information 4. Reality as symbolic discourse 5. Reality as social construction 6. Reality as projection of human imagination Source: Tomkins and R.

Groves, 'The everyday accountant and researching his reality', Accounting, Organizations and Society, vol. As we move down through the categories we are gradually relaxing our assumptions about the 'concreteness' of the world: In category 6, humans are not expected to behave according to a set of behavioural rules that apply to everyone equally.

Complex interrelationships and individualistic decision models are assumed. Individuals are not expected to think alike. Because individualism is expected in category 6, the scientific method and statistical tests are inappropriate because their assumptions are violated. Although individuals may behave rationally according to their personal understanding of the world and of the outcomes of particular actions, they do not share a common understanding of how the world works, and they have different preferred outcomes from their decisions.

For example, some managers might prefer to maximise their personal wealth; others might prefer to maximise their subordinates' job satisfaction; and others might prefer to minimise their personal work effort. Understanding decision making involves understanding individuals' perceptions and preferences. For categories , it is more appropriate to use the scientific approach. By appropriate observation and measurement, it is assumed that one has readily available, stable and usually very simple functions relating to isolated and small subsets of the social world that can be used for accurate predictions.

Symbolic interactionists see their world as one in which people form their own separate impressions through a process of human interaction and negc-tiation.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.

Such theories are important since they explain the economic, or wealth, effects of accounting and why accounting is important to various parties such as shareholders, lenders and managers - all of whose personal wealth is affected by accounting decisions.

These are then manipulated partitioned and summed on the basis of the premises and assumptions of historical cost accounting. To download free introduction to financial accounting theory mcgraw-hill you Financial Accounting Theory need to register.

Accounting Theory Godfrey 7th Edition Solution

When researchers view the world as a concrete structure category I , this enables them to use the scientific approach and statistical methods to test their predictions. What I really hate i s when people say the public sector i s inefficient when the entire reason is that the public sector was sold a completely dud product by the private sector.

Chambers summarised a view that accounting has mainly developed in an improvised fashion rather than systematically from a structured theory: Deegan, C. Jermakowicz, Abacus, vol.