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In relation to accounting, these assumptions might relate to such things as what motivates people or what is the central objective of accounting. Positive theories are typically evaluated by considering how well the explanations or predictions relate to actual observations. Normative theories are not evaluated on the basis of their correspondence with observations of real world phenomena. For example, a researcher may develop a theory that prescribes a particular approach to asset valuation.

The theory should not be considered as invalid if people currently do not adopt the prescribed approach to asset valuation. 1. 6 The SAAB and the FAST are currently developing a revised conceptual framework of financial reporting. If you have been asked to review the framework-?which is an example of a normative theory of accounting-?why would it be important for you to pay particular attention to how the objective of financial reporting is defined within the framework?

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If the revised conceptual framework (which is an example of a normative theory) is based upon, or built upon, a particular objective (or, ‘assumption’) then, before we are likely to accept the prescriptions provided by the revised framework we would need to satisfy ourselves that we accept the central assumption. If we reject the central assumption, then no matter how logically developed the theory might be we will reject its prescriptions.

Within the exposure draft released in 2008 as part of the development of the revised framework it was stated: The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders and other creditors in making decisions in their capacity as capital providers. Therefore, if we rejected the above belief bout the objective of general purpose financial reporting then we would probably reject the contents of most of the revised conceptual framework; given that is has been developed from the perspective of this underlying objective.

For example, if we believed that general purpose financial reporting should provide information about the financial impacts an organization has a broad group of stakeholders beyond those that hold, or intend to hold, a financial interest (that is, we take a broader accountability-based perspective rather than one that focuses on providing information to parties involved in source allocation decisions) then we would question the prescriptions provided by the framework. 1. 8 What is the difference between developing a theory by induction and developing a theory by deduction?

As explained in this chapter, theory that is developed through induction is developed as a result of undertaking a series of observations of particular events, and on the basis of these observations, a theory is developed. Early theories of accounting (for example, in the 1 sass) were often developed by observing what accountants were actually doing in practice. This led to the formulation of certain conventions and doctrines of accounting which were considered to be theories.

As we discussed however, developing theory on the basis of observation typically does not allow us to address the issue of what would be the most appropriate behavior in particular circumstances (and determining ‘appropriate behavior will in turn be influenced by particular assumptions or value judgments made by the researcher). That is, it does not encourage us to evaluate what the accountants are doing. By contrast, developing theory on he basis of deduction does not rely upon observation. Rather, it relies upon the use of logic to develop arguments and related theory.

Some theories developed through deduction-?such as positive accounting theories which are developed and then used to predict particular behavior – can be tested (but not initially developed) through subsequent observation. Other theories developed through deduction-?such as Chambers’ theory of accounting (Continuously Contemporary Accounting)-?should not be evaluated through us bequest observation as he was prescribing a particular approach to counting that was in stark contrast to what accountants were doing at the time. 1. Is the study of financial accounting theory a waste of time for accounting students? Explain your answer. Some interesting answers should be given here. The perspective adopted by the author of your textbook, and many other accounting academics, is that the outputs of the accounting system are used in many decisions throughout society and hence it is important to consider how particular accounting methods, or changes thereto, will impact various groups. If we only considered how to calculate counting numbers, without considering their impacts, then we would be only getting a fraction of the total ‘story.

People involved in accounting logically need to have some perspective about how people will react to different accounting numbers or forms of disclosure; accounting theories can provide us with such insight. Apart from considering how accounting numbers might impact different groups, people involved in accounting should arguably understand the different factors which might have influenced accounting standard-setters when they developed particular requirements. They should also be aware of research that suggests improvements to current practices (with such information perhaps being derived from different normative theories of accounting).

As you will see throughout the textbook, there are various perspectives about why organizations might adopt particular accounting methods. If we are ultimately involved in reading financial statements, then understanding the possible motivations of those in charge of preparing the financial statements will be useful. For example, some theories suggest that managers will want to use those accounting ethos that provide the greatest benefits to themselves personally (from Positive Accounting Theory).

Other theoretical perspectives suggest that a reporting entity will be motivated to provide information primarily to powerful stakeholders (from Stakeholder Theory), or that the managers of reporting entities provide information to legitimate the entity’s ongoing existence (from Legitimacy Theory). Chapter 12 of the book provides a perspective (a critical perspective) that suggests that financial accounting is a mechanism to further the interests of those people who currently have lath, and to undermine the interests of those without wealth.

As this brief discussion shows, there are numerous views about the implications of accounting, and the factors which cause managers to select one accounting method in preference to another. Such insights might be useful when interpreting particular accounting disclosures. If we do not read about accounting theory then these insights might not be available to us. 1. 24 What do we mean when we say that ‘theories are abstractions of reality? Do you agree that theories of accounting are necessarily abstractions of reality? It is generally accepted that theories cannot be ‘proved’.

They are often developed to explain a particular phenomenon (positive theory) and will rely upon a number of simplifying assumptions to make them ‘workable’ (some of the ‘best theories are often considered to be the simplest theories). When considering the development of theories to explain human behavior (for example, the behavior of accountants or the behavior of users of financial statements) a number of assumptions must be made about how people act, how they are motivated, and so on. Arguably, people are all different and heir behaviors cannot be predicted with total accuracy.

Further, people will not always be consistent in how they act. If we attempted to develop a theory to predict behavior with near-perfect accuracy then the development of the theory would take forever and really could probably never achieve its goal. Hence, theorists make simplifying assumptions and the ultimate theory will therefore be a simplifying abstraction of reality.