Accounting Theory ( 6th edition) Wolk, Dodd & Tearney Copyright 2004 Chapter 2: Approaches to the Formulation of Accounting Theory After studying this chapter , you will be able to : 1.Differentiate between traditional and new approaches to accounting theory construction. 2. Focus on different concepts in the ethical , social and economic approaches to the development of accounting theories. 3.Distinguish between the deductive approaches and inductive approaches to accounting theory formulation. Chapter 1: An Introduction to Accounting Theory

Accounting Theory ( 6th edition) Wolk, Dodd & Tearney Copyright 2004 Chapter 2: Approaches to the Formulation of Accounting Theory After studying this chapter , you will be able to : 4.Explaine the electric approaches to the formulation of accounting theory. 5.Sketch the new approaches to the development of accounting theories. Chapter 1: An Introduction to Accounting Theory

Attempts to formulate a generally accepted accounting theory have not succeeded so far because of different assumptions ,methodologies and users. We shall discuss in brief the different approaches to the formulation of an accounting theory under two heads : 1. The traditional Approaches . 2. The new Approaches. It should ,however , be understood clearly that these approaches are not independent of one another. Generally , more than one approach ,is used in the development of accounting principles.

Traditional Approaches Most of these approaches are theoretical, except Pragmatic and an Authorization approach are practical. The Pragmatic Approach. The Authorization Approach. The Deductive Approach. The Inductive Approach. The Ethical Approach. The Sociological Approach. The Economic Approach. The Electronic approach.

1.The Pragmatic Approach. This approach consists of the formulation of a theory which is in conformity with real (current) practices. Based upon the concept of utility or usefulness – (utility approach). In this approach ,accounting principles are chosen because they are useful to the different categories of “users of accounting information and their relevance to decision making. an attempt to find a practical solution . Most accounting theory was developed using this approach

2. The Authorization Approach. This approach is used by professional organization and the governments. It consist of issuing pronouncements for the regulation of accounting practices .in developing economies, where financial accounting and reporting practices differ a lot . This approach has its own utility . It also attempts to provide practical solution.

“a theory without practical consequences is a bad theory” In these (utility) approaches ,the emphasis is on accounting practices, and the logical conclusion is that accounting theory is to be derived from practices. “a theory without practical consequences is a bad theory”

3.The Deductive Approach In this approach we go from general to particular . In accounting , this approach begins with basis accounting propositions (Assumptions) and proceeds to derived by logical means the accounting principles.

3.The Deductive Approach Steps used to derive the deductive approach in accounting: Specifying the objectives of financial statements. Selecting the ‘Assumptions’-basic accounting propositions- of accounting. Deriving the ‘principles’ of accounting. Developing the "techniques of accounting”. * Thus, the sequence is { objectives – assumptions – principles – techniques }

4.The Inductive Approach In this approach we go from particular to general. On the basis of particular observation and measurement ,generalized conclusion are drawn. The inductive approach in accounting “begins with observation of financial information of business enterprise and proceeds to draw generalization and principles of accounting “. Thus, accounting and financial information leads to the formulation of assumptions and principles.

4.The Inductive Approach - The inductive approach to a theory involves the following four stages: 1. observations , and Recording of all observations 2. Analysing and classifying these observations. 3. Inductive derivation of generalisations and principles of accounting from observations . 4. Testing the generalisations

It will be noted that to develop accounting theory , there has been an application of both the approaches . Principles are derived by deductive process , while the general proposition are formulated through an inductive process .a combination of the two approaches has been used by most authors.

5.The ethical approach This approach should not taken as an independent approach. The basic core consists of the concepts of fairness, justice (equity), and truth. These concepts as the main criteria in the formulation of accounting theory. “Fairness: refers to the basic concept that accounting data should be fair ,unbiased”. “Justice: equitable treatment to all interested parties”. “Truth: true , and accurate financial accounting statements without misrepresentation”.

The ethical approach In general, the purpose of having these approach that accounting statements have not been subject to undue influence or bias The words “true and faire” have to be special mentioned in audit reports.

6.The sociological approach The economic impact of corporation is measured by financial accounting methods and reported in financial statement, however, no established methods and standards for measuring and reporting on corporate social performance. Emphasizes the social effects of accounting techniques According to this approach, a given accounting principle or technique is evaluated for acceptance on the basis of its reporting effects on all groups in society Implies that accounting data will be useful in making social welfare judgments