Contemporary Issues in Accounting 2e Customised 1st Edition by Craig Deegan Solution manual
Chapter 1: Introduction to financial accounting theory
Solutions
1.1 Broadly speaking, a positive theory seeks to explain and/or predict particular
phenomena whereas a normative theory seeks to prescribe what should be done
in particular circumstances based on particular assumptions made by the
researcher. 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.
1.2 If we developed a theory to explain how a financial statement preparer’s cultural
background influences how they prepare financial statements then, as we are
attempting to ‘explain’ particular practice, we have developed a positive theory.
Such a theory would then be evaluated in terms of how well its predictions
(perhaps based on particular cultural attributes of a given population) correlate
with the predicted accounting practices (for example, we might have predicted
that people from a ‘conservative’ society are more likely to adopt historical cost
accounting rather than utilising valuations based on fair values). In developing
such a theory we are not attempting to prescribe what accounting methods
should be used – which contrasts our research with normative research.
1.3 A conceptual framework, such as the International Accounting Standards Board
(IASB) Conceptual Framework for Financial Reporting, provides some
fundamental assumptions about the role of general purpose financial reporting
and the attributes that financial information should possess for it to be useful in
assisting the resource allocation decisions of financial statement readers. As
indicated in this chapter, the United States’ Financial Accounting Standards
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
2
Board (FASB) defined a conceptual framework as ‘a coherent system of
interrelated objectives and fundamentals that can lead to consistent standards’.
Since conceptual frameworks provide perspectives about such issues as: the
qualitative characteristics that financial information should posses; the
identification of the types of entities that should produce general purpose
financial reports; the way in which the elements of financial accounting should
be defined and recognised, and so forth (note the emphasis on ‘should’), the
conceptual frameworks—in providing prescription—are considered to be
normative in nature. Positive research, on the other hand, might simply attempt
to describe or predict the behaviour of those people in charge of producing
general purpose financial reports, or the behaviour of financial report readers
1.4 Arguably, Peter Costello has a hunch, rather than a theory. The Oxford English
Dictionary defines a theory as ‘a scheme or system of ideas or statements held as
an explanation or account of a group of facts or phenomena’. Theories would not
generally be considered to be ad hoc in nature, and should be based on
systematic and coherent reasoning. It is not obvious that Peter Costello’s ideas
match with our views of what constitutes a theory.
1.5 Prescriptions are clearly not the same thing as predictions. If, for example, a
researcher is prescribing a particular approach to accounting (that is, he or she is
being ‘normative’ in nature) that does not mean when we look at actual
accounting practice we will find that the prescribed method is being used. In
fact, the reason why the researcher developed a particular normative theory (a
theory that prescribes what should be done) could well be driven by the
researcher’s observation of the inadequate practices currently being employed.
For instance, Raymond Chambers developed a theory of accounting (labelled
Continuously Contemporary Accounting) which prescribes that assets should be
valued on the basis of exit (market) values. He did this on the basis of the
perceived limitations of historical cost accounting. The fact that almost all
reporting entities used historical cost at the time does not of itself invalidate
Chambers’ theory.
Solutions
1.1 Broadly speaking, a positive theory seeks to explain and/or predict particular
phenomena whereas a normative theory seeks to prescribe what should be done
in particular circumstances based on particular assumptions made by the
researcher. 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.
1.2 If we developed a theory to explain how a financial statement preparer’s cultural
background influences how they prepare financial statements then, as we are
attempting to ‘explain’ particular practice, we have developed a positive theory.
Such a theory would then be evaluated in terms of how well its predictions
(perhaps based on particular cultural attributes of a given population) correlate
with the predicted accounting practices (for example, we might have predicted
that people from a ‘conservative’ society are more likely to adopt historical cost
accounting rather than utilising valuations based on fair values). In developing
such a theory we are not attempting to prescribe what accounting methods
should be used – which contrasts our research with normative research.
1.3 A conceptual framework, such as the International Accounting Standards Board
(IASB) Conceptual Framework for Financial Reporting, provides some
fundamental assumptions about the role of general purpose financial reporting
and the attributes that financial information should possess for it to be useful in
assisting the resource allocation decisions of financial statement readers. As
indicated in this chapter, the United States’ Financial Accounting Standards
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
2
Board (FASB) defined a conceptual framework as ‘a coherent system of
interrelated objectives and fundamentals that can lead to consistent standards’.
Since conceptual frameworks provide perspectives about such issues as: the
qualitative characteristics that financial information should posses; the
identification of the types of entities that should produce general purpose
financial reports; the way in which the elements of financial accounting should
be defined and recognised, and so forth (note the emphasis on ‘should’), the
conceptual frameworks—in providing prescription—are considered to be
normative in nature. Positive research, on the other hand, might simply attempt
to describe or predict the behaviour of those people in charge of producing
general purpose financial reports, or the behaviour of financial report readers
1.4 Arguably, Peter Costello has a hunch, rather than a theory. The Oxford English
Dictionary defines a theory as ‘a scheme or system of ideas or statements held as
an explanation or account of a group of facts or phenomena’. Theories would not
generally be considered to be ad hoc in nature, and should be based on
systematic and coherent reasoning. It is not obvious that Peter Costello’s ideas
match with our views of what constitutes a theory.
1.5 Prescriptions are clearly not the same thing as predictions. If, for example, a
researcher is prescribing a particular approach to accounting (that is, he or she is
being ‘normative’ in nature) that does not mean when we look at actual
accounting practice we will find that the prescribed method is being used. In
fact, the reason why the researcher developed a particular normative theory (a
theory that prescribes what should be done) could well be driven by the
researcher’s observation of the inadequate practices currently being employed.
For instance, Raymond Chambers developed a theory of accounting (labelled
Continuously Contemporary Accounting) which prescribes that assets should be
valued on the basis of exit (market) values. He did this on the basis of the
perceived limitations of historical cost accounting. The fact that almost all
reporting entities used historical cost at the time does not of itself invalidate
Chambers’ theory.