Alaa Aliasrei @Aliasrei عالء محسن شحم
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
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
1
, Alaa Aliasrei @Aliasrei عالء محسن شحم
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.
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
2
, Alaa Aliasrei @Aliasrei عالء محسن شحم
1.6 If the revised conceptual framework (which is an example of a normative
theory) is based upon, or built upon, a particular 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 component of the revised IASB Conceptual Framework for Financial
Reporting that was released in 2010 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 about 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 organisation has on 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 resource allocation decisions) then we would
question the prescriptions provided by the framework.
1.7 Yes, we can reject a theory even though we believe that it is very logical. For
example, if we were to adopt an assumption that capital markets are efficient and
that individuals are motivated by self-interest tied to wealth maximisation (two
very important assumptions made in a great deal of economics literature) that
might lead us to make particular prescriptions about what information
organisations should produce. However, if we reject these assumptions (perhaps
we consider that markets are not efficient and that human behaviour is not based
upon self-interest) then we might consider that the prescriptions provided by the
theory are unsound – and potentially even damaging to particular groups within
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
3
, Alaa Aliasrei @Aliasrei عالء محسن شحم
society – even though we might nevertheless believe that the theory is logically
developed.
1.8 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 1960s) 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 behaviour in particular circumstances (and determining
‘appropriate behaviour’ 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 the 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
behaviour—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 subsequent observation as he was prescribing a particular
approach to accounting that was in stark contrast to what accountants were doing
at the time.
1.9 Some interesting answers should be given here. Some students might argue it is
a total waste of time. The perspective adopted by the author of your textbook,
and many other accounting academics, however, 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 accounting
numbers, without considering their impacts, then we would be only getting a
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
4
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
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
1
, Alaa Aliasrei @Aliasrei عالء محسن شحم
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.
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
2
, Alaa Aliasrei @Aliasrei عالء محسن شحم
1.6 If the revised conceptual framework (which is an example of a normative
theory) is based upon, or built upon, a particular 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 component of the revised IASB Conceptual Framework for Financial
Reporting that was released in 2010 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 about 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 organisation has on 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 resource allocation decisions) then we would
question the prescriptions provided by the framework.
1.7 Yes, we can reject a theory even though we believe that it is very logical. For
example, if we were to adopt an assumption that capital markets are efficient and
that individuals are motivated by self-interest tied to wealth maximisation (two
very important assumptions made in a great deal of economics literature) that
might lead us to make particular prescriptions about what information
organisations should produce. However, if we reject these assumptions (perhaps
we consider that markets are not efficient and that human behaviour is not based
upon self-interest) then we might consider that the prescriptions provided by the
theory are unsound – and potentially even damaging to particular groups within
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
3
, Alaa Aliasrei @Aliasrei عالء محسن شحم
society – even though we might nevertheless believe that the theory is logically
developed.
1.8 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 1960s) 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 behaviour in particular circumstances (and determining
‘appropriate behaviour’ 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 the 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
behaviour—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 subsequent observation as he was prescribing a particular
approach to accounting that was in stark contrast to what accountants were doing
at the time.
1.9 Some interesting answers should be given here. Some students might argue it is
a total waste of time. The perspective adopted by the author of your textbook,
and many other accounting academics, however, 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 accounting
numbers, without considering their impacts, then we would be only getting a
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd
undefined Solutions Manual to accompany Deegan, Financial Accounting Theory 4e
4
