Dr Jamal Roudaki Faculty of Commerce Lincoln University New Zealand

Theory definition

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‘a coherent set of hypothetical, conceptual and pragmatic principles forming the frame of reference for a field of inquiry’

Accounting theories fall into two broad categories:  Positive theories  explain and predict accounting practice.  Normative theories  prescribe practice.

Dr Jamal Roudaki Accounting Research

Positive accounting theory (PAT)

 Explains and predicts accounting practice.

 Does not seek to prescribe particular actions.

 Grounded in economic theory.

 Focuses on relationships between resource providing individuals and their organisations ( Agency Relationship ):  Owners and managers  Managers and debt providers.

Dr Jamal Roudaki Accounting Research

Agency theory

The agency relationship • Delegation of decision making from the principal to the agent.

Agency costs • Costs that arise as a result of the agency relationship • Monitoring costs • Bonding expenditures • Residual loss Dr Jamal Roudaki Accounting Research The agency problem • Delegation of authority can lead to loss of efficiency and increased costs.

Positive accounting theory (PAT) Assumptions of PAT:

• Individual action is driven by self-interest.

• Individuals act in an opportunistic manner to increase their wealth.

• Notions of loyalty and morality are not incorporated within the theory.

• Organisations are a collection of self-interested individuals who agree to cooperate.

Dr Jamal Roudaki Accounting Research

Positive accounting theory (PAT) Efficiency perspective:

Mechanisms are made to minimise future agency costs (ex ante perspective).

Accounting methods adopted by firms best reflect the underlying financial performance of the entity.

Regulation is argued to impose unwarranted costs on reporting entities.

Dr Jamal Roudaki Accounting Research

Positive accounting theory (PAT) Opportunistic perspective:

Assumes managers will opportunistically select accounting methods to increase their own personal wealth.

Dr Jamal Roudaki Accounting Research

Positive accounting theory (PAT)

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Creative Accounting:

It is possible to be creative and still follow accounting standards ‘Creative Accounting’ refers to selecting accounting methods that provide the result desired by the preparers.

Dr Jamal Roudaki Accounting Research

Normative accounting theories

• Seek to provide guidance in selecting accounting procedures that are most appropriate.

• Prescribe what should be done.

• Example – conceptual frameworks  Seek to identify the objective of GPFR  Seek to provide recognition and measurement ‘coherent’ and ‘consistent’ framework rules within a  Identify the qualitative characteristics financial information should possess  Make recommendations that depart from current practice.

Dr Jamal Roudaki Accounting Research

Some normative accounting theories

Current-financial accounting: • Provides a calculation of income that, after adjusting for changing prices, can be withdrawn from the entity and still leave the physical capital (operating capacity) of the entity intact  Referred to as ‘true measure of income’.

• True income theories propose a single measurement basis for assets and a resultant single measure of income (profit).

Dr Jamal Roudaki Accounting Research

Systems-oriented theories

Stakeholder theory: 1. Ethical branch:  Stakeholders are groups or individual who can affect or are affected by the achievement of the organisation:  Includes shareholders, employees, customers, lenders, suppliers, local charities, interest groups, government.

2. Managerial branch:  Seeks to explain and predict how an organisation reacts to stakeholder demands   Firms will take action to ‘manage’ relationships Financial and social information is used to control conflicting demands of various stakeholder groups.

Dr Jamal Roudaki Accounting Research

Systems-oriented theories

Legitimacy theory:  Organisations ensure they operate within the bounds and norms of society:  Based on a ‘social contract’ between society and the organisation.

 Organisations must appear to consider rights of the public at large:     Society might otherwise: ‘Revoke’ its ‘contract’ to operate Change demand for the organisation’s products Demand taxes, fines or prohibit activity.

Dr Jamal Roudaki Accounting Research

Systems-oriented theories

Institutional theory: • Organisations tend toward homogeneous behaviour:  Structures and practices tend to become similar to conform to what is considered ‘normal’.

Public interest theory: • Regulatory body considered to represent the interests of the society in which it operates, rather than the private interests of the regulators.

• Assumes that government is a neutral arbiter.

Capture theory:  The regulated seeks to take charge (capture) the regulator.

 They seek to ensure rules subsequently released are advantageous to the parties subject to regulation.

Dr Jamal Roudaki Accounting Research

Critical theory

• • • • A measure for understanding ‘reality’, which understanding can be translated into progress and the development of societies that will enable a ‘truer, freer and more just life for all’.

Recognises the primacy of social relationships over technical approaches.

Allows an alternative approach to positivistic models.

Provides new and innovate approaches for research into accounting.

Dr Jamal Roudaki Accounting Research

Financial Information

Stockholders & creditors Dr Jamal Roudaki Financial Analysis Regulatory Authorities Business Entity Accounting Choice Earnings Management Investors Accounting Research Capital market

Thank You

Questions Discussion Dr Jamal Roudaki Accounting Research