ing Theory Chapter 1 68254r

GODFREY HODGSON HOLMES TARCA

CHAPTER 1 INTRODUCTION

Overview of ing Theory What is a theory? Hendriksen’s definition: …the coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.

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Overview of ing Theory What is an ing theory? Hendriksen’s definition: …logical reasoning in the form of a set of broad principles that • provide a general framework of reference by which ing practice can be evaluated and • guide the development of new practices and procedures. 3

Overview of ing Theory • Whether a theory is accepted depends on how: – well it explains and predicts reality – well it is constructed both theoretically and empirically – acceptable its implications are

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Overview of ing Theory The development of ing theory has been mostly unstructured Chambers: ing has frequently been described as a body of practices which have been developed in response to practical needs rather than by deliberate and systematic thinking.

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Pre-theory (1400s – 1800) Goldberg: No theory of ing was devised from the time of Pacioli down to the opening of the nineteenth century.

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Greek in 5th Century BC • In 1915, scientist discovered “Zenon Papyri” • Contains information about the construction projects, agricultural activities and business operations of the private estate of Apollonius for a period of about 30 years during the 3rd century BC • A written record of all transactions, a personal for wages paid to employees, inventory records and a record of asset acquisitions and disposals 7

Italy • The Romans kept elaborate records but since they expressed numbers through letters of the alphabet, they were not able to develop any structured system of ing

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Italy (Renaissance 13001500) • The Italians were vigorously pursuing trade and commerce, and the need to keep accurate records arose • Italian merchants borrowed the arabic numeral system and the basis of arithmetic and an evolving trend toward the double-entry bookkeeping system 9

Italy, 1494 • An Italian monk, Fra Luca Pacioli, “Summa de Arithmetica Geometria Proportioniet Proportionalita”, a book on arithmetic • Desribed doube-entry bookkeeping • Formalized the practices and ideas that had been evolving over the years 10

1600 • Statement of profit & loss and statement of balances • The primary motive for separate financial statements was to obtain information regarding capital • Balance sheet data were stressed while income and expense date were viewed as incidental 11

1800 • Evolution of t ventures into business corporations in England • Bookkeeping expanded into ing • The concept of net worth (owner’s original contribution +/- profits/losses) emerged • Periodic reporting for owners and prospective owners 12

1800 • Companies Acts in England stimulated the development of ing standards and laws to safeguard shareholders against improper actions by corporate officers • Dividends were required to be paid from profits and s were required to be kept and audited by persons other than the directors • Industrial revolution 13

Later part of 1800 • Industrial revolution arrived in the US • Railroad industries created the need for ing industries, led to increases in the market for corporate securities and an increased need for trained ants • ants were initially trained through an apprenticeship system , later private commercial college emerged 14

1900- 1915 • The concept of income determination was not well developed • Debate over which financial statement should be viewed as more important • 1904 : international congress of ants in US which formed American Associaton of Public ants. In 1916 • Many universities began offering ing courses 15

After the Great Depression • 1933 : Securities Act • 1934 : Securities Exchange Act which established SEC • 1935 : American Association of University Instructors in ing changed into American ing Association • 1936 : AIA 16

Pragmatic ing (1800– 1955) • The ‘general scientific period’ – based on empirical observation of practice – provided an explanation of ing practice – focused on the existing ‘viewpoint’ of ing

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Normative ing (1956-1970) • Sought to establish ‘norms’ for the best ing practice • Focused on what should be (the ideal) v. what is

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Normative ing (1956-1970) • Degenerated into battles between competing viewpoints • Two groups dominated: – conceptual framework proponents – critics of historical cost

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Normative ing (1956-1970) • Factors prompting the demise of the normative period include: – the unlikelihood of one particular normative theory being generally accepted – the application of financial economic principles – the availability of empirical data and new testing methods 20

Normative ing (1956-1970) • The major criticisms of normative theories were: – they do not necessarily involve empirical hypothesis testing – they are based on value judgements

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Positive ing (1950 to the present day) • A shift to a new form of empiricism called ‘positive theory’ • Had its origins in the ‘general scientific period’ • It seeks to explain the ing practices being observed

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Positive ing (1950 to the present day) • Its objective is to explain and predict ing practice e.g. the bonus plan hypothesis

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Positive ing (1950 to the present day) • It helps predict the reactions of ‘players’, such as shareholders, to the actions of managers and to reported ing information

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Positive ing (1950 to the present day) • Major deficiencies are: – ‘wealth maximisation’ has become the answer to explain all ing practices and reported information – it relies excessively on agency theory and dubious assumptions about the efficiency of markets

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Positive ing (1950 to the present day) • Behavioural research: – concerned with the sociological implications of ing numbers and the associated actions of ‘key players’ – emerged in the 1950s – despite growing acceptance since the 1980s, positive ing theory still dominates 26

Recent developments • Academic and professional developments in ing theory have tended to take different approaches • Academic research focuses on capital markets, agency theory and behavioural aspects • The profession has sought a more normative approach – what ing practices should be adopted 27

Recent developments

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Recent developments • Conceptual framework – resurrected in 1980s – states the nature and purpose of financial reporting – Establishes criteria for deciding between alternative ing practices – SACs 1–4

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Recent developments • Conceptual framework – Recent Developments – t project between IASB & FASB – International harmonisation of ing practices through a single consistent set of international financial reporting standards (IFRS)

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Recent developments • The conceptual framework underpinning the IFRS favours a move toward – ing practices that provide information for enhancing decision making by investors and others – recognising all gains and losses in the ing periods in which they occur – measurement using exit values 31

Content outline • Part 1: ing theory (chapters 1 – 3) • Part 2: Theory contributing to practice (chapters 4 – 10) • Part 3: ing and research (chapters 11 – 14)

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Summary • ing theory • Major periods of ing theory development • Normative ing • Positive ing • Conceptual framework • IFRS 33

Key and concepts • • • • • • •

Theory ing theory Normative theory Positive theory Behavioural theory Conceptual framework IFRS 34