Financial Accounting Theory Essay

1794 Words Apr 27th, 2012 8 Pages
Chapter 1 – Financial Accounting Theory

1.1 What is Financial Accounting Theory?

Henderiksen (1970) – Theory is defined as: A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.

FASB – a coherent system of interrelated objectives and fundamentals that can lead to consistent standards.

Introduction – theories of financial accounting

Accounting is a human activity and will consider such thing as people’s behavior and/or people’s needs as regards financial information, or the reason why people within organizations might select to supply particular information to particular stakeholder group.

Theories will include consideration of: •
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E.g. A positive theory of accounting may yield a prediction that, if certain conditions are met, then particular accounting practice will be observed.

Positive theories can initially be developed through some form of deductive (logical) reasoning. Their success in explaining or predicting particular phenomena will then typically be assessed based on observation –that is, observing how the theory’s predictions corresponded with the observed facts.

Positive Accounting Theory is developed by Watts and Zimmerman, which seeks to predict and explain why managers elect to adopt particular accounting methods in preference to others. The theory relied in great part of work undertaken in the fields of economics, and central to the development of Positive Accounting Theory was the acceptance of economics based ‘rational economic person assumption”.
That is the assumption that an accountant are primarily motivated by self-interest, and that the particular accounting method selected will be dependent on certain conditions.
Factors - FAT
1. Assumption : self-interest
2. Premises : a. The accountant is rewarded in terms of accounting-based bonus; b. The organization they work for is close to breaching negotiated accounting based debt covenants.

However, PAT does not seek to tell us that what is being done in practice is the most efficient or equitable process.
Chapter 1 –
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