Accounting Theory Construction PDF
Accounting Theory Construction PDF
@ PRAGMATIc THtoRlEs
DescriPtive Pragmatic apProach
ThedescriptivepragmaticapproachtoaccountingtheoryConslnrc.tionisaninductive
upp.ou.r',-i..i,u","ao,-'continualobservationofthebehaviourofaccountants
inordertoCopytheiraccountingproceduresandprinciples.Hence,.atheorycanbe
developedfromobservationsofhowaccountantsactincertainsituations.Thetheory
canbetestedbyobservingwhetheraccountantsdo,infact,actinthewaythetheory
Suggests.Sterlingcalledthismethodthe,anthropologicalapproach,:
y";'J:l;
;. jiH:a:Hi,::fJ::::?:il'":1li$:il:es[ffi ::i:Tf'ry$HT'fl
whether or not accounting man does
in fact record a
test this principle by ouse-wing th:-111t3* of diversity"
sets fo;h
conservative figure. If the
".."r'",i"g ^nthropologist
,'gJ:*',;:J*xlxli*i,"'l;{*rlxiT;;xl*coun'iinsmandoesinrac'1
Thedescriptivepragmaticapproachisprobablytheoldestandmostuniversallyused of
untii quite recently' ft yu.t u popular way
method of accounting theory construction.
learningaccountingskills_futureaccountantsweretrainedbybeingapprenticedor
articled to a practising accountant' to accounting theory
However, there have been several criticisms of this approach
of accounting Phenomena'
o|"
(a) ls there a flaw in the syntax the general
what l' tn" ifu*l (Hlnt: Consider"whether
conclusion is not true? lf so
must always be true')
premise ut'tn"''tu'ioithe syllogism invalld and its conclusion false?
(b) what is the pracrical significance "i',h;il;;r;eing
Questions have been raised also about the imprecision of definitions in accounting.
In terms of a Popperial approach to science, many of the propositions of conventional
accounting are not falsifiable. Take, for example, the following criticism of a definition
of depreciation:
Definitions are unacceptablewhich implythat depreciation fortheyearis a measurement,
expressed in monetarv terms, of the physical deterioration within the year, or the decline
in monetary value within the year, or, indeed of anlthing that actually occurs within
the year.7
Sterling takes this point further by stating that the problem lies in the way accountants
have defined the determination of costs and profit as a choice among conventions,
which are in turn defined so that a present magnitude depends on a future magnitude.
For example, depreciation depends on allocation, which in turn depends on a future
sale (disposal value) and the expected useful life of the asset. The same is true for profit.
tlnder this logic, true profit cannot be determined until the firm has been liquidated.
Theories based on historical cost conventions lead to cautious hypotheses. The
hypotheses therefore are unable to be tested and, as per the falsificationist approach
(in which a hypothesis is not informative and does not add to scientific progress if
it is not worded or proposed so that it is falsifiable), they are not useful for financial
decision making except to verifi, accounting entries. Hence, they are uninformative and
do not add to knowledge or progress in accounting. The above criticisms of historical
cost are essentially criticisms about measuring current values and were the forerunner
of the current move of International Financial Reporting Standards (IFRS) towards
'fair value' accounting.
In defence of the historical cost system, accountants argue that there is no requirement
that accounting outputs should have any semantic content (correspondence with current
real-world events, transactions, or values) or be subiect to falsification rules. They
counter by using the argument that the role of accounting is to allocate the historical
cost of resource usage against revenue the matching concept - to determine the
-
surplus secured from economic activity. In this case, assets, Iiabilities and equitl' are
"
;;:
;:?ti
::'r1.',"r,t'Jf
thenrm,sp."d,:;;i:T$:Jrl"?:T:.^:::,.fi
users rhe likelv life and value
:.:Hi"ffi i:i:-,,":m:*i:.,,_?J
of th" urr"i" Agenry*-tr;;;;;s
technique required to minimise that the accounring
the costs of
to situation. Moreover, different potrticat .or.t.ucti.rg will often differ from situation
ana ."gutotJry .or,, ,rr"o each
firms seek to minimise all cosrs, firm. Since
because historical cost alrocarion
frt ili lhoor" different u..o.,r,ir.g rechniques
allows l-ri u.turrtiul ,rr,,b;.;;;llocarion and
then firms can simply choose rechniques,
ttr" _ort technique.
"in"cient
should be pragmatic only to the extent that they were surrogates for
direct experience'
when observing financial statements, users should act
The pragmatic tests were that,
represented'S
as though they actually observed the events the financial statements
Although this methodoiogy has both syntactic and semantic features, it relies mainly
'hypothetico-deductive''
on synlctic relations andiherefore has been labelled
An important question in this accounting research concerns the usefulness of
of operations based
accounting data. Are the quantitative data we derive from given sets
To find the
on an overall theory of accounting useful to users of financial statements?
accounting systems
answer, what was usually done was to take the output data of specific
and determine whethei this data helped decision makers make the right financial
theory. Figure 2'1 indicates the
decisions. This is a direct approach to testing accounting
makers use accounting
procedure. The arrows signit, the output of each model. Decision
predictions, they decide
data to make predictions about the company. Based on these
what to do, such as sell shares in the company or buy more'
Accounting
system of
company X
[:j:il#ff"lT:*.iiJ:l"jl?,".,::,_lT:.]:l
local authorities from I Anril rnin r_'-i^::^:''
April 2010lor the
.\EPUrr'rrrB )tanoards
T,"p.iing
preparation
standards aare to be used by UK
r,_ not . - ,, I of
ur
one of tt-,oru *no {o;I;;;' "
Nrnr, I'm
Now, ^^. usuaily th"eir
tr rcrr dLcounts.
"..orn,r.
,""y,'lr;;"i;;;.";rl
monev/ Iargetv because irn"" is c:irr ,^u u^^^'lllsuggesting
the public sector is wasring
'rid;;J;;;"; ##;?t;ilr;'J"#""c
au i'
when a1
of human fallibility than the )re prone to the frailty
orivate .".r^. ;,^,iJ.^ r i,h-.,^ ...:".-- ,
j
:j : 1T
ffin.u,,on
fl,,l j:il :i: *1,,: ::ii
thisi,loccasion r,, goingll, ,,-s.,,;iJ;ffiT:iX#i::[n:frT::flffil
t"ffi""#J;#,: i;n I f :,li:,;11
waste. "",
a straightforward con.
lamangry.AndsoshouldalllocalauthoritytaxpayersintheUK'We'regoingtobetaken
for a ride unless we Protest now' org ul<
corporate accor-rntabilitv' w$'w t'rxresear.ch
-souft.e,: Tax Research UK, Rich;rrcl MUrllhy orr tax ;lncl
Questions
I";";;;;l."mments on the dirrerent theories :1 u.."y1,1,19^*::::T::[1y,[:^^P' what
#;;;;;; ;. ilnf
a;: I^'"i ii r ns deemed
r in approp
w!
j3 r o-ca t
ri ate.
dirrerent
t
11tn'.1':'::1svstems? For
accounting
.,
i:::Tff;;;:d#;b; M;;phy
thoutd
have
local auihorities? For different countries?
3.WhatapproachisMurphyusingwhenheaddressesthequestionofaccountingforlocal
authorities?
4.WhydoyouthinklFRShasbeenadoptedforlocalauthorities?lsitscientificor
unscientific?
; lfrit'ff:',"|:fl ,.;ru:,:#iru;fi'
u, u"; ilil;''ini,, *i n
rhat invesrors have
t" n y
Commodities are a particulai
concern. I think Xstrata's Mick
r
","",
r ir,
",
Tuesday when he oointed Davis caught the mood on
to the "frothi irrui r-,ra
"sentiment has been driuingp,i.ir,';;;;,^;h;, ";;;;;il ill
,.rn_ro in metat prices.
a more pragmatic reading of
frndrr;;;;;,',-n-" *l,"nua. r,m arso
the domestic interest rate outlook expecring
Equity investo^ uoouui to be to soften the local currencv. -
searching ro, un excuse to take
pinching rhemserves, as rhey
..r" ,, i*'r"#wirh thejrLc-eri some profits. Many are sti,
in the US wourd be the rikerieu.r,.ryrii"r,n,, ,1rd,.,o* s..j f.*rne. Seling pressure
underwav, ,o,J J""ur,,n-,Lrw
rilri8.r.r,,, though with reporring
;:il#i::X.set rioaii'ii,rii'outcomes courd provide
so how should investors play this?
As volatility
"o. returns, the market will inevitably
foot many as it moves to find wrong-
accrued since the March rows
u'r"* rr"rr. you rook ,. arr.* ,J"rrtage of gains
una to.l ,Iini" u*ryi o, J. that have
out any shofl{erm voraririry,,
before the exp".,"a j"*.ir,_;#;rlHrLprion ,r, *r,, your teeth and ride
market trend? wharevel,Ralh of rhe dominanr
you rake,;i:;rry correcrion
remember whar we said back as an added opporruniry.
i, ,ra.r.rr.'ror"gu, ,"rring ,"ur;, Jusr
,o buy
Source: The Australian Financial
Review, O Rugust-ZOttO
, -itl',,il"
pp. 23,25, www.afr.com.
dips.
Questions
1. What is a bull market? What is
a bear market?
2' why would high commodity prices and'Jow interest rates herp to
maintain share prices?
' Hiil,;'#;'I:J'",:""'rvi'g tn"
'aJ'l'io u,v tr," 'aip,;ii,-thl, u no,.,ative rheory?
@= POSITIVE THEORIES
During the 1g70s, accounting
theory saw a,move back to empirical
methodorogy,
1,,:i :;,:[t ,|;T:'.:1
real world' Positive accounting
j:#
hmt * f*:* j##*[;H
iesearch first focused on empiricalry
:ffi* ffi:
the assumptions made by the-norm",t""l..""rting testing some of
questionnaires and other theoristr. Fo, ou-ple, by using
suwey t".rrrriq*r, attitudes
accounting techniques to the ,ofulrr"r. of different
y"r." d"-,:r^inea. a typicar approach *urio ,r*"y
of financial analysts' bank offrcers the opinions
inflation accounting methods
u"J on the usefurness of different
"Jiorrrants
in their J".irio.,
bankruptry or deciding whether
b b;;";;I shares).-rr.i"g l"rr.]"isuch as predicting
Another approach was to tesr
PART 1 Accounring theory
the assumed importance of accounting outputs in the marketplace. Tests attempted to
determine whether inflation accounting increased the information efficiency of share
markets; whether profit is an important determinant in share valuation; whether the
cost of gathering 'finer' accounting data outweighed the benefits; or whether the use of
different accounting techniques affected value.
Today, the greater bulk of positive theory is concerned mainly with 'explaining'
the reasons for current practice and 'predicting' the role of accounting and associated
information in the economic decisions of individuals, firms and other parties that
contribute to the operation of the marketplace and the economy. This research
tests theories that assume that accounting information is an economic and political
commodity, and that people act in their own self-interest. Positive accounting theory
in particular covers questions such as: Do firms substitute alternative ways of financing
assets when the rules governing the accounting for leases change?rWhich firms are more
likely to use straight-line depreciation rather than diminishin{-balance depreciation,
and why? The theory used to answer these questions generally revolves around
managers' incentives to ma-ximise bonuses based on their companies' profits, their
incentives to avoid breaching accounting-based debt covenants and thereby reducing
the cost of debt, or their incentives to use accounting techniques to divert attention
from their high profits if those profits would attract public or government scrutiny, and
perhaps lead to higher taxes. In this book, chapters 71, 12 and 13 focus on different
types of positive accounting theories.
The main difference between normative and positive theories is that normative
theories are prescriptive, whereas positive theories are descriptive, explanatory or
predictive. Normative theories prescribe how people such as accountants should behave
to achieve an outcome that is judged to be right, moral, just, or other-lvise a 'good'
outcome. Positive theories do not prescribe how people (e.g. accountants) should
behave to achieve an outcome that is judged to be 'good'. Rather, they avoid making
value-laden prescriptions. Instead, they describe how people do behave (regardless of
whether it is 'right'); they explain why people behave in a certain manner, for example
to achieve some objective such as maximising share values or their personal wealth
(regardless of whether that is 'right'); or they predict what people have done or will do
(again, regardless of whether that is 'right' or 'best behaviour').
Many positive theory researchers are largely dismissive of normative viewpoints.
Similarly, many normative theorists do not accept the value of positive accounting
research. In fact, the theories can coexist, and can complement each other. Positive
accounting theory can help provide an understanding of the role of accounting which,
in turn, can form the basis for developing normative theories to improve the practice
of accounting.
r= DIFFERENT PERSPECTIVES
To this point, we have focused on what may be considered to be a highly structured
approach to theory formulation
- the scientific approach. We start with a theory based
on prior knowledge or accepted 'scientific' theory constructions. When we obserwe
real-world behaviour that does not concur with the theory, we treat that anomaly as a
research issue and express it as a research problem to be explained. We develop a theory
to explain the obserwed behaviour and use that theory to generate testable hypotheses
that will be corroborated only if the theory holds. We then follow precise and highh,
stnlctured or predetermined procedures for data collection and, after subjecting the data
(usually) to mathematical or statistical techniques, we validate or refute the hypotheses
Tomkins and Groves disagree with this viewpoint. They see the naturalistic
research approach as being more appropriate to different ontological assumptions.ll
Differences in ontological assumptions imply different research styles and influence
the research questions asked and investigated. For example, we may view accounting
as a social construction. We may wish to understand what self-images people hold,
what underlying assumptions sustain that view, or what part this perception plays in
controlling the way they perform their everyday role. These are the ty.pes of questions
that might be researched using a subjective ontology.
Assumption
1. Realityas a concrete structure
2. Realityas a concrete process
3. Realityas a contextual fielcl of information
4. Realityas symbolic discourse
5. Realityas social construction
6. Reality as projection of human imagination
Source; C. Tonrkins and R. Croves. ,The
everyday accoLlttant ;r nd rese;rrch r.rg h is rea I itv,,,A
Orianitations Jlrl \orielr, rul. B. no. -1, 1 eB3, i a c oLtt1 t i n g
pp. -t6t 7 4.
Naturalistic research
Scientific research
is socially constructed and
Ontological . Reality is objective and concrete'
reality' a product of human imagination'
I
o AccountinB is objective
assumPtions I . Accounting is constructed reality'
-n"ut''ty
. Holistic
Epistemological
knowledge
t . Complexity of the world cannot be
approaches solved bY reductionism
. Reductionism
I
.
o TestinB of individual hypotheses lrreducible laws
. Laws iapable of Seneralisation
. Structured . Unstructured
MethodologY
. Prior theoretical base . No prior theory
on accounting
illustration of different perspectives
In the following arlicle as a fufiher
,Financial accounting: an epistemological research
theory formation, *,r".i, from theory
2oo7) provide an ov^erview of accounting
note' (Schiet-ttt, so'Uu, i;i-ni t't"tiu theories'
development and the ^t"ttott
view on the development of accounting
research note
Financial accounting: an epistemological
Borba' and Fernando Dal-Ri Murcia
by Eduarclo Schiehll, Jos6 Alonso
basic question
what is accounting? lt is amazing how
this
i""ffivvrvv /
:iTpl",' ii:ff:"lfT;:t:r"J:1
Y,:::ff ii:il''i8ili''t'ffi,if
precisely (Kam, Ivoo]' "\ 5rr.rPrc
recording,
otrv
t*ii*."*':.*":'i:.'iXffi:,'::H::','J,l
'nformation about an
identifying, measu.ns, ,":d 1":T:i:::l:?-*,::H'J concept was derived
:H:YIi;"T:",'^T1?',,,T:ilhtr11y:1**:il:*'l*;J}'ffi::T,'"-"1',fl ml
it emphasizes the application
;'j#fi,1iir",ilff';J il" il";".;;."pi, "i accounting,
I
-l
I
l
aspect of accounting knowledge. Viewing this definition from an epistemological perspectii e,
one might argue that the object of study is not well defined, the methodology (truth criterial
is not identified, and the purpose of accounting research is poorly delimited. The aim of this
document is not to criticize this specific definition, but to argue that one of the difficulties
in understanding accounting as a scientific discipline resides in its definition as stated in the
literature. Among others, the importance of viewing accounting as a scientific field is that
fundamental or applied research is the only way to generate and improve knowledge in a
scientific field. In other words, the relevance of, and incentives for, conducting research in a
specific discipline like accounting depend on the extent to which specific methods may be
applied to improve the discipline's body of knowledge.
Following this line of reasoning, we believe that in order to perceive and appreciate
accounting as a scientific field, a first, essential step would be to understand the distinctions
and associations between accounting theory and accounting practice. According to the
framework proposed by Kuhn (1972), for example, we may conjecture that accounting
theory is a body of statements or propositions connected by rules of inferential reasoning
(i.e. testable hypotheses or premises and conclusions) that form the general frame of reference
for the development or explanation of accounting practices. The study by Hendriksen (1982)
corroborates this argument, adding that accounting theory may be defined as logical reasoning
in the form of a set of broad principles that:
(1) provide a general frame of reference by which accounting practice can be evaluated, and
(2) guide the development of new practices and procedures.
According to these principles, we argue that the next step in perceiving accounting as a
scientific field would be to identify the accounting theories that are being developed and how
they are verified. ln this respect, Popper (1 982) suggests that accounting knowledge is a body
of normative and positive empirical theories built around inductive inferences.
"Normative" means that accounting theories contain imperative value judgments stemming
from factual statements about the object of study, e.8., the market value of firm equity. Another
justification is that normative conclusions are very often the origin of policy recommendations,
which may or may not be adopted by practitioners in the field. According to Watts &
Zimmermann (1986), normative theories are almost entirely devoted to the examination of
questions of "what ought to be done." Thus, this theory attempts to prescribe what information
ought to be communicated and how it ought to be presented. ln other words, the normative
theories attempt to explain what accounting "should be" rather than what accounting "is."
On the other hand, positive theories attempt to explain why accounting is what it is. They
describe not only what accounting information should and how it should be communicated
to its users, but also why accountants do what they do and the effects of all this on people
and resource utilization (Christenson, 1983). However, as suggested by Schroeder and Clark
(1995), ideally there should be no such distinction (normative versus positive) because a well-
developed and complete theory encompasses both what should be and what it is.
The empirical and inductive attributes of accounting theory are easier to justify. ln fact,
according to Sterling (970), only mathematics and logic can be classified as non-empirical
sciences. Accounting theories in particular are fundamentally based on experience and
observation. For example, the qualitative and quantitative variations of firm equity studied
in Financial Accounting, or the dysfunctional behaviors of budgetary control investigated in
Management Accounti ng.
However, accounting premises and conclusions are connected by inductive inference.
Double-entry bookkeeping system can serve to illustrate this point. The double-entry system
is based on noting changes in the wealth of a firm and an attempt to translate the qualitative
and quantitative variations in the firm's equity. The double-entry system, perhaps the first
and most important paradigm* of accounting science, was invented in the commercial city-
states of medieval ltaly in response to the emergence of trade and commerce. According to
de Roover (.1 938) the double-entry was born when people came to see that you could not take
something out of one pigeonhole without putting it into another. lt has emerged as a natural
outcome of the evolutionary process to the need of times (Kam, 1986). The first published *
Final remarks
This brief epistemological overview of the history of financial accounting
research
demonstrates how it gained importance as a hands-on activity
before the accountifg theorists
arrived on the scene. consequently, accounting practices were shaped
rry
interest in ti-re"i..r"ti"g
practitioners and the Sovernment authorities, which took a keen
protectioX
of capital markets and creditors. The capital market still wields a strong
influence over the
sociological and discursive branches of financjal accounting science.
Research programs
have been supporred by regulatory bodies such as ArcpA (Ls,c) ana
C|CA (Canada] and
professional accounting associations such as AAA (USA) and
CAAA (Canada)**. Financial
accounting research has also been impacteci by the corporative influence.
This influence
has taken the form of standards designed to control financial
accounting practices instead of
fostering discussion on the anomaliei between the reality and
evaluatioi of firm equity. As a
consequence, few paradigms or accounting theories have been
put forwarcl to guide ,"senrch
avenues in financial accounting. When Positive Accounting t'heory
brought"to u..ornaing
a.theory-testing approach, researchers embarl<ed on an eff"ici"nt capital
i-rarket approachl
which led to improved utilization of rigorous research methods and statistical
analysis. These
factors may have shielded financial accounting from criticism, and
therefore'creat,;;t,
compared to other management disciplines, wheie there was more incentive
for qualitative
and interpretative investigation. At the same time recent accounting scandals
involving highly rr
scientific fields.
x Both inductive
and dedrctive inferences may generate positive
or normative theories. pr
what and how accounting informarion ;, p,"i",,"J
attempt to prescribe what data ought to be communicated
n"J;.;;,;;;i;,.," ..,ffi:#li:ti:XTlT:ilii:,;::il::
and how ,r,"y i. b" iresented, that is, they artempr to
explain what should be rather than what is. Watts
& Zimmermann (19g6). "rgLi
*x AICPA is
the acronym for American lnstitute uf certified
Public Accountantsi crcA is the acronym
Accountants oI Canada; AAA is the acronym for chartered
for American 'Accounting,qr.o.irr_n,
--"-"'"'b and CAAA is the acronvm for
Canadian Academic Accounting AssoLiation.
References
Beaver,w. Financial Reporting: an accounting reuolution.3rd ed. prentice
Hall, 1998.
Belkaoui, A. AccountingTheory.3rd,ed. Dryden
Press, I993.
tTlrl:lr?;. (1e83), The Methodoiogv of positive Accounting. .rhe
Accounting Reuiew, v. 58,
de Roover, R. characteristics of Bookkeeping
before pacioro. Accounting Reuiew,p. 146, 1938.
clautier, M.; underdown, B. AccountingTheory and practice.sth
ed. pi,rnu, publishing, 1994.
Hendriksen, E. s. AccountingTheory.4th ed. Irinois:
Richard D. Irwin, Inc, p. 589, chap. 1_4,
Questions
1' outline at least two theories mentioned above
and describe the ontological and
epistemological assumptions made in each theory.
Questions
do businesspeople rear ir thev do not
' Yi,i:n,]|::lii,illX'l meet their rorecast earnings or
2' Mr Fletcher describes how he has learned
not to publicry disclose 5-year annual
growth lar8ets' Explain what is likely profit
to huu" .urr*d him io learn that lesson.
whar upp'o,.h'io',n;.'i .""r,,ucion In cominq
has Mr Fretcher appried? Exprain
;:l?Til:lsion'
Accounti ng theory
3. Can the scientific approach to theory construction and testing be useful in relation to
predicting when and how investors will react to earnings announcements? Why or why not?
4. What is the importance to society of developing a theory to explain the relationship
between earnings forecasts, earnings announcements, and share price movements?
Telstra Corp., Australia's largest phone company, reaffirmed its forecast for earnings and sales to
climb this year on growth from its mobile and internet units amid the global financial turmoil.
Earnings before interest, tax, depreciation and amortlzation will probably rise as much as
7 percent in the 12 months ending June 30, Telstra said today in a statement to the Australian
stock exchange. Sales this year may climb between 3 percent and 4 percent, the company said.
Telstra, based in Melbourne, stuck to its forecasts even as the credit crisis forces some
companies to cut earnings estimates. The phone operator is three years into a five-year plan
to raise profit by slashing its workforce by as much as 12,000 and has said it will invest more
than Ag'10 billion ($6.8 billion) to upgrade the speed and geographic coverage of its networks
to counter failing revenue from fixed-line operations.
"Unlike most companies at this time, Telstra is in an enviable position," Chief Executive
Officer Sol Trujillo told investors in Sydney today. "You can take it to the bank that we're
going to grow earnings."
- mobile-phone unit sales rose by a "double-digit" percentage in the fiscal first quarter ended
Sept. 30, he said.
Telstra, which has cut 9,584 jobs since it announced its five-year plan, expects to save
between Ag200 million and A$300 million in labor costs by June 2010, Chief Financial
Officer John Stanhope said. The phone operator had 46,649 workers at the end of June 30,
according to its annual report.
Source: O 2008 Bloomberg L.P. All rights reserved. Used with permission.
Questions
1. What market backlash do businesspeople fear if they do not meet their forecast earnings or
growth targets? Why?
2. Can the scientific approach to theory construction and testing be useful in relation to
predicting when and how investors will react to earnings announcements? Why or why
not?
3. What is the importance to society of developing a theory to explain the relationship
between earnings forecasts, earnings announCements, and share price movementS?
lil
early literaturJ on auditing focused on
arising in the conduct of an audit, such issues
as the emphasis on flaud detection,
of errors of principre and the nature of account discovery
verificarion. 1r th; pa;;# ,rr..";i
to auditing theory development is evident in early
principles of auditing' For example, the
tot, the p.o."r,
concept of professional "4pt"iring ".rd
scepticism has its roots
in principles laid down in nineteenth-century
legal cases, such as Kingston cotton
(in 1896) and London and Generat Bankii M1116
the Kingston cotton Mill case deflned the
1ii rsssl'*;l""or"^ent of Lopes L| in
auditor's responsibilities with respect to
detection of fraud as the right to believe the
company representatives, provided reasonable
care is taken' Further cases in various jurisdiitions
refined and developed the concept
of professionar scepticism,lB and the auditing
standards have adapted and deveroped
over time to incorporate this concept.
Today's standards still refer to the auditor,s
to accept records and documents as genuine, right
provided the
if any condition creates doubt about Lut presumption.le auditor investigates further
Mau1z and Sharaf in 1961, attempted
to generalise the existing literature and provide
a comprehensive theory of auditing.2, Their
modvation ,o *riL the monograph was
to counter the prevailing view that auditing
was a practical exercise, not only without
any theoretical underpinnings, but not requiring
theoretical developmen 1.21 Matstz
and sharaf argued that practical issues
could be ,"iorrr"a o.rry tf a"r"top_ent
of theory' They provided eight postulates and use
as a foundatio.r iorih" theory of auditing
and developed the basic concepis of such
a theory. These concepts were identified
evidence, due audit care, fair presentation, as
ira"p"ra"r." conduct. However,
although these concepts are now embedded ""j ",rrr;al and
inthe auditirgrtur;uras
the development of an auditing theory progressed regulations,
slowly in the years
folowing Maua
and Sharafs publication.zz
The normative era of accounting theory
and research also coincided with a normatiye
approach to auditing th-eory. In the early
1970s the American Accounting Association
(AAA) established the committee on
Basic Auditing concepts to investigate
and function of auditing, to make recommendations rhe role
for research projects, examine
the problems of evidence, and issue a position
paper on the scope of auditing by
accountants'23 The repoft provides a normative statement
emphasis on concepts that should be studied
on auditing with an
by students, urrarrgg"r,ions for research
which may 'lead to better fulfirment of the
rore of auditing i., ,o.i"ry ,, The resulting
Statemenr of Basic Auditing Conceprs (ASOnA6;zs
emphajsed thl of auditing
as the collecting and evaluating
of evidence withtut fury a"rr"lopi.rg"rr".r."
the
evidentiary material is usedin the reasoning theory of how
process to support the auditor,s
The growth of positive theories of accJunting opinion.zo
in the ilz0s was accompanied by a
change in direction of auditing research.
Two major streams of research developed,
both of which relied on empirical data and
were design"J i; ; positive or scienrific
framework' Experimentalists focused
on a micro-level understanding of the audit
testing/judgement process (known as
IDM, or judgement/decision making research).27
This research sought to explain how
auditors make judgements and decisions
they could predict how auditors would so that
behave when placed in certain situations.
The early research in this field provided somewhat disturbing
iudgements by auditors when presented with the same
of differing
"rria".r."
informltion,28
effects appeared at least partly due to although these
the prolt"- of creating realistic audit
experimental setting.2e tasks in an
The other major stream of empirical
auditing research that
developed in this era
examined questions of auditor ctroice
by companies and the factors affecting
the level
PART 1 Accounting theory
of fees paid by companies to their auditors. This research was particularly interested in
whether the quality of audits performed by different auditors in different circumstances
difFered. DeAngelo3o argued that audit quality is positively related to audit firm size
because larger auditors have 'more to lose' by failing to report a discoyered breach in a
particular client's records. That is, large audit firms have more clients to lose than small
audit firms from compromising their independence on an audit in order to please
the dient. This theory helps explain why large audit firms dominate the audit services
market. Simunic3l developed a theory to explain that audit fees are based on client
characteristics and reflected the forces of demand and supply. This literature is based on
economic concepts of efficient markets and the role of the auditor in resolving agency
conflicts between shareholders, managers and lenders. These theories are discussed
further in later chapters.