the conceptual framework, accounting principles and …

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THE CONCEPTUAL FRAMEWORK, ACCOUNTING PRINCIPLES and what we believe is trueQuintus VorsterAccountancy SA; Jun 2007; Accounting & Tax Periodicalspg. 30


degree of formalization of a theory leadsto six main types of theoretical structures:deductively complete theories, systematicpresuppositions, quasi-deductive theories,theoretical attempts, concatenated theoriesand hierarchical theories."

Two approaches in theory formulation shouldbe noted: the deductive approach and theinductive approach.

Hendriksen (1982:7) notes that all theoriesmust include elements of both deductive andinductive reasoning. The deductive approachessentially starts with certain generalisationsregarding a particular field of study andends with formulated rules and proceduralmethods regarding the chosen field of study.For financial accounting, the structure ofdeductive theory construction includes:

• the formulation of objectives of financialreporting;

• determining the postulates (acceptableassumptions) of accounting;

• setting constraints in order to guide thereasoning process;

• aset of symbols (or framework)within which ideas are expressed andsummarised; the formulation of principles;and

• the formulation of procedural methods andrules.

While the deductive approach starts with thebroad and the general (objectives, postulates)and ends with the specific (methods, rules),the inductive approach, on the other hand,generally follows the opposite pattern: itdraws generalized conclusions from detailedobservations and measurements. It shouldbe noted, however, that the data that areselected for observation in order to applyinductive reasoning, are selected throughdeductive reasoning, thereby rendering theoryformulation an almost endless iterativeprocess.

Accounting theories

Hendriksen (1982: 1) describes an accountingtheory as ~.. logical reasoning in the formof a broad set of principles that (1) providea general frame of reference by whichaccounting practice can be evaluated and(2) guide the development of new practicesand procedures~ According to him, anaccounting theory should provide ageneralframe of reference against which soundaccounting practices can be evaluated. Atheory encompasses aset of statements orpropositions ~.. connected by rules of logic orinferential reasoning. The statements mustinclude testable hypotheses or premises

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and a conclusion, although one or more ofthe premises may be based on explicit valuejudgements. The primary test of a theory,however, is its ability to explain or predict~

There is no universally accepted single theoryof accounting. By employing acombination ofdeductive and inductive reasoning processes,accounting theories are developed. DeeganEt Unerman (2006:5) state that there is nouniversal agreement on how accountingtheories should be developed, since thereare so many different perspectives on therole of accounting theory. They neverthelessdistinguish three broad categories ofaccounting theory, viz. prescriptive (normative)accounting theories, inductive accountingtheories and predictive accounting theories.An overview of the literature indicates thatthese broad categories appear (in some formor another) in most works on accountingtheory (Hendriksen, 1982; Ryan et aI., 2002,Belakoui, 2(04).

Prescriptive (normative) accounting theoriesare based upon what the researcher believesshould occur in particular circumstances.These theories describe what financialaccounting should be: what should beregarded as assets, liabilities and so on, andhow they should be valued. Since thesetheories are not based on observation, theydo not necessarily reflect accounting 122

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practice. Deegan & Unerman (2006:10) state,for instance, that Chambers advocated thevaluation of assets at market values at atime that historical cost accounting was theaccepted norm. The conceptual frameworkcan be viewed as a normative accountingtheory.

Inductive accounting theories are constructedby observation and by drawing generalizedconclusions from practical observations andmeasurements. This approach is probablythe oldest variant of theory construction inaccounting. Accounting practices that havedeveloped in apragmatic and even haphazardfashion, were observed, generalisations weredrawn from such observations and thesegeneralisations were eventually documented asaccounting theory. Riahi-Belkaoui (2004:113)notes that theorists such as HRHatfield, SGilman, A. Clittleton, WA Paton and Yuji Ijiricould be regarded as inductive theorists.

Predictive accounting theories (also called"positive accounting theories') focus onexplaining and predicting accountingpractice, rather than prescribing suchpractice. Such theories are also basedon observation and they often lead toaccounting research that is termed positiveaccounting research. Through observationof existing phenomena, they attempt topredict possible future outcomes, such as, forinstance, what particular accounting policiesare likely to be adopted by managers inparticular circumstances.

Beattie (in Ryan et al.: 107) states thatpositive accounting theorists such as Wattsand Zimmerman ':" argue that 'scientific'research can only be concerned with 'whatis' questions, it cannot be used to answer'what ought' questions': Positive accountingtheories can be contrasted with normativeaccounting theories. The latter describe whataccounting practices should be pursued,the former seeks to explain and predictaccounting phenomena. Examples of positiveaccounting theories include the use ofagency theory to help explain and predictmanagerial choice of accounting policies(Deegan and Unerman, 2006:212).

A brief historical perspective ofthe accounting frameworkAccounting as a discipline developedcenturies ago in an evolutionarymanner from the need to keep a recordof transactions between parties and

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to communicate the results of thosetransactions to interested parties. As thetransactions became more sophisticated,greater demands were placed on accountingdisclosure. To meet the demands, a setof "rules" was inductively developed asgeneralisations of existing practice to ensurethe orderly processing of accounting dataand a more consistent reporting framework.

The greater sophistication of businessactivities during the nineteenth andearly twentieth centuries necessitated aconcomitant sophistication in accountingpractice that, nevertheless, developed in arather pragmatic and haphazard fashion. Theaccounting "rules" became more voluminousand conflicting and, in general, lackedcoherence. The development of railways inthe USA and Europe since the second half ofthe nineteenth century (Salmonson 1969),the advent of the company as a form ofbusiness (Lee, 1974) and the concomitantdevelopments in the legal world, especiallywith regard to taxation (Alderman et aI.,1982), technological changes (Hendriksen,1982), the development of economics asa field of study (Salmonson, 1969), theestablishment of professional accountingand regulatory bodies (Beattie, 2006) and theglobalisation and growth of world markets(Beattie, 2006) were all contributing factorsthat necessitated the development of, andthe search for, a body of accounting theoryand the standardisation of accountingpractices.

In the USA, the Accounting PrinciplesBoard (APB) was established in 1959 asa committee of the American Institute ofCertified Public Accountants. One of theobjectives of the APB was to "formulate"principles, to standardise accountingpractices and to take the lead in solvingaccounting issues. During its existence, theAPB published thirty one opinions and fourstandards, the most controversial of whichwas probably Accounting Research Study no.I, entitled The basic postulates ofaccounting(1961), Accounting Research Study no. 3,entitled A tentative set ofbroad accountingprinciples for business enterprises (1962) andAccounting research study no. 4, entitledBasic concepts and accounting principlesunderlying financial statements ofbusinessenterprises (1970).

This body was, however, heavily criticised forits apparent inability to achieve its objectives(Spacek, 1969), resulting in the establishmentof two study groups, one with the objective

of establishing accounting principles (theWheat Committee), and the other to establishthe objectives of financial reports (theTrueblood Committee). The report of theWheat Committee ultimately resulted in thedisbanding of the APB and the establishmentof the Financial Accounting StandardsBoard (FASBj in 1973 the USA, with theexpress objective to formulate a conceptualframework of accounting, a seminal event inthe history of accounting. The latter body wasresponsible for the conceptual frameworkproject and soon after its inception in 1978published its first statement, Statements ofFinancial Accounting Concepts No. I, entitledSFAC 1- Objectives ofFinancial Reporting byBusiness Enterprises. Since then, a numberof SFACs have been issued by the FASB, as awhole constituting what is today known asthe FASB conceptual framework.

In the UK, against the background of severalpublic "accounting scandals", the AccountingStandards Steering Committee, later renamedthe Accounting Standards Committee, ASC)was established in 1970 (Beatie 2006:98). Amilestone publication of this body was Thecorporate report, published in 1975, dealingalso with the objectives of financial reports.During 1990, the ASC was superseded bythe Accounting Standards Board (ASB),which was responsible for the publicationof a conceptual framework documententitled Statement ofPrinciples for FinancialReporting in December 1999.

During 1989, the then InternationalAccounting Standards Committee (IASC)issued a statement entitled Frameworkfor the preparation and presentation offinancial statements, which in 2001 wasformally adopted by its successor body, theInternational Accounting Standards Board(IASB). This document is loosely based on theFASB's conceptual framework. The documentis, however, not an accounting standard andconsequently does not override any formalaccounting standard, such as InternationalAccounting Standards (lASs) or InternationalFinancial Reporting Standards (IFRSs). Itdoes not have the same authority as anIFRS. Where there is a conflict between theframework and a specific Standard, theStandard will always prevail.

Currently, the FASB and the IASB areengaged in a joint project to revise theirconceptual frameworks in order to refine,update, complete and converge them intoa common framework that can be used forthe development of new standards as well


as for the revision of existing standards. Animportant objective is for the standards to be"principles-based", implying that standardsmay not be a collection of conventions, butshould be based on fundamental conceptsor "principles" that should constitute aframework that is sound, comprehensive andinternally consistent. In order to result incoherent financial accounting and reporting,the fundamental concepts need to constitutea framework that is sound, comprehensive,and internally consistent. However, as is thecase today, once the converged frameworkhas been completed, some existing FASBand IASB financial reporting standardswill inevitably conflict with the concepts.Accounting standards will probably notimmediately be changed to reflect the new,converged framework, because both boards'standards assume hierarchical priority overconcepts, hence priority is likely still to begiven to standards. It is expected, however,that conflicts between concepts and standardswill gradually disappear as new, converged,principles-based standards are developedthat are based on the improved, convergedconcepts.

The conceptual framework is thereforean attempt to assist standard settersto harmonise accounting practices,standards and procedures, and to ensurethat accounting standards published byaccounting bodies are inherently consistent,as they will then theoretically all conformto the framework. An important furtherobjective of the framework is to provide abasis for reducing the number of alternativeaccounting treatments.

The relationship betweenaccounting theory, accountingstandards and the conceptualframework

From the brief historical perspective above,it should be clear that that neither theframework published by the FASB, nor theFramework of the IASB or the Statement ofPrinciples of the ASB could be described asthe theory of accounting. This will also betrue of the new converged framework, onceit is finalised. The framework is merely theculmination and, as such, a relatively tinyportion of what could be considered as thebody of normative accounting theory, howeverunstructured such body of theory may seemto be. The FASB should be commended for

its definitive work in this regard. Cognisanceshould be taken of the vast body of literature,research and debate that underlies thisframework, has ultimately influenced the latersimilar documents published by the IASC andthe ASB, and which will probably also have amaterial influence on the expected convergedframework.

The conceptual framework constitutes merely(a part of) the body of accounting theory,a normative theory. There is also a hugebody of positive and inductive theories to befound in accounting literature. Together theyconstitute the body of accounting theory.

Furthermore, underlying, and indeedsurrounding the framework, the postulates,principles, procedures, rules and conventionsof accounting are to be found. Accountingstandards do not necessarily encapsulatethe principles (or postulates) of accounting,however, they often do describe procedures,rules and conventions.

Therefore, to term the currentinternationalisation of accounting standardsas a move toward "principles-basedstandards" might be a touch ambitious. SirDavid Tweedie, chairman of the IASB, asreported in Accountancy SA (March 2007:5).implied as much with the statement that':.. (t)he IASB would be moving towardsprinciple-based standards with vigour in thefuture. The need by the regulators and theaudit firms for one interpretation or view onan issue had destroyed the principle-basedapproach to standard-setting and resultedin rules-driven standards': Principles-basedstandards will, inter alia, result in theelimination of exceptions to the scope of suchstandards and various accounting treatments.Application guidance will be limited.

Good news for accountinglecturers and practitioners

Sir David Tweedie's observations are good newsfor accounting lecturers and practitioners!

As most lecturers, with their students,slog through each rule, each bullet, eachconvention in (almost) every standard,illustrating each with numerous examplesin order to "ensure" that "everything" is"covered", while subconsciously believingthey're teaching the principles (even thetheory) of accounting, they may be forgivenfor occasionally falling into a state of despair.The sheer volume of what is to be "covered"is truly overwhelming. They may even beforgiven for believing that "everything" is

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capable of being "covered".

As practitioners struggle to find theappropriate accounting treatment, usuallyby way of analogy, of a transaction that isnot "covered" in any accounting standard,they, together the lecturers described inthe previous paragraph, should take heart.Sir David's message must go out to them:although we haven't seen them yet, r~al

principles-based standards, hopefully basedon sound accounting theory, are apparentlyon their way. What we believe, may indeedeventually become true.

Bibliography

Accountancy SA, March 2007.

Ahmed Riahi-Belkoaui , Accounting Theory,5th edition, 2004, Thompson.

Alderman et aI., Other comprehensive Basesof Accounting: Alternatives to GAAP?, Journalof Accountancy, August 1982

Beattie, Vivien in Ryan, Scapens andTheobald, 2002.

Bunge, Mario, Scientific Research I: TheSerach for System, Springer, 1967.

Chambers, R. J., Positive Accounting Theoryand the PA Cult, Abacus, 29(1).

Deegan, Craig Et Unerman, Jeffrey, FinancialAccounting Theory, European Edition, 2006,McGraw Hill.

Hendriksen, Eldon S, Accounting Theory, 4thedition, 1982, Irwin.

Lee, GA, Modern Financial Accounting, 1974,Thomas Nelson and Sons.

New Webster's Dictionary and Thesaurus ofthe English Language, 1992, Lexicon.

Ryan, Bob, Scapens, Robert Wand Theobald,Michael, Research Method Et Methodologyin Finance Et Accounting 2nd edition, 2002,Thompson.

Salmonson, Basic Financial AccountingTheory, Wadsworth,1969.

Spacek, Leonard, A Search for Fairness inFinancial Reproting to the Public, 1969, ArhurAndersen Et Co.

Watts, RL, and Zimmerman, J L, PositiveAccounting Theory, 1986, Prentice-HallInternational. ".~:

ProfQuintus Vorster is Head: Department ofAccounting at the University of Pretoria.

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