CHAPTER HIGHLIGHTS - Accounting Theory (9 th edition) CHAPTER HIGHLI...

Chapter 2: Accounting Theory and Accounting Research Instructor’s Manual

Accounting Theory (9 th edition) Page 1 of 9

CHAPTER HIGHLIGHTS

The chapter provides the student an appreciation for the contribution of research to the general growth of our knowledge about accounting. It shows how accounting research affects the standard-setting process in financial accounting.The chapter focuses on the roles of deductive and inductive reasoning and how they relate to financial accounting. It is also important to stress that these methods are complementary and not an either/or orientation. It is important to stress that empirical research generally looks at fairly small, manageable types of questions. It thus can provide input to the standard-setting process.Making accounting rules, however, must still be seen as a normative function. The chapter also stresses that empirical research cannot be value-free. Values are embedded in the questions that are asked and the parameters that are used in attempting to measure phenomena.Given the rise of formal approaches to theory and a concern for the process of measurement discussed in Chapter 1, the question arises as to whether accounting is an art or a science. A science might be defined as a discipline or area where considerable measurement problems exist.In the physical and natural sciences, there should be a high degree of consensus among measurers. This will be less the case in the social sciences simply because of the variability of human behavior. Nevertheless, they should come under the domain of science. Accounting could certainly move closer to the science realm as a result of the rise of scientific method and the concern for measurement.The chapter also briefly discusses accounting research directions or trends. These are expanded throughout the text. The chapter closes with a look at the question, stemming from Kuhn, concerning whether a “scientific revolution” is occurring in accounting. At this time, the answer appears to be a fairly clear “maybe.” The included PowerPoint, revolutions and paradigms.ppt, references an article from The Wall Street Journal, that suggests the beginnings of a paradigm shift.

QUESTIONS

Q-1 Do you think that the work of a policy-making organization such as the FASB or the SEC is normative (value-judgment oriented) or positive (oriented toward value-free rules)? Discuss.It is unquestionably normative because judgments must be made in accordance with objectives or other criteria. While a standard-setting group may attempt to be neutral, it usually must decide among different positions, each of which will have its adherents. A standard-setting organization may use empirical research (which attempts to be descriptive or positive) as part of its input into the standard-setting process. Ijiri used the term “policy science” to describe financial accounting.

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Chapter 2: Accounting Theory and Accounting Research Instructor’s Manual

Accounting Theory (9 th edition) Page 2 of 9 Q-2 An individual who was appraising accounting education had the following premises

(assumptions):

• Accounting professors used to do more consulting with accounting practitioners than they do today.• Accounting professors have become more interested in research that is abstract and not necessarily practical.He, therefore, concluded that accounting students are not as well prepared to enter the accounting profession as they used to be. Which type of reasoning was the individual using? What is your assessment of his conclusion?The individual used deductive reasoning. The conclusion was not warranted from the premises because accounting professors generally teach “what is” as opposed to what research may say or imply.

Q-3 In 1936 the United States was still suffering from the Great Depression. During the presidential election campaign, an extensive survey of voter attitudes was undertaken to find out whether the public preferred the incumbent, Franklin Delano Roosevelt, or the challenger, Alf Landon. The sample was gathered randomly from telephone book listings throughout the country. A preference was found for Alf Landon; however, Roosevelt won re-election by a huge landslide. What type of research was being conducted? Why do you think it failed to make an accurate prediction?

The method employed is inductive (empirical). The research failed because in 1936 a representative sample could not be gathered solely from people who had telephones because large segments of the population did not have telephones. The magazine (The Literary Digest) in fact failed as a result of its prediction that Landon would win; Franklin Delano Roosevelt won in a landslide. Interestingly, at about the same time pundits predicted that a telephone in every U.S.home was an impossibility. The reason being that the female population was insufficient to run the manual switchboards.

Q-4 In accounting, deductive approaches are generally normative. Why do you think this is the case?

As long as there is a value judgment or normative type of premise in the system, the results must be normative. If the premises (assumptions or postulates) are purely descriptive, it is highly likely that the conclusions derived from the system will be trivial. Therefore, the real issue is one of how acceptable any normative premises can be made.

Chapter 2: Accounting Theory and Accounting Research Instructor’s Manual

Accounting Theory (9 th edition) Page 3 of 9 Q-5 A frequent argument is that inductive reasoning is value-free because it simply investigates empirical evidence. Yet some charge that it is not value-free. What do you think is the basis for this charge?As long as there are choices to be made, then research cannot be value-free. The choice of what one examines (question A versus question B) entails a value judgment. Parameters used in the research require value judgments. Furthermore, assumptions that may not even be stated are evidence that value judgments are being employed (the assumption that economic systems tend to move toward equilibrium is a value judgment, for example).

Q-6 Several years ago an author stated that corporate income could be scientifically ascertained, but any type of adjustment for inflation would be pure folly because measurements would tend to become very subjective. Do you agree with the author’s appraisal? Comment in detail.The question pertains to an actual article that appeared in the early 1950s. The word “scientifically” was not defined in the article, so it is difficult to know what the author meant.The word was, however, undoubtedly being used to create an impression. The author appeared to be willing to sacrifice more economic reality (“faithful representation,” as it would now be called) because of a presumed lack of objectivity in measurement. The position was not unreasonable, but the real issues were hidden because of the way the author phrased his belief.

Q-7 Of the four disciplines in the following list, which do you think qualify as sciences and which do not? State your reasons very carefully.Law Medicine Cosmetology Accountancy Cosmetology (barbers and beauticians) is concerned with a relatively frivolous subject matter; hence, it should not qualify. While law uses a system of precedence and deductive reasoning, the judge (not to mention the jury) ultimately employs judgments in making decisions. The lawyers, of course, have vested interests. Measurement is not directly applied except in a crude ordinal fashion. As the chapter states, accounting is moving somewhat toward the realm of science. Policy-making in accounting may use the results of research, but it is not a scientific endeavor itself. Medicine might fall into the category of an “applied science,” because the results of scientific endeavor are used for particular purposes. There is a fair analogy between accounting and medicine, but accounting is certainly far cruder at this time.

Chapter 2: Accounting Theory and Accounting Research Instructor’s Manual

Accounting Theory (9 th edition) Page 4 of 9 Q-8 Several occupations within two of the aforementioned disciplines are listed here.Which do you think come closest to being scientific?Accounting researcher Chief accountant for an industrial firm Medical researcher Doctor (general practitioner) The accounting researcher and the medical researcher obviously come closest to being scientists, insofar as their work should be value-free (though this is not totally possible). They should be using formal research techniques to attempt to shed light on unanswered questions. Significant measurement problems are also present in work of this sort. Other researchers should arrive with similar results when they employ the same methods the original researchers used. However, replications should more easily come up in medical science than in accounting, because accounting is a social science where measurement pertains to human beings and their actions, choices, and values, and disagreement at basic research levels tends to be present.The chief accountant and the general practitioner are using or applying the results of science as opposed to being scientists themselves. As a result, they fall more into the line of being professionals. Furthermore, the chief accountant undoubtedly is not neutral in his work: he is concerned with making his firm look as good as possible. The doctor should be concerned with maximizing the health of his patients as opposed to maximizing his or her own wealth.

Q-9 What are some of the pitfalls of empirical research?There are many pitfalls. Sample size relative to the universe being examined should be large enough to draw an inference with minimal chance of an incorrect conclusion. The parameters selected should be reasonable: for example what do we mean by “large firms” and “small firms.” Does the evidence that we examine really pertain to the hypothesis selected? Thus the presumed relationship between general price level adjusted income and reported historical cost income may or may not indicate something relative to a firm’s self perception of whether it may be subject to anti-trust action or other types of pressure if it is deemed to be large. We should also be careful of data manipulation possibilities: Watts and Zimmerman themselves determined the general price level adjusted incomes of the firms examined. It goes without saying that appropriate statistical tests and methods should be used.

Q-10 If Watts and Zimmerman are correct that managers of very large firms oppose accounting standards that would raise their income and favor those that would lower it, what policy implications would this have for a standard-setting organization such as the FASB?Managers of very large firms might fear possibilities such as antitrust action, excess-profits taxes, and adverse public opinion, which could unfavorably affect sales and profits. These same possibilities could affect FASB’s deliberations. Since one of the hallmarks of FASB deliberations is due process—listening to those who would be affected by accounting standards—it would be useful to understand firms’ motivations. If the FASB knows a lobbying firm’s intentions, it helps the FASB maintain its neutrality.