Summary 3 Financial Accounting Theory

Name : Aninda Putri Liyana

NIM : 2302112747
Topics : Accounting is seen from various interests, and groups and traditional
formulations in accounting theory

Over time, various approaches have been used to develop accounting theory. Some of these,
often called traditional approaches, are characterized by the absence of a rigorous verification
process and rely more on conventional reasoning than on new streams of research. These
approaches aim to build a conceptual framework for accounting and include the non-
theoretical, deductive, inductive, ethical, sociological, and economic approaches.

The nature of accounting has been described in different ways over time. The Committee on
Terminology of the American Institute of Certified Public Accountants originally defined
accounting as the art of recording, classifying, and summarizing in a meaningful way the
financial transactions and events of an entity, and interpreting the results. Later definitions
shifted the focus toward information, describing accounting as a service activity whose
function is to provide quantitative, primarily financial, data to assist in making informed
economic decisions.

These definitions portray accounting as either an “art” or a “service activity,” emphasizing its
role as a body of techniques that serve practical purposes in various fields. According to the
Handbook of Accounting, accounting is useful in financial reporting, tax determination and
planning, independent audits, data processing and information systems, cost and management
accounting, national income accounting, and management consulting.

Over the years, different images of accounting have shaped the development of accounting
theory. These images present accounting as a language, a historical record, a reflection of
current economic reality, an information system, a commodity, and an ideology. Each image
highlights a unique perspective on the role and function of accounting in society and
contributes to the way accounting theory has been formulated.

Accounting has been perceived as an ideological phenomenon- as a means of

sustaining and legitimizing the current social, economic and political arrangements.
Karl Marx maintained that accounting perpetrates a form of false consciousness and
provides a means for mystifying rather than revealing the true nature of the social
relationships that form productive endeavor. Accounting has also been perceived as a myth,
symbol, and ritual that permits the creation of a symbolic order within which social agents
can interact. Both perceptions are also embodied in the prevalent view of accounting
as an instrument of economic rationality and as a tool of a capitalistic system.

Accounting has long been perceived as the language of business, serving as a primary means
of communicating information about a firm’s activities. This view is emphasized in many
widely used accounting textbooks. For example, Ijiri explains that, like any language,
accounting shares common features with communication systems such as English. Business
activities are expressed in accounting statements just as news events are conveyed in
newspapers. However, expressing an event in accounting carries additional risks, such as
being misunderstood or even facing penalties for misrepresentation, false reporting, or
perjury. To be effective, comparability of statements is crucial, just as consistency is essential
for any language. At the same time, accounting must remain flexible to adapt to changing
economic and business environments.

The parallels between accounting and language can be better understood by looking at the
general features of language. Hawes defines language as a systematic arrangement of
symbols that follow certain rules, known as grammar. According to this view, language
consists of two main components: symbols and grammatical rules. Recognizing accounting as
a language therefore requires identifying its own unique symbols and grammar.

In accounting, symbols function much like the meaningful words of a language. These
include numerals, words, and technical conventions such as debits and credits, which are
unique to the discipline. Meanwhile, the grammatical rules of accounting refer to the
procedures and principles used to prepare and present financial data. Just as a speaker of a
natural language ensures grammatical correctness, the CPA (Certified Public Accountant)
certifies the accuracy of financial information by verifying that accounting rules have been
applied correctly. In this way, accounting rules formalize the structure of the discipline,
making it function as a language for business communication.

Accounting has often been viewed as a means of providing the historical record of an
organization and its interactions with the environment. For owners or shareholders,
accounting records serve as evidence of management’s stewardship over the resources
entrusted to them. The stewardship concept is rooted in the principal–agent relationship,
where the agent (management) is expected to safeguard and properly use the resources of the
principal (owners). Over time, the way stewardship is measured has evolved.

Birnberg identifies four distinct periods in this evolution: (1) the pure custodial period, (2) the
traditional custodial period, (3) the asset-utilization period, and (4) the open-ended period.
The first two periods emphasize the agent’s responsibility to return the principal’s resources
intact, with only minimal tasks required to fulfill the custodial role. During these stages,
disclosing balance sheet data was considered sufficient.

The third stage, the asset-utilization period, expands the agent’s role by requiring initiative
and judgment in using assets effectively to achieve agreed-upon plans. This period goes
beyond simple balance sheet disclosure and includes performance evaluation data to assess
how well assets are being used. Finally, the open-ended period differs by offering greater
flexibility in asset use, allowing management to redefine how resources are applied. Birnberg
explains that this stage not only requires initial direction but also the ability to recognize
when strategies must change. Much like strategic control, this version of stewardship places
significant responsibility on management and is often marked by limited structure and
considerable uncertainty.

Accounting has always been viewed as an information system. It is assumed to be a

process that links an information source or transmitter (usually the accountant), a
channel of communication, and a set of receivers (external users). Basically; when
considered as a process of communication, accounting can best be defined as “the process of
encoding observations in the language of the accounting system, of manipulating the signs
and the statements of the system and decoding and transmitting the result”. This view of
accounting has important conceptual and empirical overtones. First, it assumes that the
accounting system is the only formal measurement system in the organization. Second,
it raises the possibility of designing an optimal accounting system capable of providing
useful information (to the user). The behavior of the sender is important in terms of both
the reaction to the information and the use made of the information. Both behaviors
are the subject of conceptual and empirical research in the field of behavioral accounting. The
superiority of the image of accounting as an information system is stated as follows:
Alternative accounting systems need no longer be justified in terms of their ability to
generate “true income” or on the faithfulness with which they represent history. As long as
the different users find the information useful, the utility of the system can be established.
Accounting is also viewed as a commodity that results from an economic activity. It exists
because specialized information is in demand and accountants are willing and capable of
producing it. As a public commodity, accounting provides ideal ground for regulation,
making an impact on public policy and monitoring of all types of contracts between the
organization and its environment. The choice of accounting information and/or accounting
technique then may have an impact on the welfare of various groups in society As a result;
there is a market to accounting information with its derived demand and supply. This image
of accounting as a commodity is having and will continue to have a profound impact on
accounting thought and research.

The primary objective of accounting theory is to provide a foundation for predicting and
explaining accounting behavior and events. A theory is generally defined as a set of
interrelated concepts, definitions, and propositions that present a systematic view of
phenomena by identifying relationships among variables in order to explain and predict them.
However, it must be recognized that no comprehensive accounting theory currently exists.
Instead, the literature contains a variety of theories, many of which have emerged from
different approaches to constructing accounting theory or from efforts to develop middle-
range theories rather than one overarching framework. These middle-range theories often
differ because researchers interpret both the “users” of accounting data and the
“environments” in which accounting operates in diverse ways.

Such divergences led the American Accounting Association’s Committee on Concepts and
Standards for External Financial Reports to conclude that no single governing theory of
financial accounting can adequately address the full spectrum of user and environmental
needs. Rather, the field contains a collection of theories that vary according to these
specifications. In this context, Hendriksen defines accounting theory as a set of broad
principles that (1) provides a general frame of reference for evaluating accounting practices,
and (2) guides the development of new practices and procedures. This definition suggests that
accounting theory should serve as a coherent and logically structured framework for both
assessing current practices and shaping future ones.

McDonald further argues that for a theory to be valid, it must contain three essential
elements: (1) the encoding of phenomena into symbolic representations, (2) the manipulation
or combination of those symbols according to established rules, and (3) the translation of
symbolic results back into real-world phenomena. Each of these elements can be identified in
accounting. First, accounting makes use of unique symbolic representations, such as “debit,”
“credit,” and specialized terminology. Second, it employs translation rules by converting
economic events and transactions into symbolic form and then interpreting them back into
meaningful information. Third, accounting relies on rules of manipulation, such as techniques
for profit determination, which function as methods for processing and combining these
accounting symbols.

Although no single comprehensive theory of accounting exists, various middle-range

accounting theories have been developed using different approaches. For clarity, this chapter
will focus only on the traditional approaches to the formulation of accounting theory. These
approaches have gained greater acceptance and exposure compared to newer approaches,
which will be discussed later in Chapters 4, 10, and 11.

The traditional approaches can be grouped into two categories: non-theoretical and
theoretical. The non-theoretical, also called practical or pragmatic, relies on informal
reasoning rather than formal theory-building. The theoretical approaches, on the other hand,
include six types: (a) deductive, (b) inductive, (c) ethical, (d) sociological, (e) economic, and
(f) eclectic.

In general, the formulation of accounting theory and the development of accounting

principles have followed an eclectic approach, meaning a combination of several approaches
rather than reliance on a single one. This eclecticism reflects the numerous efforts of
individuals, professional bodies, and governmental organizations to contribute to the
establishment of accounting concepts and principles. As a result, newer approaches have
emerged in the literature, including the regulatory, behavioral, event, predictive, and positive
approaches.

The traditional approaches to accounting theory have employed either a normative or

descriptive methodology, a theoretical or non-theoretical orientation, and reasoning that may
be deductive or inductive. These approaches have also focused on different underlying
concepts such as fairness, social welfare, or economic welfare. Regardless of the approach, it
is essential to emphasize that any accounting theory must be tested and confirmed in order to
gain acceptance.