Muhammad Faizal

1201103040015
1. Deductive Method
Deductive

approach

to

accounting

theory

construction

begins

with

establishing the objective of accounting. Once identified, definitions and

assumption must be stated. The researcher must then develop a logical structure
for accomplishing the objectives, based on the definitions and assumptions.
Deductive method begins with basic accounting premises and proceeds to
derive by logical which means that the accounting principles as the guides and
bases for the development of accounting techniques. This method moves from
the general to the particular. The steps used to derive the deductive method will
include:
1. Specifying the objectives of financial statements.
2. Selecting the postulates of accounting.
3. Deriving the principles of accounting.
4. Developing the techniques of accounting.
Example: An economist who asks wether a government program of public works
spending will stimulate a region's economy will proceed to research the issue,
collect and analyze data, and based on conclusions, form a general theory about
the economic impact of fiscal policies.

2. Inductive Method
Inductive method emphasis making observations and drawing conclusions
from it and is often be going from specific to general because the research
generalizes about the universe on the basis of limited observations of specific
situations.
Applied to the accounting, the inductive approach begins with observations
about the financial information of business enterprises and proceeds to construct
generalizations and principles of accounting from those observations on the
basis of recurring relationship. The inductive method to a theory involves four
stages:
1. Recording all observations
2. Analysis and classification of these observation to detect recurring
relationship.
3. Inductive derivation of generalizations and principles of accounting from
observation that depicts recurring relationship
4. Testing the generalizations.

Example: The only way to study the spending habits of a particular society is to
collect the spending data of each individual. After analyzing those data, you can
make generalizations about the spending habits of the society. This process is
known as inductive reasoning. As you notice here, induction moves from a part
to the whole.

3. Normative theory
Normative (Prescriptive) theory prescribe the particular action based on
what the researcher believes should occur in particular circumstances (the
norms/values/beliefs held by the researchers proposing the theories). However, it
is not based on observation and therefore cannot be evaluated whether they
reflect actual accounting practice or not. They may rather suggest radical
changes.
Normative theory attempts to justify what ought to be, rather than what is.
The major criticism of normative theories is that they are based on value
judgments.

4. Positive Theory
Positive (Predictive) theory focuses on explaining and predicting accounting
practice, rather than prescribing such practice. This theory developed through
some form of deductive (logical) reasoning in explaining particular phenomena. It
also attempts to find relationships that actually exist by undertaking the good
predictions of real world events through the numerous observations that based
on empirical observation.
Positive

theory

of

accounting

principally

developed

by

Watts

and

Zimmerman, which is called Positive Accounting Theory (PAT), seeks to

predict and explain why managers elect to adopt particular accounting methods
in preference to others. The central of development of PAT was the acceptance of
the economics based on rational economic person assumption. This is an
assumption that an accountant (all individual) is primarily motivated by selfinterest (tied to wealth maximization), and that the particular accounting method
selected will be dependent upon certain consideration.
Positive accounting practices are best used when trying to set future
economic policy based on theory.

It has three hypotheses around which its

predictions are organized:

1. The bonus plan hypothesis states that all other things being equal,
managers of firms with bonus plans are more likely to choose accounting
procedures that shift reported earnings from future periods to the current
period. By doing so, they can increase their bonuses for the current year.
2. The debt covenant hypothesis states that all other things being equal,
the closer a firm is to violating accounting-based debt covenants, the
more likely the firm manager is to select accounting procedures that shift
reported earnings from future periods to the current period. By increasing
current earnings, the company is less likely to violate debt covenants, and
management has minimized its constraints in running the company.
3. The political cost hypothesis states that all other things being equal,
the greater the political costs faced by the firm, the more likely the
manager is to choose accounting procedures that defer reported earnings
from current to future periods. This is because high profitability can lead to
increased political heat, and can lead to new taxes or regulations.
Theories that explained why regulation is introduced:
Theories that seek to explain how regulation is developed. Some theories
suggest that regulation is introduced to serve the public interest by regulators
who work for the public good. Other theories of regulation assume that the
development of regulation is driven by considerations of self-interest. Overall,
the selection of one theory over another will depend on the views and
expectations of the researcher in question. No one theory of accounting can be
described as a best theory however, different theoretical perspectives can at
various times provide valuable insights in accounting issues.
1. Public Interest Theory
Public Interest Theory holds that the regulation put in place to benefit
society as a whole, rather than particular vested interests, and the regulatory
body is considered to represent interests of the society in which it operates,
rather than private interests of the regulators. In this theory, the government
assume as a neutral arbiter.
2. Capture Theory
Under this perspective, the regulated party to seek to take charge of the
regulator with the intention that the rules are advantageous to those parties
subject to the requirements.

3. Economic Interest Group Theory

Assumes groups will form to protect particular economic interests
Groups are often in conflict with each other and will lobby government to
put in place legislation which will benefit them at the expense of others
no notion of public interest inherent in the theory
regulators (and all other individuals) deemed to be motivated by self
interest
The regulator is not a neutral arbiter but is seen as an interest group
Regulator is motivated to ensure re-election or maintenance of its position
of power
Regulation serves the private interests of politically effective groups
Those groups with insufficient power will not be able to lobby effectively
for regulation to protect their own interests
Example: Industry groups may lobby to accept or reject a particular accounting
standard e.g. insurance oil, gas industry; Large politically sensitive firms found to
lobby in favor of general price level accounting in US (led to reduced profits) ;
Accounting firms lobbying to protect their own interests.