Nature and Scope of Accounting

Definition of Accounting
AICPA said that Accounting is the art of recording, classyfying and summarizing
in a significant manner and in terms of money, transactions and events which
are, in part at least, of a financial character, and interpreting the results thereof.
While AAA, description of Accounting is the process of identyfying, measuring,
and communicating economic information to permit informed judgement and
decision by users of the information.

Logic of Double Entry

1. Classificational View

In this traditional view, double entry is represent a two classificational system

with a focus on the total assets. The assumption in this, is that people want to
know the two feature about the asset, Physical and Equity characteristics.

In this Classificational view, there is the equation, Assets = Libalities + Equity.

In the double entry system, the main concern is to keep count of the amount of
the total assets and its changes in the context of theri physical and equity traits.

2. Causal View

Causal double entry treats the increase-decrease total assets of a transaction as

a cause and aeffect relationship. Duality correlates with this cause-effect
association. While, the duality in the Classificational view indicate two
claasifications and increase and decreases in total assets are a seperate,
independent issue.

3. Significance of Double Entry

With the double entry errors can be found more readily and imposes a
systematic and orderly accounting of transactions. A lack of Accountatbility
cannot occur with the double entry, because oen transaction cannot be isolated
into one account.

Authoritative Bodies

1. Securities and Exchange Commision

2. Financial Accounting Standard Board (FSAB)
3. Other Groups
a. American Institute of Certified Public Accountants (AICPA)
b. American Accounting Association (AAA)
c. National Association of Accountants (NAA)
4. Canada Institute of Chartered Accountants (CICA)

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Accounting Theory
Theory is an abstraction, a construct, as opposed to something that is
operational in the real world. The theory of accounting envisioned here is an
elaborate deductive system consisting of three distinct levels of statements of
decreasing generality, At first level, at the top, consist of most general
statements. These are the postulates or basic assumption of accounting. The
second Level consists of principle or standard of accounting, and the last level is
composed of the statements on the specific procedures of accounting, such as
straight line depreciation method.

1. Need For Theory

For a long time, there is no general theories in accounting studies, FASB and
other Accounting organizaton tried to looked for the theory and decided that the
Conceptual Framework can be viewed as a general theory of accounting with
respect to business firm. FASB said that a general theory hope to lead to
consistent standard and... prescribe the nature, function, and limits of financial
stataments.

2. Agreement on Postulate and Principle

Entity Monetary Unit Exchange Prices
Continuity Time Period

Objectives of Accounting
FASB Concept statement No. 1 : Financial report should provide information that
is useful to present and potential investors and creditors and other users in
making rational investment, credit, and similar decision.

1. Information for decision making

Accounting information for the external users is based on the past events
but the orientation on the decision making itself is for the future. FASB
states investors, creditors and others need information to help them
form rational expectations... . Current value is the most relevant value for
decision making, but historical cost is still relevant for the decion making.

a. Decision theotretical Approach

Overall Theory Of Accounting Individual Accounting

System

Prediction Model Of Users

Decision Model Of User

2. Users of Accounting Information

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Users of externally reported accounting information are present and
potential investor, creditor, and other users.

a. Society Users

Everyone in the society is also a users of accounting information as they

are affected by reported accounting data whether they know or not and if
society is desgnated as users it lead to Social Accounting.

b. Naive or Informed Users

A trueblood committee believed that Financial Statement should meet the

needs of those who have limited Access to information and limited ability
to interpret it but FASB states that accounting information should be
comprehensible to those who have reasonable understadning of business
and economic activities and are willing to study the information with
reasonable diligence which means that the user has the responsibility to
learn to utilize it properly.

3. Information that is useful

A useful information is when there are two characteristic, relevance and

reliability. Revelant if it makes a difference in the decision of the user and
reliable if it represent what it purpose to represent. The useful information
itself include the truth, justice and fairness.

a. Circumscribed view
b. Allocation to capital

Efficient Market Hypothesis

A efficient Market Hypothesis talked about the stock price that adjust rapidly and
appropriately to the new information. EMH itself is diveded into three forms,
Weak, Semistrong, and Strong. Weak is when the prices reflect to all information
that is embodided in past prices. Semistrong when prices reflect all publicly
available information. Strong form is associated with the position that prices
reflect all information, both public and private. The one that importatnt for
accountant is the Semistrong as it quickly absorb the public information.

1. Market Inefficiency

Inefficient means that investor are not able to interpret new information
accurately, adn when a investor placed much higher value on the
company prospect it can lead into a disaster. Market efficiency cannot be
proved directly and it can only be inferred on the basis of empirical
findings that do not reject the hypothesis.

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EMH point out that securities market will be efficient, but it is not. Because
if EMH is valid, every one would expect that and poeple will recognize the
face and act in a manner consistent with its implications, but the action
taken by managers indicate a disbelief in EMH.

2. Implication for Accounting

If the semistrong form of the EMH is true then it is useless for companies
to manipulate accounting method and if the information is publicly
disclosed, the market is not decieve by these tactics. The EMH does not
assert that accounting data are of no value, Beaver stated It may very
well be that the publishing of financial statements data is precisely what
makes the market as efficient as it is. Even if EMH is true, it can only be
applied to stock amrket.

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 The Scientific View and Accounting
Theory Formulation
1. What is Theory
Theories can be defined as hypothesis or proportions, a tehory need to
have a general scope and must have a wide application.
2. Parts to Theory
Syntatics (Logical Relation), the one who linked the basic concepts.
Semantics, the one who linked the concepts to objects in real world,
sometimes reffred as rules of correspondence, or operational definition
and the more precise the relation, the less possibility of
misunderstanding or error.
Pragmatics, not many theories involve the pragmatics aspect and
pertain to the effect of words or symbol on people.
3. Paradigms and Scientific Development

A paradigm can be considered a theory, hypothesis, frame of refence, school of

thought, or principle by which a group of investigators operate. If one theory or
set of procedure is dominat, it is the accepted overall paradigm and after some
time, the old paradigm is replaced by the new, which can be seen as revolution.
The establishment of the new paradigm generates a wave of research based on
it. In accounting, the conventional paradigm is based on the historical cost and
the principle of matching and sales revenue recognition. But there has been
numerous attack from the positive scienctific approach.

4. Accounting Theory

FSAB generate a conceptual framework rather than a overall theory and this
conceptual framework reveral the intituitive comprehension of various statment
that make up the theory of accounting. This Comprehersive theory should twll us
how to measure income and capital properly, theory is seen as an instrument
used by accountants to derive proper rules and procedures. And it lead to
interpreting this as explaination that lead to prediction. But the thory of
accounting do not have the explaination and prediction value, so this means that
theory of accounting is a set of assumption, definition, recognition and
measurement principles and procedures for the purpose of determinign income
and capital.

5. Normative and Positive Theory

Normative Thoery is dominating the accounting research in the past and it

usually include the should or ought statement. The notion is that we must find
what is the best or most feasible and prescribe this as the way practice should
be done. While Positive theory see the objective accounting as an attempt to
explain and predict accounting practice.

Why there is a demand for accounting research

a. Information Needded

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 b. Pedagogic demand
c. Justification demand

The misconception in positive theory is when the positive phylosophy fail to note
the difference between a theory that has to do with accounting entities and a
theory concerning the behavior of individuals.

Testing of Theories
1. Criteria of Truth

Truth and criteria of truth is different, in truth it deals with question of

what it means for a statement to be true, while Criteria of truth delas with
question of how we are to recognize a statement as true. The term truth
itself refers to a quality that is attributable to a statemetn or a belief.

Three different criteria bases :

a. Dogmatic Basis

Dogmatic is when we believe the statement that are made by others, in

accounting it means that we follow the rule and procedures that been
stated by the Accounting Organization. The weakness of these is that
introspective evidence, is acceptable in determining whether the
statement is true and the objective of these statement is secondary.

b. Self-evident Basis

The Justification of self evident as a way to determine truth is the

reasonableness, sensibility, or obviousness of a statement based on our
general knowledge, experience and observation. The Criterion of self-
evidence has revealed its untrustworthiness in the sciences. Some proves
false and no longer considered as self-evidence truth.

c. Scientific Basis

In this basis, there are two categories that need to be filled, first are those
statements can be ascertained to be true or false by logic or reasoning
alone. Second, are those statement whose truth or falsity can only be
known by reference to empirical evidence. Numoreous proposition in
accounting relating certain variables to each other are tested
scientifically,but the evidence is often weak. In accounting practices,
Assertion are not ususally generally descriptive, but prescriptive or
singular in nature. Signular statement are nor in meaningful in scientific
testing whuile prescriptive statement can only be tested in pragmatic way.

Measurement Theories

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 1. What is Measurement

Norman Campbell Assignment of numerals to represent properties of

material systems other than numbers, in virtue of the laws governing
these properties

Stevens Assignment of numerals to objects or events according to rules

2. Scales

The rule to assign number create scale. A scale shows how much
information the numbers represent.

a. Nominal Scales

Number are used only as a labels. The nominal scales simply represent
classification.

b. Ordinal Scales

Created when an operation rank-orders ther objects in question with

respect to a given property. The weakness of the ordinal scales is theat
the difference does not necessarily equal. The difference do not tell
anything about the difference in the quantity of the property of the
objects, another weakness is theat the number do not signify how much
of the attribute the object possess.

c. Interval Scales

In interval scale it is not only the rank order of the object is known but
also the difference between one to another is equal, and there is a
selected zero point in the scales. The difference between numbers can be
translated directly to reprents the difference in the characteristic of the
onjects. The weakness of the interval scale is that the zero point is
arbitrarily established so that the numbers do not convey as much
meaning for a ratio scale.

d. Ratio Scales

Ratio Scales is where (1) the rank order of the objects or events with
respect to a given property is known, (2) the interval between the objects
are equal and are known, (3) a unique origin, a natural zero point, exists
where the distance from it for at least one object is known.

3. Permissible Operation of Sales

The ratio scale allows for all the fundamental arithmetical operations of
addition, subtraction, multiplication, and division, and also algebra,

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analytic geometry, calculus, and statistical methods. A ratio scale remain
invariant over all transformation when multiplied by a constant.The
invarianve of a scale permit us to know the extent to which a theory or
rule remains basically the same, even though the scale is expressed in
different units, such as meter to inch.

With an interval scale, not all arithmetical operation are permissible.

Addiction adn subtraction can be used but Division and Multiplication
cannot be employed with reference to the particular number, only to the
intervals. While with ordinal scales, none of the arthmetical operation can
be employed.

Kinds of Measurement
1. Fundamental Measurement

A fundamental measurement is one where the numbers can be assigned

to the property by reference to natural laws, and which does not depend
on the measurement of any other variable. Fundamental propertive are
additive, and it is simple to find the physical parrarels to the operations of
arithmetic.

2. Derived Measurement

A derived Measurement is the one that depends on the measurement of

two or more other quantities. Derived measurement operations depend on
known relationship to fundamental properties and based on a confirmed
empirical theory relating the given property to other properties.

3. Flat Measurement

A flat measuremnet is when a measurement would encompass those

based on arbitrary definitions, but the problem of this measurement is
becasue it is not based on confirmed theory, is the numerous ways in
which the scales can be constructed.

Reliability and Accuracy

1. Sources of error
a. Measurement operation stated imprecisely
b. Measurer
c. Instrument
d. Environment
e. Attribute unclear
2. Reliable Measurement

In Statistic, Reliability demands that measurement be repeatable or

reproducible, thereby demonstrating their consistency, but the reliability

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itslef is a measurement pertain to the precision with which a specific
property is measured by use of a given set of operations.

3. Accourate Measurement

Accuracy has to do with how close the measurement is to the true value
attribute measured, and even though the result is consistent, precision
and reliable it do not necessary lead to accuracy. The problem of this
measurement is when we did not know the true value. in accouunting, we
need to know what Attributes we should measure to achieve the purpose
of the measurement and the accounting objective itself is usefulness to
the information, which makes accuracy of measurement relate to the
pragmatic notion of usefulness. But some accountant are not agree in this
term and it is wise to change the accourate term to validity.

Scientific Approach Applied to Accounting

1. Misconception of Purpose

There are two misconception of purpose in scientific approach applied to

accounting, the first is when someone using the sceintific approach to
acccounting, then it is to make scientists out of accounting practioners,
and they mainly become a researcher. The second misconception in
sceintific applied to accounting when people search for the absolute truth.
Absolute truth in science is not exist, as theory and also knowledge keep
evolving and people trying to find a new theory that fit the lacking theory
we used to know.

2. Testing Accounting Theory

The most critical question in Accounting theory is the usefulness of data,

what we want to know is Are the quatitive data, which we derive from
given sets of operations based on an overall theory of accounting, useful
to users ?

Accounting System of X company Prediction model of User Decision

Model of User

Decision whould be made based on the accounting data to make

prediction about the company. But there are problem in this diagram, First
if the prediciton is verified, it verifies the perdiciton model of the user, not
accounting system and second if the decision turns out to be the right
one, it verifies the decision model, not accounting system.

3. Other Viewpoint on Testing

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Mattesich recommends a long-range cost benefits analysis of the
accounting system, while Sterling believe htat accounting is part of
decision theory. While FSAB recommenf that certain qualitative
characteristic be considered as criteria for the selection data to report.
This includes the characteristic of relevance, reliability, neutrality,
comparability, and materiality.

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