Question 1 (1000 words maximum)
Explain why theories need to be evaluated. Identify and justify the factors you would consider before deciding that a theory appears sound. Apply the factors you have identified to an accounting theory of your choice (e.g. Normative, Positive etc).
A theory could be defined as a consistent set of concepts that are aimed to explain and foresee a particular occurrence or “phenomena” (Kerlinger, cited in Mathews & Perera, 1996, p.51). Accounting theory could be described as a group of practical constructs that implementconjectures on accounting issues into accounting procedures (Sterling, cited in Mathews & Perera, 1996). This definition usefully relates ...view middle of the document...
Prior to accepting a theory to be sound the following factors should be considered:
1) Ensure that the theory is based on a reasonable central assumption(Tilley, 1977).For example, normative theories are based on propositions considered by researches developing these theories and appealing to find reasonable solutions to certain issues (Deegan, 2009).
2) Does the theory apply its proposition logically when deriving a conclusion (Deegan, 2009). To illustrate, positive theories asses their assumptions using inductive logic in order to make certain predictions of phenomena (Deegan, 2009).
3) Whether the theory uses an applicable evidence to support its’ argument (Deegan,2009).Again, as positive theories are inductive they use observations of specific events as their evidence for the general conclusion (Mathews & Perera, 1996).
4) Whether the theory is advanced to any other existing theory (Popper, cited in Mathews & Perera, 1996). Deegan suggests that preference of one theory over another is based on “particular value judgements” and satisfaction of certain information needs (2009, p.16).
5) Do the majority agree with the theory so that there is a prospect of its implication in the relevant area (Deegan, 2009).
6) Whether the theory can be seen to be working in practice (Deegan, 2009).
In order to exemplify the application of the above factors in practice more thoroughlya concept of Historical Cost Accounting (HCA) could be evaluated. Starting with the first criterion, the central assumption of HCA is that “money holds a constant purchasing power” (Deegan, 2009, p.165). However, according to Elliot in current economic conditions that proposition could not be of the same value as it used to be upon its development as the following circumstances apply: constant changes in price level due to rapid modifications in “consumer preferences”, inflation andalterations in exchange rates (Elliot cited in Deegan, 2009, p.165). Thus, the HCA inclines tooverestimate profits during the periods of high inflation (Deegan, 2009). That inconsistency of the central assumption of the concept might have an impact on financial management decisions (Deegan, 2009).
Equally, when applying the second criterion there is a concern whether the HCA concept enables users to perform logical calculations with financial parameters. For instance, the relevance of totalnon-current assets derived from assets revalued in different periods of time might be argued as during those periods money had different purchasing power (Deegan, 2009). Likewise, certain assets such as inventory, for example, that might be valued at net realisable value, could be added to assets that are valued at cost (Deegan, 2009). Thatcould question the relevance of the information performed in the financial statement.
Furthermore, in regrds to the third criterion the HCAas a theory derives its supportive evidence from the fact that it is currently applied in practice among the majority of business...