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Importance of Accounting Theory in Finance

Importance of Accounting Theory in Finance


A careful examination of accounting literature reveals the prospect for developing normative accounting theory that is capable of meeting society’s needs at any given time. Despite the importance and the possibility of developing such a type of theory, research concerning normative theorization ceased in favor of the new empirical accounting research, which investigates the usefulness of accounting information to decision-making. Launching this line of research was a consequence of changing the objectives of financial accounting. This study empirically analyzes the shift in academic accounting research as proxied by The Accounting Review (TAR). TAR is the American Accounting Association’s premier journal and the American oldest accounting journal devoted to the development of accounting theory. Coding of the articles published in TAR is the research method.

Accounting is not merely practiced processes and techniques. Chatfield (1977, p.217) documents that “accounting has always been based on a structure of ideas” that can be explained as “patterns of thought underlying accounting processes which afford rational explanations for particular methods which finally evolve.” Moreover, the emergence of accounting from practice (e.g. Hopwood, 1987; Sterling, 1977) does not mean that accounting should not possess its own philosophy (Ijiri, 1967) and general theory (e.g. Maskell, 1955; McCredie, 1957; Oehler, 1942; Wright, 1914). Such theory would not only base the already practiced procedures and methods on reasoning, but also assist accounting practitioners in deciding upon accounting procedures and methods that ought to be practiced.

Theory is “the soul of practice” to the extent that without theory to “animate” it, practice is “mere mechanism” (Wright, 1914, p.432). In addition, without a philosophical foundation, accounting becomes “a patch collection of practice” (Ijiri, 1967, p.ix). Hopwood (1987, p.210) emphasizes that “accounting, even in the conventional view, is not a mere technique. Knowledge does not stand outside of accounting…” Thus, a theory of accounting is necessary (McCredie, 1957). Such a theory is “a guide for practitioners in their individual decision-making capacity” (Archer, 1993, p.62). McCredie (1957, p.222) stresses that “the whole structure of accounting as a theory can be set up to precede the structure of accounting as [practiced].”

The relationship between accounting theory and accounting practice is well recognized by accounting writers, especially during the early age of the development of accounting thought (e.g. Maskell, 1955; McCredie, 1957; Oehler, 1942; Wright, 1914). The case has always been such that complexities create a demand for a sound theory upon which sound practice depends (Jastrow as cited in Wright, 1914, p.431). In a politically democratic society where “extensive financial control requires legitimation” (Montagna 1986 p.104) and given the increasing complexities of “our civilization and commercial machinery”, “sound theory” becomes for accountants a necessity to function fruitfully in society (Wright, 1914, p.432). “Accountants provide that legitimation,” Montagna (1986, p.104) continues to argue, “through theory and practice.”

Statement of the problem

The necessity of a theory for accounting extends to accounting research. Wheeler (1970, p.1) claims, “research without a theory leads to aimless wandering in the morass of data…with little hope of meaningful results in terms of the better understanding of accounting.” At the same time, in its development, accounting theory relies on academic accounting research. Wolk et al. (2004, p.29) assert that “an important segment of accounting theory is derived from the research process.” Thus, interdependence exits between accounting theory and academic accounting research.

Accounting theory has been associated with the separation between management and ownership in modern corporations. Writing in 1993, Mumford argued that “the term accounting theory has come over the past fifty years to refer to just a single aspect of corporate reporting” (p.8). Accounting theory has been used in conjunction with “the problem of financial reporting by corporate entities to external parities” (Mumford, 1993, p.8) created by the separation between ownership and control in corporations (Berle and Means, 1932). Gaffikin (1988a, p.10) observes that “almost all efforts (in English) were concerned with building a theoretical structure for external financial reporting.”

Purpose of the study

The main purpose of this study is to discover the theoretical basis for financial accounting. In 1926, DR Scott observed a tendency of accounting theory to become a body of principles. Because accounting rules cannot be justified in theory and practice (Jones, 1857), accounting rules cannot be integrated to a theory and thus do not yield a theory of accounting. Accounting principles, on the other hand, can be integrated in a form of theory (see for example, Carlson 1964; Cohen, 1960). Accounting practice has developed from “fundamental premises” (McCredie, 1957, p.222) that can be established in the form of a theory of accounting. Accounting theory, which is based on principles (Chatfield, 1975; Flesher, 1991), can guide accounting practice.

Several studies have explored and investigated the decline in accounting theory. Analyzing the first fifty years of TAR’s publications, Chatfield (1975) concludes that the era of the middle 1950s can be characterized as an epoch of candidates for accounting theory. Chatfield (1975) also concludes that since the beginning of the 1960s, the emphasis of TAR on accounting theory, as it has been traditionally understood, declined in favor of empirical studies. Chatfield’s (1975) study does not present data supporting such conclusions, nor does it reveal explicitly what materials constitute an article focusing on accounting theory. In defining accounting theory based on accounting principles, Chatfield did not list the accounting principles that allowed him consider an article to be about accounting theory.

Other studies utilize data to show that such a decline has occurred. Some of these studies do not describe how accounting theory is defined while others lack definitions for normative accounting research. Analyzing 80 years of TAR’s publications, Heck and Jensen (2007) argue that normative accounting theory is approaching zero, but they do not reveal how normative accounting theory is defined in their study nor do they report data supporting their arguments. Instead, they cite previous studies like Chatfield (1975).

Oler et al. (2008), who report a similar finding, loosely define normative accounting research. Oler et al (2008) define traditional normative research as “catch-all.” They list categories for classifying articles. At the bottom of their classification, they have a category called normative accounting research. Articles that do not fit under other categories are classified as normative accounting research. Such a definition is not well defined operationally. Some accounting researchers may face difficulties using and employing such a definition in their studies.

Since these views do not test this implicit hypothesis about the decline of accounting theory, there is still a need for testing the hypothesis of accounting theory’s decline relying on a well-defined definition and on an objective measure.

What this study is concerned with is the proportion of financial accounting articles that can be associated with the rise of imported theories from the economic and finance disciplines. Excluding market studies from financial accounting, Kinney (1990) reports a small increase in the ratio of financial accounting (43.7%) as compared to the ratio of financial accounting published during Sundem’s (1987) term as TAR’s editor which was 41%.


It is thus hypothesized that:

H1: Accounting theory in academic accounting research has decreased over time.

The accounting practice community considers empirical research in accounting to be promising for the advancement of accounting practice (Reiter and Williams, 2002). The hope that empirical research provides academic accounting research a scientific status (e.g. Devine, 1985a; Devine, 1985b; Mautz, 1963; Reiter, 1998) may have popularized and accelerated the use of the empirical archival method. While empirical research can be conducted using several methods, i.e., case study, experiment, field study, survey, laboratory, and archival (see Fulbier and Sellhorn, 2006), the empirical archival method has dominated contemporary academic accounting research. Oler et al. (2008) found that archival methodologies have dominated accounting research since 1960.

Studies have argued that the dominance of the empirical archival method has been at the expense of accounting theory. Previts and Robinson (1997) argue that the rise of empirical research has been in conjunction with a decline in research for accounting theory, but no data was supplied to support such an assertion. A study by Rodgers and Williams (1996) reached a similar conclusion supported by data. Analyzing a sample of articles published in TAR during the period 1967-1993, Rodgers and Williams (1996) find that while data tapes and lab experiments rose in importance, accounting theory has declined. They based their conclusion on descriptive statistics. Rodgers and Williams restricted the articles, which they analyzed, to the ones written by the “elite” authors, as they defined them. There might be, however, non-elite authors who published articles about accounting theory in TAR during that period.

Structure of the study

This dissertation is composed of five chapters: the first chapter will introduced the background of the study and will detail the aims and objectives and the hypothesis of the study. In the second chapter, the researcher will review the literature on accounting theory, the need for philosophy of accounting and for general accounting theory, will discuss the nature and the flexible role of accounting and will discuss the early accounting professionals proposing theories of accounting. In the third chapter the researcher will detail the research method and the development of the hypothesis of the study. The fourth chapter will discuss the study design, the data and the sample selection for this study. The fifth chapter will discuss the results and findings of the study.