Is knowledge and theory embedded across the study of accounting?

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Module Name: Accounting Theory

‘Knowledge and theory are embedded across the study of accounting’.

Critically evaluate this statement and provide examples to illustrate your answer.

There is no scientific research which can prove as to where accounting has begun its journey. However, according to several findings, accounting can be dated back to the ancient civilisations such as the Ancient Mesopotamia. Accounting is defined as the process of measuring, communicating and processing financial information into a more suitable statement for the users of accounting to understand.

There are two types of people in accounting, the accountants and the users of accounting. The users consist of several groups of people who are equally interested in knowing and understanding the financial statements of companies. They are the shareholders, customers, managers, banks and financial institutions, the government and the competitors. It allows them to make better decision making in the future. For some people, accounting is a social science that happens in the society while for others, accounting is a language to communicate financial and other organizational information to the users of accounting. It is practiced for the people by the people. Different users have different realities. This give rise to expectation gap between the users and the accountants. While the accountants would want to protect its interest and the interest of the company, the users instead would expect factual and honest communicated information. According to Hines (1988), accountants construct economic reality, but in communicating reality, accountants construct reality.

Doctors and scientists base all their facts upon truthful and realised researches had a theoretical knowledge base to back them up while during that period accounting had just been introduced. Being active for 150 years, Accounting did not have any theoretical knowledge base or theory, instead they had rules.

So what is Theory? According to the Oxford English dictionary; Theory is ‘a scheme or system of ideas or statements held as explanation or account of a group of facts or phenomena’. In the past, there have been several authors who tried to come up with suggestions in the form of theories or imagery as to how accounting should function in the society. Hendriksen (1970, p1) defines theory as ‘a coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of enquiry’.

David Solomons (p.287, 1991) explained with the use of images as to how accounting should be used in the society and how accountants should behave. According to Solomons, “the task of accountants is to provide information as free from bias as possible for better decision making”. He gave reference to the notion of ‘Neutrality’ where without it the accounting profession would be in great danger. He described his findings into four steps as to how accounting can seek to be more neutral. First, he explained how accountants should behave like journalist that is they should try to report news accurately and not make it. Furthermore, he explained that accounting is like cartography and that accountants must be able to map out the finance of the company accurately. Thirdly, Solomons said that accounting should be like telephony that is the ability to communicate information properly without any tampering. Lastly, he explained how accounting might be connected as to a speedometer.

However, Tony Tinker questioned the analogies of Solomons. For example, he explained that if accountants were to behave like journalist, at some point they would make up news just like some journalists do which contradicts the theory that accounting should be reported with a true and fair view. He goes on explaining that Solomons’ analogies are problematic on various levels, both on epistemological and on practical grounds.

According to Morgan (1986), ‘the subjective nature of images leads us to believe that on one image can capture fully the essence of accounting’. He says that with time new images should surface up in order to add new dimensions to accounting and to shape the accounting process to meet with the modern changes.

Over the years, many people has come and claimed to have ‘knowledge’. However no one really knows what knowledge is or where did it come from. Apart from having a background, the knowledge communicated must be true, factual and that it corresponds to the reality of the society. The theory of knowledge is called Epistemology. The Greek philosopher Plato had described knowledge into three criteria known as the Tripartite Theory of Knowledge. The first one being belief, Plato said that unless one believes in something, one cannot know it. That is, if something exist, and has good reasons to believe that it’s true, one cannot know it unless it is believed in. Second condition is Truth. If one knows something then it must be true. It does not matter whether there is a strong belief behind it, if it is not true, it cannot constitute of knowledge. The third criteria would be Justification that is to justify the reason of believing in it. To only believe in it is not enough, one should have a strong proof as to what the belief stands for. However, in 1963 another philosopher Edmund Gettier challenged the accepted definition of Knowledge.

According to Gettier (1963), there are certain circumstances in which one does not have knowledge, even if all the three criteria are met. Gettier argued that there exist certain situations in which one's belief may be justified and true, and still not count as knowledge. Sometimes, despite the statement being true and believed in, it might not be sufficient. There are other problems also which can be traced up such as, knowledge maybe true without any adequate evidence. Being true maybe totally independent of belief. Belief may be true, but the evidence supporting it might be just a coincidence.

In the beginning, accountants were being trained as to how to produce accounts and maintaining the books, but for over a century the society had since evolved with larger organisations, expansion of businesses and in decision making processes. The society had developed more complex relationships with the individuals and groups which were divided into political, social, economic and organizational. In order to preach, teach and impart knowledge, it has to come from somewhere and cannot be made up. The question remains as to where do we get this theory and from where.

We can refer to the Process of Induction diagram to understand how theories are made and how they become knowledge to the next user.

Laws/ Theories

Process of Induction

During the 1920-1960’s, the development of accounting theory relied heavily on the process of induction as a source of gathering knowledge. They would go out and observe then form theories and give out reasons. Accountants usually based themselves over this process in order to compute accounts for example, the stock valuation system. These repetitive behaviours of the accountants were considered as being ‘consistent’ and ‘prudent’ (Deegan and Unerman (p.6)). However, the major setback would be that if accountants generate theories based on observations, various problems might come up. It is not necessary that the information obtained is correct all the time. It can also be biased.

Another two approaches were introduced in the 1960’s and in the 1970’s, namely; the Positive theories which emphasised on predictions and explanations based on observations and the prescriptive accounting theories based upon what researchers believe should occur all the time. Actually according to Deegan and Unerman (2006, p.10) ‘the conceptual framework of accounting is an example of a normative theory of accounting. It relies upon various assumptions about the type or attributes of information’.

Nonetheless, no one theory is the best. It is better to have more than one theory. As such a falsificationist named Karl Popper suggested that ‘knowledge develops as a result of continual refinement of theory’. According to Popper, truths can be falsified when more knowledge and resources towards a particular theory becomes available. For example, after a certain number of observations, one can say that ‘all swans are white’. If tomorrow a swan is found out to be black, then the previous set of observations will be dismissed which actually happened in the 1930s. Instead of saying ‘all swans are white’, one can say that ‘Some swans are white’. This is one of the reasons why accountants like to give out vague statements. The statement is vague, and thus cannot be proven wrong.

However the question remains as to where do we get this knowledge. There are different sources of knowledge.

As such there are seven known sources of knowledge such as Perception (from the senses of our body), Introspection (through feelings and occurrences), Memory (remembering past experiences), Logical deductive reasoning (understandings and reasoning), Faith (believing in something or by being religious), Intuition (the ability to pick up hints) and through Testimony (by reading in a book or researching). Nevertheless, these sources do come with their share of problems.

As accounting did not have any theoretical frame work, a lot of scandals and frauds were happening because of the loopholes. The need to be able to control and organise the profession had become a must. This had led the incorporation of the legal framework and self-regulatory framework within the profession.

The first report published was the 1975 Corporate Report which identified the users of accounting and its financial statements. It intended to examine the scopes and aims of published financial reports for the modern days. The Standard of Statutory Accounting Principles 2, abbreviated as SSAP2 came into existence in 1971. It was being used as a base to provide knowledge for accounting by providing the first opportunities into figuring out a meaning to the practices of accounting which had evolved. For almost 20 years, the concepts of SSAP remained untouched and became obsolete. As such the Accounting Standard Board decided to review them mainly because of the publication of the 1999 Statement of Principles (SOP). SSAP 2 had pointed out four main accounting concepts out of several others. The four concepts were the Consistency concept, the Accruals concept, the Prudence concept and the Going concern which was then reviewed by FRS18.

Before the FRS18, FRED 21 restated that in the modern days, the Going concern and the Accruals concept are more important that the Prudence concept and the consistency concept which are nonetheless desirable within the walls of a business organisation. According to Lunt (2002), FRED 21 warns that prudence may lead to bias if this means that gains and assets are understated and losses and liabilities overstated. In the past, Prudence was used as a method of smoothing profits.

According to Paterson (2002), ‘over use of Prudence might lead to losses in liquidity a term which is why the Accounting Standards Board must be very cautious about the Prudence Concept’. For example in 1993, the case of Daimler-Benz where he had to reconcile his German GAAP Accounts with that of the US Accounting Principles, there was a misstatement concerning the profit which was entered as a loss. This scandal had had many commentators confused. FRED 21 then became FRS18 ‘Accounting Policies in December 2000 because of which Prudence is now considered as being a subset of reliability.

Accountants must ensure that all the information they communicate are based in a true and fair basis. There should be a true and fair view in accounting as it is what forms the backbone of accounting, to provide clear, honest and up to date financial statements communicated to the users of accounting.

According to Immanuel Kant, all our knowledge begins with the senses, proceeds then to the understanding, and ends with reason. There is nothing higher than reason. As said earlier, accounting has no concrete background like science. Accounting is a craft and the accountants are the artists who design it. It has been made, prepared, improved and strengthened throughout the years with theories and knowledge. The study of accounting is constantly improving for the betterment of the users of accounting and that of the accountants themselves. Despite having no prior background, we can say that knowledge and theory has been embedded across the study of accounting.


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