ACCT90013 · Financial Accounting Theory And Practice
Accounting Theory Foundations
Before any standard, ratio or disclosure, one question sets the whole subject: why does financial accounting information exist, and what work does it do? ACCT90013 answers in the research tradition — accounting is not a bookkeeping ritual but an economic institution that helps markets price firms and helps contracting parties discipline managers. This opening chapter builds the four foundations the rest of the subject stands on. First, a theory is a coherent set of propositions that either explains and predicts (positive) or prescribes (normative) — and you must be able to classify and exemplify each. Second, accounting research follows the scientific method: puzzle → hypothesis → evidence. Third, accounting plays dual roles — a valuation / information role and a stewardship / contracting role — which conflict, and that conflict recurs every week. Fourth, the friction that motivates everything is information asymmetry: adverse selection (hidden information, pre-deal) and moral hazard (hidden action, post-deal). Get these four straight and the rest of the subject is variations on one theme.
What this chapter covers
- 011.1 What a theory is — and why accounting needs one
- 02Positive vs normative theory: classify and exemplify
- 03The scientific method in accounting research (puzzle → hypothesis → evidence)
- 04The role of theory in standard-setting and practice
- 05The dual roles: valuation / information vs stewardship / contracting
- 06Information asymmetry: adverse selection vs moral hazard
Worked example: classify the theory, then anchor it
- +1(a) First statement: it predicts what managers will do given their contracts — an explain-and-predict claim about the world. STATE: this is a positive theory.
- +1(a) Second statement: it says what accounting ought to do (“should recognise”) — a prescription. STATE: this is a normative theory.
- +1(b) Testability: only the positive statement is falsifiable — you can gather data on covenant-heavy firms and test whether income-increasing choices are more frequent.
- +1(b) The method: frame it as a puzzle → hypothesis (covenant proximity → income-increasing choice) → evidence (a sample, a measured association). The normative claim rests on a value judgement and cannot be settled by data alone.
Key terms
- Positive theory
- A theory that explains and predicts what happens in the world (e.g. which accounting policies managers choose). It is testable against evidence — contrast with a normative theory, which prescribes.
- Normative theory
- A theory that prescribes what accounting ought to be (e.g. “assets should be measured at fair value”). It rests on a value judgement and cannot be settled by data alone.
- Scientific method
- The research cycle accounting theory runs on: identify a puzzle, state a falsifiable hypothesis, and confront it with evidence. It is what makes a positive claim scientific.
- Dual roles of accounting
- Financial accounting does two jobs at once: a valuation / information role (help markets price the firm) and a stewardship / contracting role (write and enforce contracts). These two roles conflict — the tension recurs all semester.
- Information asymmetry
- When one party holds information the other lacks. Adverse selection is hidden information before a deal; moral hazard is hidden action after it. Reducing asymmetry is the economic reason accounting information exists.
Accounting Theory Foundations FAQ
What's the difference between positive and normative theory in ACCT90013?
A positive theory explains and predicts what people actually do (and is testable); a normative theory prescribes what should be done (and rests on a value judgement). The classic exam trap is treating a “should” statement as positive. Watch the verb: predicts/explains = positive; ought/should = normative. Most of the subject (EMH, PAT, agency) is positive; conceptual-framework and measurement debates turn normative.
Why is a postgraduate accounting subject all theory and almost no journal entries?
Because you already know how to record a transaction. ACCT90013 steps back and asks the researcher's questions: does this disclosure actually move price? does this pay contract actually align the manager? should the rule be mandated? The marks are in the argument, not the journal entry — which is why the answer engine (STATE → APPLY → EVALUATE → CONCLUDE) matters more than any calculation.
What are the ‘dual roles’ and why do they matter so much?
Accounting simultaneously helps markets value the firm (information role) and helps parties contract over the firm (stewardship role). They matter because they conflict: information that is most relevant for valuation (e.g. volatile fair values) can be least reliable for contracting, and vice versa. Nearly every later debate — relevance vs reliability, efficiency vs opportunism — is this one tension in a new costume.
How do I tell adverse selection from moral hazard?
Timing and what is hidden. Adverse selection = hidden information before contracting (the “lemons” problem). Moral hazard = hidden action after contracting (the agent shirks). The fix differs too: disclosure/signalling for adverse selection; incentive contracts/monitoring for moral hazard. In a scenario, ask: is the problem something one party knows that the other can't see, or something one party does that the other can't observe?
Exam move
This chapter is the vocabulary the whole exam is written in, so over-learn it. Drill three reflexes. First, classify on the verb: “predicts/explains” → positive (testable), “ought/should” → normative (value judgement). Second, when you see two parties and an information gap, immediately ask which asymmetry — hidden information before (adverse selection) or hidden action after (moral hazard) — and pair it with its mitigation. Third, learn the dual-role tension as a template: any later debate can be re-cast as valuation vs contracting. Practise the STATE → APPLY → EVALUATE → CONCLUDE skeleton on a one-line scenario so it is automatic before the harder chapters arrive.
