FINANCIAL ACCOUNTING

THEORY AND ANALYSIS:

TEXT AND CASES
11TH EDITION

RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY
 CHAPTER 1

THE DEVELOPMENT OF
ACCOUNTING THEORY
Introduction
■ What is theory?
❑ Webster defines theory as:
“Systematically organized knowledge, applicable in a relatively wide
variety of circumstances, a system of assumptions, accepted principles
and rules of procedure to analyze, predict or otherwise explain the
nature of behavior of a specified set of phenomena.”
• Normative theory
• Positive theory
■ Why is the development of a general theory of
accounting important?
❑ Allocating scare resources
■ What is the relationship of accounting research
to accounting theory?
❑ Various theories of accounting will be discussed in
Chapter 4
THE EARLY HISTORY OF
ACCOUNTING
■ Denise Schmandt-Besserat
❑ Origins of writing are actually found in counting.
❑ Pieces of fired clay in Middle Eastern archeological sites.
❑ Tokens comprised an elaborate system of accounting that was used
throughout the Middle East from approximately 8000 to 3000 B. C.
❑ Each token stood for a specific item
■ Used to take inventory and keep accounts

■ Other accounting records dating back several thousand

years have been found in various parts of the world.
❑ These records indicate that at all levels of development, people desire
information about their efforts and accomplishments.
THE EARLY HISTORY OF
ACCOUNTING
■ For example the Zenon Papyri
❑ Who was Zenon?
❑ Information about the construction projects, agricultural
activities, and business operations of the private estate of
Apollonius for a period of about thirty years during the third
century B.C.
■ Renaissance
❑ Italians pursuing trade and commerce needed records
❑ Fra Luca Pacioli
 THE EARLY HISTORY OF
ACCOUNTING
■ The evolution of joint ventures into ongoing
businesses
❑ Caused need for external financial reporting
■ The impact of the industrial revolution and the
progressive movement
❑ Widespread speculation in the securities markets, watered
stocks, and large monopolies that controlled segments of the
U.S. economy.
❑ 1900 report suggested that independent public accounting
profession should be established to curtail observed
corporate abuses.
THE EARLY HISTORY OF
ACCOUNTING
■ The concept of capital maintenance
❑ Viewed as a way to curb corporate abuses
■ The accountant as a protector of business interests
❑ American Institute of Accountants (AIA)
❑ American Association of the University Instructors in
Accounting
ACCOUNTING IN THE UNITED
STATES SINCE 1930
■ Because of fear of government intervention
❑ Meetings between NYSE and AIA
❑ AAA
❑ SEC
■ What caused formation of SEC?
❑ Securities Act of 1933
❑ Securities Exchange Act of 1934
■ Difference between public and private sector formulation of
accounting principles
 ACCOUNTING IN THE UNITED
STATES SINCE 1930
■ 1936 - 1938
❑ SEC: internal debate about whether it
should develop accounting standards.
■ 1938
❑ Accounting Series Release (ASR No. 4)
■ SEC allowed private sector to set accounting principles
■ Reports filed with SEC must be prepared in accordance with accounting principles
that have “substantial authoritative support{.
■ A Statement of Accounting Principles
❑ Sanders, Hatfield & Moore
❑ Because accounting profession did not think it had time to develop
theoretical framework of accounting
❑ “Do what you think is best.”
American Institute of Certified Public Accountants
(AICPA)
■ Formed in 1936
■ Influence on development of accounting theory
❑ Committee on Accounting Procedure
❑ Accounting Principles Board
❑ Financial Accounting Standards Board
■ Each has issued pronouncements
❑ Have become primary source of today’s generally
accepted accounting principles
Committee on Accounting Procedure (CAP)
■ Formed in 1936
❑ Professional accountants
■ Accounting Research Bulletins (ARBs)
❑ Pronouncements
❑ Did not dictate mandatory practice
❑ Received authority only from general acceptance
■ ARBs consolidated in 1953
❑ Accounting Terminology Bulletin NO. 1, “Review and Resume”
and ARB No. 43
❑ ARB 44-53 published 1953 – 1959
❑ FASB Accounting Standards Codification (Discussed later in the
chapter) includes recommendations of these bulletins that
have not been superseded
 THE ACCOUNTING PRINCIPLES
BOARD (APB)
■ CAP criticized
❑ Methods of formulating accounting principles didn’t arise from
research based on theory
❑ Acting in piecemeal fashion & Issuing inconsistent standards
■ Resulted in APB
❑ Formation and structure
❑ Types of pronouncements
■ APB Opinions
■ Accounting for the investment
tax credit (1961)
❑ APB Opinions 2 & 4
❑ Rule 203
 THE ACCOUNTING PRINCIPLES
BOARD (APB)
■ Criticism of the APB
❑ Independence of members
■ Members had full-time responsibilities elsewhere that could influence
views
❑ Structure
■ “Big 8” automatically awarded 1 member
■ Usually 5 or 6 other public accountants on board
❑ Response time
■ Part-time members not able to investigate
and resolve emergency issues in timely
manner
 THE FINANCIAL ACCOUNTING
STANDARDS BOARD
■ Because of growing criticism of APB
■ 1971: Board of Directors of AICPA
appointed 2 committees:
❑ The Wheat Committee
■ How to establish accounting principles
❑ The Trueblood Committee
■ Objectives of financial statements
■ The FASB was established
 Structure of the FASB
Appoint and Financial Govern Appoint
Board of Electors
fund
------- Accounting
| Trustees
| Foundation
|
Appoint and
fund
Financial
Accounting Financial
Task Forces
Standards Accounting Appoint
of the
Advisory Standards
Standards
Committee Board
Board
(approx. ( 7 members)
20 members)

Admin. Research Staff

Staff
 FASB
■ Mission – establish standards

■ Types of pronouncements

• Statements of Financial Accounting Concepts

• Statements of Financial Accounting Standards
• Interpretations
• Technical Bulletins
FASB
■ Emerging Issues
❑ Lack of timely guidance
■ Standards Overload
❑ Too many standards
■ Standard setting as a political process
❑ Some users found that best way to influence
formulation of accounting standards is to attempt
to influence standard setters
❑ Example: SFAS No. 123 and 123R
■ Economic Consequences
 GAAP
■ Evolution of phrase:
❑ Changed wording of auditor’s certificate brought about by
meetings between NYSE and AIA
❑ The APB’s definition
■ “present fairly…in conformity with generally accepted accounting
principles:
❑ The Auditing Standards Executive Committee’s definition
■ No singular reference source exists for all principles
■ Makes general acceptance of a specific principle
difficult
■ SAS 69: determining acceptance of a
specific principle is difficult
SFAS No. 162
▪ Hierarchy of GAAP
A ▪ Four levels
■ FASB codification project reduced
B this to 2 levels:
❑ Authoritative
C ❑ Not authoritative

D
The FASB’s Accounting Standards Codification

■ Hundreds of accounting standards promulgated by

several different accounting standard setters.
■ Accounting standards had evolved to the point that
professionals could not keep up.
■ September, 2004: the FAF Trustees approved funding for
the FASB’s codification and retrieval project