Solution Manual for Accounting Theory: Conceptual Issues in a Political and Economic Environment, 9th Edition

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 1 of 14CHAPTERHIGHLIGHTSThe chapter is concerned with what accounting theory is and where it fits within the “structure”of financial accounting. The definition of accounting theory used in this chapter is broad andcomplements the objectives of the text. Theory itself helps to explain and predict phenomenathat exist in a given field, and this likewise holds true in accounting. In accounting, theory canbe developed in response to needs arising from practice, including concepts such as realizationand matching. However, as an “infrastructure” has developed in financial accounting, theory isformulated in a more institutionalized way by means of the research process.Along with political factors and economic conditions, accounting theory contributes to thestandard-setting process. The process of developing standards or making rules is itself largely adeductive process and is certainly concerned with accounting theory.The relationship of theory to measurement is very important. While some see measurement asclosely related to but separate from theory (as we did in earlier editions), its importance relativeto theory is so great that we now consider it to be part of theory. Measurement is the assignmentof numbers to the attributes or properties of objects being measured. The different types ofmeasurements and the quality or “goodness” of measurements are examined. The latterembodies (1) the usefulness of the measurement, illustrated here in a predictive context butshowing up later in an assessment mode and (2) verifiability or objectivity, which is the degreeof consensus among measurers in the statistical sense.The various valuation models are presented in Appendix 1-A. The models come under the scopeof accounting theory. In addition, the different models are mentioned in several theory chapters.QUESTIONSQ-1What does the term “social reality” mean and why are accounting and accountingtheory important examples of it?The termsocial realitypertains to the measurement of social phenomena and the use of thesemeasurements. The measurements may be representationally faithful (low in bias) and have ahigh degree of objectivity (verifiability). Or the opposite for either or both of these qualities maybe the case. The important thing to grasp, however, is that important consequences stem fromthe measurement, whether they are “good” or “bad.”For example, an excellent year in terms ofincome could cause management to be highly rated by shareholders and other interested parties,resulting in high management bonuses, or provide increased dividends to shareholders. All ofthis could occur even though income is a “construct”: not a “real” factor but a conceptualartifact.This example shows why accounting is an important area relative to social reality measurementsand constructs. Hopefully, accounting theory can improve the fairness and usefulness of thesemeasurements.

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 2 of 14Q-2Why do the value choices (entry value, exit value, and historical cost) fall within thedomain of accounting theory?These are examples of different concepts involved with measuring income which have differentunderlying purposes. These different purposes—which affect social reality—are discussed in theappendix.Q-3Of the three inputs to the accounting policy-making function, which do you think is themost important?Of the three inputs (economic conditions,political factors, and accounting theory)to the policy-making function,economic conditionsis clearly the most important input. Economic conditionscan easily influence the accounting theory track as well as the policy-making function. Inflation,for example, in the USA during the 1970s and 80s triggered a significant amount of theoreticalwork. Theory responded to the actual economic environment. Another prominent example ofthe influence economic conditions has is the merger and acquisition wave of the 1960s, whichlead to APB Opinion Nos. 16 and 17. Many other standards have also been triggered byeconomic conditions.Q-4How can political factors be an input into accounting policy-making if the latter isconcerned with governing and making the rules for financial accounting?Those who are affected by the rules will usually try to influence what those rules will be. Theinvestment tax credit provides an excellent example. When APB Opinion No. 2 did not allowflow through, lobbying led to APB Opinion No. 4, which did allow immediate recognition inincome of investment tax credits. The stock option battles of the 1990’s (and continuing today)is another example of the political process and its effect on rule-making. From a predictivestandpoint, we are concerned with how and why political factors play a role in the standard-setting process.Q-5Is accounting theory, as the term is defined in this text, exclusively developed andrefined through the research process?Absolutely not. Many concepts such as conservatism and revenue recognition arose on a“common law” type of basis. They were responses to particular problems. Research has, ofcourse, dealt with these issues. Any attempt to leave these concepts outside of the definition ofaccounting theory would make the subject matter of accounting theory artificial and incompleteQ-6What type of measurement is the measurement of objectivity in Equation (1.1):nominal, ordinal, interval, or ratio scale?It is ordinal, due to the squaring effect on each individual deviation from the mean. The zeropoint, however, is unique. Hence, there would be perfect consensus among measurers. It wouldmean that each individual measurement would be the same for all measurers.

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 3 of 14Q-7The measurement process itself is quite ordinary and routine in virtually all situations.Comment on this statement.This is not necessarily the case. Measurements can be extremely complex. For example,measuring the temperature of the earth’s atmosphere is extremely difficult. The increasingtemperature has led both to the hypothesis of the greenhouse effect and to the theory that thewarming global temperatures are simply a fluctuation, a naturally occurring variation.Measuring the success of a man’s life can be perplexing. How does accumulation of Bill Gates’monetary wealth compare with the accomplishments of Ghandi, Nelson Mandela, or WolfgangAmadeus Mozart? What does one actually measure to determine success?Measurements in accounting are significantly less complex, but should not be taken lightly. Forexample, determining the replacement cost or exit value of a firm’s machinery and equipment isnot an easy task. Determining net income or earnings during a specified period of time may bemore complicated that it appears to be on the surface.Q-8Can assessment measures be used for predictive purposes?Though an assessment measure concerns an attribute or characteristic of an object at the presenttime, it could be used as a surrogate for a prediction measure if none exists. For example, thebest indicator of the current ratio of a firm in a year may be the current ratio today, if budgetshave not been prepared.Q-9A great deal of interest is generated each week during the college football and collegebasketball seasons by the ratings of the teams by the Associated Press and United PressInternational. Sports writers or coaches are polled on what they believe are the top 25teams in the country. Weightings are assigned (25 points for each first place vote, 24for each second place vote, . . . one for each 25th place vote) and the results aretabulated. The results appear as a weekly listing of the top 25 teams in the nation. Doyou think that these polls illustrate the process of measurement? Discuss.An argument can be made that a number is assigned to a team on the basis of a property thatmight be called the “goodness” or “strength” of a team. However, these measurements do nothave a great deal of precision. How good a team is relative to other teams is a property orquality that is extremely intangible compared to other measurements such as median weight ofinterior linemen, average speed of running backs per 100 meters, etc. Unquestionably, themeasurements are indirect.The qualifications of the measurers are also open to question. Do sportswriters really “know”football? Constraints are also present because the voters may have seen very few teams and theymay also have regional biases. The numbering scale used is basically ordinal because 1 isconsidered to be better than 2, which is better than 3. However, the “goodness” of the intervalbetween rankings is not uniform. For example, a voter may feel it is a virtual “toss-up” between1 and 2, both of which he considers to be vastly superior to 3. As a result, the aggregatingprocess is open to serious question.

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 4 of 14It is also not clear whether the pollsters are making assessment or prediction measures. Themeasures would be prediction measures if the voter presumes that 1 would beat 2 if they playedthe following week. We suspect, however, that an assessment measure is being made. Theproperty being assessed is the team’s record to date. Hence, a team with a 6-0-0 record is usuallyranked higher than a team with a 5-0-1 record.Q-10Accounting practitioners have criticized some proposed accounting standards on thegrounds that they would be difficult to implement because of measurement problems.They therefore conclude that the underlying theory is inappropriate. Assuming that thecritics are correct about the implementational difficulties, would you agree with theirthinking? Discuss.This question brings together the relationship among theory, policy, and practice. It also bringsup Larson’s warning of the necessity to differentiate between theory and measurement eventhough we believe that Larson’s statement is too strong. Hence, even though the practitionersmay be correct about the measurement process recommended by the proposed standard, it doesnot necessarily mean that the underlying theory is inappropriate. Some theories may indeed leadto dead ends in terms of implementation. More time may also need to be taken to make themeasurements operational.Q-11Some individuals believe that valuation methods proposed by a standard-setting bodysuch as FASB should be based on those measurement procedures having the highestdegree of objectivity as defined by Equation (1.1). Thus, some assets might be valuedon the basis of replacement cost and others on net realizable value. Do you see anyproblems with this proposal? Discuss.The problem here is basically the opposite of that presented in question 10. In this case, part ofthe measurement problem might be solved, but at the cost of sacrificing the theoretical base.Hence, the cart is put before the horse, conceptually speaking. However, there are othermeasurement problems presented by this proposal. It is questionable whether replacement costdollars and net realizable value dollars can be meaningfully added together, even if computed forthe same point in time (this is the problem of additivity). Moreover, if firms were given latitudeto employ valuation methods for their various balance sheet items that were more objective intheir own particular cases, there could well be a major problem of lack of comparability in theresulting financial statements between and among firms.

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 5 of 14Q-12What type of measurement scale (nominal, ordinal, interval, or ratio scale) is beingused in the following situations?a.Musical scalesb.Insurance risk classes for automobile insurancec.Numbering of pages in a bookd.A grocery scalee.A grocery scale deliberately set 10 pounds too highf.Assignment of students to advisers, based on majora.Musical scales, Interval, there is no natural zero tonal point.b.Insurance risk classes for automobile insurance: Ordinal, Class 1 is “better” than Class 2 tothe extent that people have had fewer accidents. However, within classes people do not haveuniform accident records, and the “accident interval” between classes is not totally uniform.c.Numbering of pages in a book: Interval (possibly nominal).d.A grocery scale: Ratio.e.A grocery scale deliberately set 10 pounds too high: Interval — In effect, the “zero” point isset at 10 pounds, but interval differences remain constant.f.Assignment of students to advisers, based on major: NominalQ-13If general price-level adjustment is concerned with the change over time of thepurchasing power of the monetary unit, why is it not considered to be a current valueapproach?Current value approaches (replacement cost and exit value) are concerned with questions such aswhat would it cost to replace an asset today with the same type of asset in the same condition orhow much would an asset sell for if it were sold today. General price-level adjustment attemptsto restate historical cost of assets in terms of the contemporary purchasing power of the moneyexpended.Q-14How do entry- and exit-value approaches differ?As noted previously, entry value (replacement cost) concerns the cost of replacing an assetalready owned in markets in which the asset is generally acquired by the firm. Exit value is theprice the firm could get for the asset less costs of getting rid of the asset (e.g., removal costs,transportation).Exit value is generally lower than replacement cost because of restricted access to the market,disposal costs, and the possibility of “the perception of a lemon” on the part of prospectivebuyers.

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 6 of 14Q-15Why is discounted cash flow extremely difficult to implement in the accounts?The difficulty relates to measurement. Which discount rate should be used, how far in the futureshould one go, and how should one estimate cash flows? In addition, many assets contributejointly to generating future cash flows. Problems of separating the cash flows for valuationpurposes are virtually impossible to solve.Q-16How do measurement and calculation in accounting differ from each other? Give threeexamples of each.Measurementin accounting is concerned with determining real economic phenomena such ascurrent values (entry and exit values) and discounted cash flows.Calculationsare simplymechanistic assignments of the monetary unit to accounting categories. The wordcalculationisvery similar toallocationas developed by Arthur Thomas (see Chapter 8).Calculations thus abound under historical costing. Some examples would be inventory amountsdetermined by LIFO, FIFO, or weighted average; depreciation calculations; and marketablesecurities carried at cost. Measurements would include inventories and marketable securitieswhen carried at market; acquisition of inventories and fixed assets in general (but only at theacquisition point) as well as assets acquired in a purchase type business combination; and thecarrying of accounts receivable (net) at net realizable value.Q-17Are issues of costliness and timeliness as they pertain to accounting standards part ofaccounting theory?Costliness and timeliness are part of accounting theory (refer to Statement of FinancialAccounting Concepts No. 2 and No. 8 of the conceptual framework). Benefits of a standardshould exceed their costs. Thus it could be too costly to improve the accuracy (representationalfaithfulness of a particular measurement of a desired characteristic of an asset). The samepertains to timeliness. A more accurate measurement requires more time, but the delay necessaryto attain the increased accuracy makes the more accurate measurement less useful.Q-18Do you think that changes brought about in accounting standards by failures ofpublicly traded companies such as Enron should be classified under political factors oreconomic decisions? Support your position.We classify these as political factors. The inability to draft workable rules to bring specialpurpose entities (SPE) to the balance sheet is definitely political in nature.Q-19Political factors are an adverse influence on the accounting standard-setting function.Discuss this statement.This is tough issue. Prior to the Enron, WorldCom, etc. scandals we would have said that to getfirms to buy into the standard-setting process, those who must work to apply the standards

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 7 of 14should have input to the process. We still believe this, however, we now know that skeptical eyesand ears are important necessities when reviewing interested party inputs. Trust with a skepticaleye.Q-20Did the 21stcentury begin on January 1, 2000?By popular acclamation the 21stCentury began on January 1, 2000. Since there was no yearzero, each century ends with a year ending with an even hundred or a thousand. This question isa good example of a social reality—the effect of the odometer turning over—overcomingmeasurement theory.Q-21Do you think that the color-coded terrorist threat system instituted by the Departmentof Homeland Security involves a measurement system? Explain.Absolutely. Different colors refer to different degrees of danger. It would be an ordinal-typescale because the difference in degrees of danger between color codings is not uniform. Forexample, the highest point on the scale indicates that a terrorist attack is virtually imminent. Thisis a large step above the next level on the scale.Q-22Since the FASB makes the standards that are used by business and industry, they makeaccounting theory. Comment on this statement.FASB uses accounting theory when developing accounting standards, but it does not make it.Does an aircraft manufacturer make aerodynamic theory when producing a new airplane or doesit use specific theories to help design and produce a high quality product?CASES,PROBLEMS,ANDWRITINGASSIGNMENTS1.Assume that three accountants have been selected to measure the income of a firmunder two different income measurement systems. The results for the first incomesystem (M1) were incomes of $3,000, $2,600, and $2,200. Under the second system(M2), results were $5,000, $4,000, and $3,000. Assume that users of accounting databelieve that dividends of a year are equal to 75 percent of income determined by M1for the previous year. Users also believe that dividends of a year are equal to 60percent of income determined by M2 for the previous year. Actual dividends for theyear following the income measurements were $3,000. Determine the objectivity andbias of each of the two measurement systems for the year under consideration. On thebasis of your examination, which of the two systems would you prefer?

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 8 of 14Designating the three accountants as A1 . . . A3 and using Equation (1.1) for measuringobjectivity, we get:M1(xi –x)2A1 (3,000 – 2,600)2 = 160,000A2 (2,600 – 2,600)2 =0A3 (2,200 – 2,600)2 = 160,000$320,000 ÷ 3 = 106,667M2(xi –x)2A1 (5,000 – 4,000)2 =1,000,000A2 (4,000 – 4,000)2 =0A3 (3,000 – 4,000)2 =1,000,000$2,000,000 ÷ 3 = 666,667To arrive at the bias present in the measures, solve for what income should be in the firstperiod (I*1j) in terms of user decision models from Equation (1.2):M1M2Dj2 = f(.75I*1j)Dj2 = f(.60I*1j)$3,000 = .75I*1j$3,000 = .60I*1j$4,000 =I*1j$5,000 =I*1jNow solve for bias by using Equation (1.3):B = (x–x*)2 i:M1 (2,600 – 4,000)2 = 1,960,000M2 (4,000 – 5,000)2 = 1,000,000Combining the two measures that are additive to arrive at an overall measure of reliability, wehave:M1M2

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 9 of 14R = V + BR = V + B$2,066,667 = $106,667 + $1,960,000; $1,666,667 = $666,667 + $1,000,000M2 appears to have more reliability than M1. M2’s poorer objectivity is more than offset byits better predictive power in this example. These numbers give a quantitative grasp ofobjectivity and bias, but one cannot claim that M1 is approximately six times more objectivethan M2 or that M1 has twice as much bias as M2. Standard deviation might have been usedfor objectivity, in which case the objectivity ratio would come down to less than 3 to 1.Hence, the measures can give a comparative ordering for reliability—but that is all.2.J & J Enterprises is formed on December 31, 2000. At that point it buys one assetcosting $2,487. The asset has a three-year life with no salvage value and is expected togenerate cash flows of $1,000 on December 31 in the years 2001, 2002, and 2003.Actual results are exactly the same as plan. Depreciation is the firm’s only expense. Allincome is to be distributed as dividends on the three dates mentioned. Otherinformation:The price index stands at 100 on December 31, 2000. It goes up to 104 and 108 onJanuary 1, 2002 and 2003, respectively.Net realizable value of the asset on December 31 in the years 2001, 2002, and 2003 is$1,500, $600, and 0, respectively.Replacement cost for a new asset of the same type is $2,700, $3,000, and $3,300 on thelast day of the year in 2001, 2002, and 2003, respectively.Revenue is $1,000 per year and the internal rate of return is 10% and all cash flows arereceived (and distributed) on December 31.Required:Income statements for the years 2001, 2002, and 2003 under:Historical costingGeneral price-level adjustmentExit valuationReplacement costDiscounted cash flows2.1Historical costing:200120022003TotalRevenue$1,000$1,000$1,000$3,000Depreciation8298298292,487Net Income$171$171$171$513

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 10 of 142.2General price level adjustment:200120022003TotalRevenue$1,000$1,000$1,000$3,000Depreciation829862a895b2,586Operating Income$171$138$105$414Purchasing Power Loss—33c66d99Net Income$171$105$39$315a $829 × 1.04 = 862b $829 × 1.08 = 895c $829 × [(1.04 – 1.00)/1.00] = $33($829 represents the firm’s cash holding on January 1, 2002)d $1,724 × [(1.08 – 1.04)/1.04] = $662.3Exit valuation:e200120022003TotalRevenue$1,000$1,000$1,000$3,000Depreciation9879006002,487Net Income$13$100$400$5132.4Replacement cost:e200120022003TotalRevenue$1,000$1,000$1,000$3,000Depreciation9001,0001,1003,000Net Income$100$0$100$ 0e Purchasing power gains and losses might be computed but are omitted for simplicity here2.5Discounted cash flows:f200120022003TotalRevenue$1,000$1,000$1,000$3,000Depreciation7518269092,486Net Income$ 249$174$91$514f The problem was structured so that the asset has a 10% internal rate of return

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 11 of 143.Objectivity (also called “verifiability”) and bias (usefulness) are two extremelyimportant characteristics of accounting. Discuss each of the following situations interms of how you believe they would impact upon objectivity and bias.The latest standard on troubled debt restructuring, SFAS No. 114, calls for newlyrestructured receivables to be discounted at the original or historical discount rate. Twoboard members disagreed with the majority position because they thought the discountrate should be the current discount rate, given the terms of the note and the borrower’scredit standing.SFAS No. 115 requires marketable equity securities to be carried at fair value (marketvalue). Its predecessor, SFAS No. 12, required marketable equity securities to becarried at lower-of-cost-or-market.Assume that a new standard would allow only FIFO in inventory and cost of goodssold accounting with weighted average and LIFO being eliminated (you may ignoreincome tax effects).This situation shows how even a minimum exposure to “accounting theory” can sharpenreasoning power. Other examples of the type illustrated here can be easily generated.The original historical rate would be more verifiable since it is precisely determinable, whereasthe current rate would not be exact but should be restricted to a very narrow range. The currentdiscount rate should be more useful because its use would help to determine the current value ofthe restructured debt. On balance, we agree with the dissenters. Verifiability problems with thecurrent discount rate should be quite small.While conservatism in accounting should not be totally thrown out, we believe that it is relied ontoo heavily. We believe that SFAS No. 115 has an absolute advantage in value terms over SFASNo. 12. Historical cost is not particularly useful for decision-making purposes. The consistentuse of fair value is more useful, we believe, than lower-of-cost-or-market. If anything,verifiability should be better under SFAS No. 115 than SFAS No. 12, since one value is involvedrather than two under lower-of-cost-or-market.The new standard would be more verifiable since only one calculation is allowed rather than two.Relative to usefulness, the usual argument might arise: LIFO is “better” in the income statementbecause costs used up are more current and thus give a better “matching,” but LIFO would beless useful on the balance sheet. Since neither of these calculations has an absolute advantageover the other, we would opt for the exclusive use of FIFO. In addition to being more verifiable,only one method would be less ambiguous for users. While the advantage is not absolute, webelieve it is clearly in favor of FIFO only.4.Accounting theory has several different definitions and approaches. Using Hendriksenand van Breda (1992, Chapter 1) and Belkaoui (1993, Chapter 3), list and brieflydiscuss these definitions and approaches. From the perspective of a professionalaccountant, evaluate these approaches in terms of their usefulness.Chapter 1 in Hendriksen and van Breda is devoted to accounting theory. Accounting theory isnot defined until the conclusion of the chapter on page 21. Using Webster’s Dictionary as abackground, accounting theory is defined as a “. . . coherent set of hypothetical, conceptual, and

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 12 of 14pragmatic principles forming a general frame of reference . . . ,” which is fairly close to thedefinition used here. The chapter talks about different “approaches” to theory, including tax,legal, ethical, economic, behavioral, and structural, hence, different frames of reference wouldevidently apply to each of these approaches. This entire framework is then related to philosophyof science issues such as the use of language involving pragmatics, semantics, and syntatics andtheory as reasoning involving deductive and inductive approaches.Chapter 3 in Belkaoui is devoted to accounting theory, which is defined as “. . . a set ofinterrelated constructs (concepts), definitions, and propositions that present a systematic view ofphenomena . . . with the purpose of explaining and predicting the phenomena.” His“approaches” then include pragmatic versus theoretical approaches with the latter mirroring theHendriksen and van Breda approaches by covering deductive, inductive, ethical, sociological,economic, and eclectic approaches.We suspect that for both books, as well as this one, defining accounting theory has been adifficult task. The whole question of what do we know and how do we know it (and know thatwe know it) is an extremely interesting area. Epistemology is as important for accounting as forother disciplines.5.What theoretical issues are involved in Statement of Financial Accounting StandardsNo. 2 which calls for expensing research and development costs?SFAS No. 2, Accounting for Research and Development Costs, issued in 1974, establishesstandards of financial accounting for research and development (R&D) costs. It requires thatR&D costs be expensed when incurred. It also requires a company to disclose in its financialstatements the amount of R&D that it charges to expense. Theoretical issues relate to:measurability (how to measure future benefits of R&D expenditures, especially given theassociated uncertainties) and matching (recognizing costs as expenses on a cause and effectbasis).6.Read “The Margins of Accounting” by Peter Miller in“The European AccountingReview(Volume 7, Number 4, 1998). What is Miller’s main point? Discuss theexamples he uses to illustrate his main point including those pertaining to managementaccounting. What do you think the significance of his article is for understandingaccounting?This 17-page reading is available through the EBSCO library database. Miller argues thatpractices at the margins of accounting today may be at the core in the future and vice-versa.“accounting innovation is not the preserve of any single group.” His examples include costaccounting and nonfinancial measures. This article emphasizes how accounting has developedin relation to “localized concerns and issues,” much like medicine and law. It implies thataccounting will change, evolve as time passes and environmental factors vary.

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 13 of 14CRITICALTHINKING ANDANALYSIS1.Is accounting theory really necessary for the making of accounting rules? Discuss.This question should hopefully shake students up. We doubt that a sophisticated answer thatmight arise when students have finished Chapter 4 suggesting that regulation, in some views, isunnecessary—will arise. Even prior to the appearance of any standard-setting agency, unifyingthemes such as realization and matching arose. In today's extremely complex environment, it isdifficult to imagine financial accounting operating without a standard-setting body and that bodyoperating without some type of conceptual (theoretical) guidelines since issues such as who theusers are and what their information needs are, costs and benefits of different alternatives,verifiability issues, attaining comparability, and increasing information symmetry are all issueswhich must be considered by standard setters.2.Every fallU.S. News and World Reportcomes out with a much awaited ranking ofAmerican colleges and universities (you may have even used it yourself). While therehas been much criticism of the methodology that the magazine employs as well assome “fudging” of the numbers by universities in their response to the questionnaire,this report represents what the chapter calls a “social reality.” What is meant by “socialreality” and why does this college and university ranking provide a good analogy foraccounting?From Question 1: The termsocial realitypertains to the measurement of social phenomena andthe use of these measurements. The measurements may be representationally faithful (low inbias) and have a high degree of objectivity (verifiability). Or the opposite for either or both ofthese qualities may be the case. The important thing to grasp, however, is that importantconsequences stem from the measurement, whether they are “good” or “bad.”For example, anexcellent year in terms of income could cause management to be highly rated by shareholdersand other interested parties, resulting in high management bonuses, or provide increaseddividends to shareholders. All of this could occur even though income is a “construct”: not a“real” factor but a conceptual artifact.This is a particularly interesting application because theU.S. News & World Reportsurvey iswell known and widely used. It may well help many students in terms of narrowing downcolleges and universities that they would be interested in by giving various “bottom line”summaries of the schools. Yet we might well ask how “good” and how meaningful thesenumbers are. Unquestionably, they influence actions. We know of college administrators whowould “kill” to improve their ratings.

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Chapter 1:An Introduction to Accounting TheoryAccounting Theory (9thedition)Page 14 of 143.Accounting rule making should only be concerned with information for investors andcreditors. Discuss.This is a good discussion question. You may want to also ask your students to determine whothe two primary standards-setting bodies (FASB and IASB) identify as their primary customersof standards. Should the customers be all those using the information for making economicdecisions or more limited to only one audience (e.g., investors, creditors, the entity alone)?Where do current and past employees fall in this investor-creditor classification? How aboutcommunities? Taxing authorities? Environmental regulatory agencies? This is a critical question,“Exactly, who is the customer?”

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Chapter 2:Accounting Theory and Accounting ResearchAccounting Theory (9thedition)Page 1 of 9CHAPTERHIGHLIGHTSThe chapter provides the student an appreciation for the contribution of research to the generalgrowth of our knowledge about accounting. It shows how accounting research affects thestandard-setting process in financial accounting.The chapter focuses on the roles of deductive and inductive reasoning and how they relate tofinancial accounting. It is also important to stress that these methods are complementary and notan either/or orientation. It is important to stress that empirical research generally looks at fairlysmall, manageable types of questions. It thus can provide input to the standard-setting process.Making accounting rules, however, must still be seen as a normative function. The chapter alsostresses that empirical research cannot be value-free. Values are embedded in the questions thatare asked and the parameters that are used in attempting to measure phenomena.Given the rise of formal approaches to theory and a concern for the process of measurementdiscussed in Chapter 1, the question arises as to whether accounting is an art or a science. Ascience might be defined as a discipline or area where considerable measurement problems exist.In the physical and natural sciences, there should be a high degree of consensus amongmeasurers. This will be less the case in the social sciences simply because of the variability ofhuman behavior. Nevertheless, they should come under the domain of science. Accountingcould certainly move closer to the science realm as a result of the rise of scientific method andthe concern for measurement.The chapter also briefly discusses accounting research directions or trends. These are expandedthroughout the text. The chapter closes with a look at the question, stemming from Kuhn,concerning whether a “scientific revolution” is occurring in accounting. At this time, the answerappears to be a fairly clear “maybe.” The included PowerPoint, revolutions and paradigms.ppt,references an article fromThe Wall Street Journal, that suggests the beginnings of a paradigmshift.QUESTIONSQ-1Do you think that the work of a policy-making organization such as the FASB or theSEC is normative (value-judgment oriented) or positive (oriented toward value-freerules)? Discuss.It is unquestionably normative because judgments must be made in accordance with objectivesor other criteria. While a standard-setting group may attempt to be neutral, it usually mustdecide among different positions, each of which will have its adherents. A standard-settingorganization may use empirical research (which attempts to be descriptive or positive) as part ofits input into the standard-setting process. Ijiri used the term “policy science” to describefinancial accounting.

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