Research Methodology and Theories on the Uses of Accounting Information

• Research MethodologyResearch Methodology• Deductive ApproachDeductive Approach• Inductive ApproachInductive Approach• Pragmatic ApproachPragmatic Approach• Scientific Method of InquiryScientific Method of Inquiry• The Outcomes of Providing Accounting Information The Outcomes of Providing Accounting Information • Fundamental AnalysisFundamental Analysis• The Efficient Market HypothesisThe Efficient Market Hypothesis

Research Methodology and Theories on Research Methodology and Theories on the Uses of Accounting Informationthe Uses of Accounting Information

To have a science is to have recognized a domain To have a science is to have recognized a domain and a set of phenomena in that domain, and next and a set of phenomena in that domain, and next

to have defined a theory whose inputs and outputs to have defined a theory whose inputs and outputs are descriptions of phenomena.are descriptions of phenomena.

-The first are observations, The first are observations, - The second are Predictions, whose terms The second are Predictions, whose terms

describe the underlying reality of the domain the describe the underlying reality of the domain the underlying reality of the domain.underlying reality of the domain.

- Over the years, accountants have done a great deal of - Over the years, accountants have done a great deal of theorizing, Providing new insights and various ways of theorizing, Providing new insights and various ways of looking at accounting and is outcomes.looking at accounting and is outcomes.

- A distinction can be made between theorizing and theory - A distinction can be made between theorizing and theory construction.construction.

- Theorizing is the first step to theory construction, but it is - Theorizing is the first step to theory construction, but it is frequently lacking because its results are untested or frequently lacking because its results are untested or untestable value judgments.untestable value judgments.

-The FASB's Conceptual Framework Project was The FASB's Conceptual Framework Project was introduced as the state- of the theory of accounting. introduced as the state- of the theory of accounting. However, this theory does not explain how accounting However, this theory does not explain how accounting information is used because very little Predictive information is used because very little Predictive behavior is explained by existing accounting theory. behavior is explained by existing accounting theory.

- Several research that might be used to develop - Several research that might be used to develop theories of accounting and it’s a number of theories of accounting and it’s a number of

theories in the outcomes of the use of theories in the outcomes of the use of accounting information. accounting information.

- Including model agency theory, human - Including model agency theory, human information processing, and critical perspective information processing, and critical perspective

research. research.

- None of these theories is completely accepted; - None of these theories is completely accepted; consequently, Each of them is somewhere along consequently, Each of them is somewhere along

the path between theorizing and theory.the path between theorizing and theory.

Research MethodologyResearch Methodology

Accounting theory can be developed by using several Accounting theory can be developed by using several research methodologies. Among the more commonly research methodologies. Among the more commonly

identified methodologies are:identified methodologies are:

(I) the deductive approach. (I) the deductive approach. (2) the inductive approach. (2) the inductive approach.

(3) the pragmatic approach. (3) the pragmatic approach. (4) the scientific method of inquiry. (The scientific (4) the scientific method of inquiry. (The scientific

method of inquiry, which is essentially a combination method of inquiry, which is essentially a combination of deductive and inductive reasoning, as a guide to of deductive and inductive reasoning, as a guide to

research, accounting theory development).research, accounting theory development).(5) the ethical approach. (5) the ethical approach.

(6) the behavioral approach. (6) the behavioral approach.

Deductive Approach: Deductive Approach: The deductive approach to the development of theory beginsThe deductive approach to the development of theory begins

with:with:1) The establishment of objectives. 1) The establishment of objectives.

2) Once the objectives have been identified.2) Once the objectives have been identified.3) Certain key definitions and assumptions must be stated. 3) Certain key definitions and assumptions must be stated.

4) The researcher must then develop a logical structure for 4) The researcher must then develop a logical structure for accomplishing the objectives, based on the definitions and accomplishing the objectives, based on the definitions and

assumptions. assumptions. 5) This methodology is often described as "going from the 5) This methodology is often described as "going from the

general to the specific." general to the specific." 6) If accounting theory is to be developed using the deductive 6) If accounting theory is to be developed using the deductive

approach, the researcher must develop a structure that approach, the researcher must develop a structure that includes the objectives of accounting, the environment in includes the objectives of accounting, the environment in

which accounting is operating, the definitions and which accounting is operating, the definitions and assumptions of the system, and the procedures and assumptions of the system, and the procedures and

practices, all of which follow a logical pattern.practices, all of which follow a logical pattern.

- The deductive approach is essentially a mental or "armchair" - The deductive approach is essentially a mental or "armchair" type of research. type of research.

- The validity of any accounting theory developed through this - The validity of any accounting theory developed through this process is highly dependent on the researcher's ability to process is highly dependent on the researcher's ability to

identify correctly and relate the various components of the identify correctly and relate the various components of the accounting process in a logical manner. accounting process in a logical manner.

- To the extent that the researcher is in error as to the - To the extent that the researcher is in error as to the objectives, the environment, or the ability of the procedures to objectives, the environment, or the ability of the procedures to

accomplish the objectives. the conclusions reached will also accomplish the objectives. the conclusions reached will also be in error.be in error.

7) Certain a special measurement constraints and using 7) Certain a special measurement constraints and using accounting information .accounting information .

8) Certain a general frame which it shows the information for 8) Certain a general frame which it shows the information for using double entry system . using double entry system .

9) A certain understood for accounting terminology .9) A certain understood for accounting terminology .10) Conclude general principle.10) Conclude general principle.

11) Drawing out the principle and ways for application .11) Drawing out the principle and ways for application .

InductiveInductive ApproachApproachThe inductive approach to research emphasizes:The inductive approach to research emphasizes:1)1) Making observations .Making observations .2)2) Drawing conclusions from those observations.Drawing conclusions from those observations.3)3) This method is described as "going from the specific to the This method is described as "going from the specific to the

general" because the researcher gener alizes about the universe general" because the researcher gener alizes about the universe on the basis of limited observations of specific situations.on the basis of limited observations of specific situations.

- Accounting Principles Board Statement No. 4 is an example of - Accounting Principles Board Statement No. 4 is an example of inductive research‘.inductive research‘.

The generally accepted accounting principles (GAAP) describe in The generally accepted accounting principles (GAAP) describe in the statement were based primarily on observation of current the statement were based primarily on observation of current practice.practice.

- The APB acknowledged that the then current principles had not - The APB acknowledged that the then current principles had not been derived from the environment, objectives, and basic been derived from the environment, objectives, and basic features of financial accounting. Thus, the study was essentially features of financial accounting. Thus, the study was essentially inductive in approach.inductive in approach.

Pragmatic ApproachPragmatic Approach- The pragmatic approach to theory development is based on The pragmatic approach to theory development is based on the concept of utility or usefulness. the concept of utility or usefulness.

- Once the problem has been identified, the researcher Once the problem has been identified, the researcher attempts to find a utilitarian solution; that is, one that will attempts to find a utilitarian solution; that is, one that will resolve the problem.resolve the problem.

- This does not suggest that the optimum solution has been This does not suggest that the optimum solution has been found or that the solution will accomplish some stated found or that the solution will accomplish some stated objective. (Actually, the only objective may be to find a objective. (Actually, the only objective may be to find a "workable" solution to a problem.) Thus, any answers obtained "workable" solution to a problem.) Thus, any answers obtained through the pragmatic approach should be viewed as tentative through the pragmatic approach should be viewed as tentative solutions to problems. solutions to problems.

Unfortunately in accounting. most of the current principles and Unfortunately in accounting. most of the current principles and practices have resulted from the pragmatic approach, and the practices have resulted from the pragmatic approach, and the

solutions have been adopted as GAAP rather than as an solutions have been adopted as GAAP rather than as an expedient resolution to a problem.expedient resolution to a problem.

Scientific Method of Inquiry:Scientific Method of Inquiry:

- The scientific method of inquiry as the name - The scientific method of inquiry as the name suggests, was developed for the natural and physical suggests, was developed for the natural and physical sciences and not specifically for social sciences such sciences and not specifically for social sciences such

as accounting. as accounting.

- There are some clear limitations on the application of - There are some clear limitations on the application of this research methodology to accounting; for example, this research methodology to accounting; for example, the influence of people and the economic environment the influence of people and the economic environment

make it impossible to hold the variables constant. make it impossible to hold the variables constant.

- Nevertheless, an understanding of the scientific - Nevertheless, an understanding of the scientific method can provide useful insights as to how research method can provide useful insights as to how research

should be conducted.should be conducted.

Conducting research by the scientific method involves Conducting research by the scientific method involves five major steps, which may also have several five major steps, which may also have several substeps:substeps:

1- Identify and state the problem to be studied.1- Identify and state the problem to be studied.

2- State the hypotheses to be tested.2- State the hypotheses to be tested.

3- Collect the data that seem necessary for testing the 3- Collect the data that seem necessary for testing the hypotheses.hypotheses.

4- Analyze and evaluate the data in relation to the 4- Analyze and evaluate the data in relation to the hypotheses.hypotheses.

5- Draw a tentative conclusion.5- Draw a tentative conclusion.

- Although the steps are listed sequentially, there is - Although the steps are listed sequentially, there is considerable back-and forth movement between the steps. considerable back-and forth movement between the steps.

for example, at the point of stating the hypotheses. it may be for example, at the point of stating the hypotheses. it may be necessary to go back to step 1 and state the problem more necessary to go back to step 1 and state the problem more precisely. Again, when collecting data, it may be necessary precisely. Again, when collecting data, it may be necessary

to clarify the problem or the hypotheses, or both, This back-to clarify the problem or the hypotheses, or both, This back-and-forth motion continues throughout the process and is a and-forth motion continues throughout the process and is a

major factor in the strength of the scientific method.major factor in the strength of the scientific method.

- The back-and-forth movement involved in the scientific - The back-and-forth movement involved in the scientific method also suggests why it is difficult to do purely deductive method also suggests why it is difficult to do purely deductive or inductive research.or inductive research.

- Once the problem has been identified. the statement of - Once the problem has been identified. the statement of hypotheses is primarily a deductive process, but the hypotheses is primarily a deductive process, but the researcher must have previously made some observations in researcher must have previously made some observations in order to formulate expectations. order to formulate expectations.

- The collection of data is primarily an inductive process. - The collection of data is primarily an inductive process. but determining what to observe and which data to collect but determining what to observe and which data to collect

will be influenced by the hypotheses. will be influenced by the hypotheses.

- Thus, the researcher may, at any given moment, - Thus, the researcher may, at any given moment, emphasize induction or deduction, but each is influenced emphasize induction or deduction, but each is influenced

by the other and the emphasis is continually shifting so by the other and the emphasis is continually shifting so that the two approaches are coordinate aspects of one that the two approaches are coordinate aspects of one

method.method.

- Unfortunately, the scientific method of inquiry has received - Unfortunately, the scientific method of inquiry has received only limited attention in accounting research.only limited attention in accounting research.

- Those procedures found to have "utility" have become - Those procedures found to have "utility" have become

generally accepted regardless of whether they were tested generally accepted regardless of whether they were tested for any relevance to a particular hypothesis. for any relevance to a particular hypothesis.

The Outcomes of Providing Accounting Information: The Outcomes of Providing Accounting Information:

- The development of a theory of accounting will not solve - The development of a theory of accounting will not solve all of the needs of the users accounting information. all of the needs of the users accounting information.

- Theories must also be developed that Predict market - Theories must also be developed that Predict market reactions to accounting information and how users react reactions to accounting information and how users react

to accounting date. to accounting date.

Fundamental Analysis:Fundamental Analysis:

- The FASB has indicated that the primary goal of - The FASB has indicated that the primary goal of accounting information is to provide investors with accounting information is to provide investors with relevant an reliable information so they can make relevant an reliable information so they can make informed investment decisions. informed investment decisions.

Individual investors make the following investment decisions:Individual investors make the following investment decisions:

• Buy-A potential investor decides to purchase a particular Buy-A potential investor decides to purchase a particular security on the basis of available information.security on the basis of available information.

• Hold-An actual investor decides to retain a particular Hold-An actual investor decides to retain a particular security on the basis of available information.security on the basis of available information.

• Sell-An actual investor decides to dispose of a particular Sell-An actual investor decides to dispose of a particular security on the basis of available information.security on the basis of available information.

- Individual investors use an available financial information to - Individual investors use an available financial information to assist in acquiring or disposing of the securities contained in assist in acquiring or disposing of the securities contained in their investment portfolios that are consistent with their risk their investment portfolios that are consistent with their risk preferences and the expected returns offered by their preferences and the expected returns offered by their investments.investments.

- The decision process used by individual investors is - The decision process used by individual investors is termed fundamental analysis. Fundamental analysis termed fundamental analysis. Fundamental analysis is an attempt to identify, individual securities that are is an attempt to identify, individual securities that are mispriced by reviewing all available financial mispriced by reviewing all available financial information . information .

- These data are then used to estimate the amount - These data are then used to estimate the amount and timing of future cash flows offered by investment and timing of future cash flows offered by investment opportunities and to incorporate the associated opportunities and to incorporate the associated degree of risk to arrive at an expected share price for degree of risk to arrive at an expected share price for a security. a security.

- This discounted share price is then compared to the - This discounted share price is then compared to the current market price of the security, thereby allowing current market price of the security, thereby allowing the investor to make buy-hold-sell decisions.the investor to make buy-hold-sell decisions.

- Investment analysis may be performed by investors Investment analysis may be performed by investors themselves or by security analysts. Because of their training themselves or by security analysts. Because of their training and experience. and experience.

- Security analysis are able to process and disseminate Security analysis are able to process and disseminate financial information more accurately and economically than financial information more accurately and economically than are individual investors. are individual investors.

- Security analysis and individual investors use published Security analysis and individual investors use published financial statements, quarterly earnings reports, and the financial statements, quarterly earnings reports, and the information contained in the Management Discussion and information contained in the Management Discussion and Analysis section of the annual report, particularly those Analysis section of the annual report, particularly those sections containing forward-looking information and the sections containing forward-looking information and the company's plans. company's plans.

- Upon review of these information sources, security analysts Upon review of these information sources, security analysts frequently make their own quarterly earnings estimates for the frequently make their own quarterly earnings estimates for the most widely held companies. most widely held companies.

-Subsequently, as company quarterly information is released, Subsequently, as company quarterly information is released, security analysts comment on the company's performance security analysts comment on the company's performance and may make buy-hold-sell recommenda tions.and may make buy-hold-sell recommenda tions.

- Security analysts' estimates and recommendations may Security analysts' estimates and recommendations may affect the market price of a company's stock.affect the market price of a company's stock.

- One school of thought, the One school of thought, the efficient market hypothesis, efficient market hypothesis, holds that fundamental analysis is not a useful investment holds that fundamental analysis is not a useful investment decision tool because a stock's current price reflects the decision tool because a stock's current price reflects the market's consensus of its value. market's consensus of its value.

-As a result, individual investors are not able to identify As a result, individual investors are not able to identify mispriced securities. mispriced securities.

The Efficient Market HypothesisThe Efficient Market Hypothesis

Economists have argued for many years that in a free market Economists have argued for many years that in a free market economy with perfect competition, price is determined by:economy with perfect competition, price is determined by:

(1)(1) The availability of the product (supply).The availability of the product (supply).(2)(2) The desire to possess that product (demand). The desire to possess that product (demand).

Accordingly. the price of a product is determined by the Accordingly. the price of a product is determined by the consensus in the marketplace. This process is generally consensus in the marketplace. This process is generally

represented by the following diagram.represented by the following diagram.