Financial Accounting Theory and Analysis: Text and Cases, 11th Edition

To have a science is to have recognized a domain and a set of phenomena in that domain, and next to have defined a theory whose inputs and outputs are descriptions of phenomena (the first are observations, the second are predictions), whose terms describe the underlying reality of the domain.¹ In Chapter 2, the FASB's Conceptual Framework Project was introduced as the state-of-the-art theory of accounting. However, this theory does not explain how accounting information is used, because very little predictive behavior is explained by existing accounting theory. Over the years, accountants have done a great deal of theorizing, providing new insights and various ways of looking at accounting and its outcomes. A distinction can be made between theorizing and theory construction. Theorizing is the first step to theory construction, but it is often lacking because its results are untested or untestable value judgments.²

In the following pages, we first introduce several research methods that might be used to develop theories of accounting and its uses. Next we discuss the use of accounting information by investors and a number of theories on the outcomes of the use of accounting information, including fundamental analysis, the efficient market hypothesis, the capital asset pricing model, agency theory, human information processing, and critical perspective research. None of these theories ...