Introduction
Financial accounting theory is an essential foundation for understanding how financial information is measured, reported, and interpreted. One of the most influential works in this area is Craig Deegan’s Financial Accounting Theory, which provides a detailed analysis of the role of accounting in society. Deegan explores the frameworks and theories that shape financial reporting, including normative and positive accounting theories, stakeholder theory, legitimacy theory, and institutional theory. In this article, I will analyze Deegan’s financial accounting theory in-depth, examining its implications for accounting practice, regulatory frameworks, and financial decision-making. I will also provide comparative insights and practical examples to illustrate key concepts.
Table of Contents
Understanding Financial Accounting Theory
Definition and Importance
Financial accounting theory examines the principles, assumptions, and methodologies that guide financial reporting. It helps us understand:
- How financial statements should be prepared.
- Why certain accounting practices are used.
- How accounting regulations evolve over time.
Deegan’s approach to financial accounting theory is particularly relevant because it considers both traditional and contemporary accounting perspectives, making it applicable to real-world financial decision-making.
Key Accounting Theories
Deegan categorizes financial accounting theory into several key areas, each with distinct characteristics and implications.
Normative Accounting Theory vs. Positive Accounting Theory
Normative accounting theory prescribes how accounting should be conducted. It focuses on ideal accounting principles and conceptual frameworks. Positive accounting theory, on the other hand, seeks to explain and predict accounting practices based on empirical evidence.
| Feature | Normative Accounting Theory | Positive Accounting Theory |
|---|---|---|
| Focus | How accounting should be | How accounting is practiced |
| Basis | Conceptual frameworks | Empirical observation |
| Example | Fair value accounting | Earnings management |
| Use in Policy Making | High | Moderate |
Deegan suggests that while normative theories help shape accounting standards, positive accounting theories help explain why firms adopt specific accounting methods.
Stakeholder Theory
Stakeholder theory argues that financial accounting should serve the interests of all stakeholders, not just shareholders. This theory considers investors, employees, customers, and society at large.
Example: A company may disclose environmental impact reports to maintain stakeholder trust and ensure long-term sustainability.
Legitimacy Theory
Legitimacy theory suggests that businesses must operate within the norms and expectations of society. If stakeholders perceive a company as illegitimate, it may lose support.
Example: Companies in the fossil fuel industry often engage in corporate social responsibility (CSR) initiatives to maintain legitimacy amid concerns about climate change.
Institutional Theory
Institutional theory examines how organizations adopt certain accounting practices due to regulatory, social, and industry pressures rather than economic efficiency alone.
The Role of Regulation in Financial Accounting
US Accounting Standards and Regulatory Bodies
In the United States, financial accounting is governed by:
- Financial Accounting Standards Board (FASB) – Develops Generally Accepted Accounting Principles (GAAP).
- Securities and Exchange Commission (SEC) – Regulates publicly traded companies.
- Public Company Accounting Oversight Board (PCAOB) – Oversees audits of public companies.
The Influence of Deegan’s Theory on Standard-Setting
Deegan’s work highlights how accounting standards evolve due to stakeholder pressures, regulatory changes, and economic realities. For example, the shift from historical cost accounting to fair value accounting reflects both normative and positive accounting influences.
Practical Applications: Examples and Calculations
Earnings Management
Earnings management occurs when firms manipulate financial statements to meet market expectations. Deegan discusses various earnings management techniques, such as income smoothing and big bath accounting.
Example: A company defers revenue recognition to the next period to lower taxable income.
Let’s say a firm has:
- Revenue of $2,000,000
- Expenses of $1,500,000
- Net income of $500,000
If the firm defers $100,000 in revenue, the reported income becomes: Net Income=(2,000,000−100,000)−1,500,000=400,000Net\ Income = (2,000,000 – 100,000) – 1,500,000 = 400,000
This reduces tax liability but may mislead investors.
Fair Value vs. Historical Cost Accounting
Deegan’s work contrasts fair value accounting with historical cost accounting. Fair value accounting adjusts asset values to reflect current market prices, while historical cost accounting records assets at their original purchase price.
| Factor | Historical Cost Accounting | Fair Value Accounting |
|---|---|---|
| Basis | Original purchase price | Market value |
| Volatility | Low | High |
| Relevance | Lower | Higher |
| Complexity | Simpler | More complex |
Example Calculation: A company purchases land for $1,000,000. After three years, the fair value rises to $1,500,000.
- Under historical cost accounting, the land remains valued at $1,000,000.
- Under fair value accounting, the land is revalued at $1,500,000, leading to an unrealized gain.
Criticisms and Limitations
While Deegan’s financial accounting theory is comprehensive, it has limitations:
- Lack of Predictive Power: Positive accounting theory can explain why firms adopt specific practices but does not always predict future trends.
- Ethical Considerations: Stakeholder and legitimacy theories suggest that accounting should serve broader societal interests, but firms often prioritize profits.
- Regulatory Challenges: Balancing transparency with complexity remains a challenge in financial reporting.
Conclusion
Deegan’s financial accounting theory provides valuable insights into how accounting standards evolve, the role of stakeholders, and the regulatory landscape. Understanding normative vs. positive accounting theories, stakeholder influences, and legitimacy concerns is crucial for accountants, auditors, and policymakers. By applying these principles, firms can enhance transparency, maintain legitimacy, and make informed financial decisions. Deegan’s work continues to shape accounting research and practice, offering a foundation for understanding the ever-changing financial reporting environment.
