The several approaches to accounting theory are not independent of each other.
This is particularly true of the ethical approach; for defining it as a separate approach does not necessarily imply that other approaches do not have ethical content, nor does it imply that ethical theories necessarily ignore all other concepts.
Pattillo, stresses the ethical concept as primary but he states that in his approach.
“Its basic standard is an ethical one, its method is logical or and coherent, and the ultimate test of the formulations lies in its application to the real world.”
The ethical approach to accounting theory places emphasis on the concepts of justice, truth, and fairness. Dr. Scott suggested that the basis for the determination of accounting practice reaches back to the principles underlying social organizations.
His basic concepts were;
- Accounting procedures must provide equitable treatment to all interested parties;
- Financial reports should present a true and fair statement without misrepresentation;
- Accounting data should be fair, unbiased, and impartial and must not serve any special interests.
To these basic concepts, he added the requirements that accounting principles should be subject to continual revision as necessary to allow for changing condition and that accounting principles should be applied consistently whenever possible.
Fairness, justice, and impartiality refer to judgments that accounting reports and statements are not subject to undue influence or bias.
They should not be prepared with the objective of serving the interest of any particular individual or group against the interest of others.
The interests of all parties must be taken into consideration duly, particularly without any preference for-the rights of the management or owners of the firm who may have greater influence over the choice of accounting procedures
Justice frequently refers to conformity to a standard established formally or informally as a guide to equitable treatment.
Truth, as it relates to Accounting, is probably more difficult to define and apply.
Many seem to use the term to mean “in accordance with the facts.”
However, not all who refer to truth in accounting have in mind the same definition of “facts.” Some refer to accounting facts as data that are objective and verifiable. Thus, historical costs may represent accounting facts.
On the other hand, the term “truth” is used to refer to the valuation of assets and expenses in current economic terms.
MacNeal stated that financial statements display the truth only when they disclose the current value of assets and the profits and losses accruing from changes in values, although the increases in values should be designated as realized or unrealized.
Truth is also used to refer to propositions or statements that are generally considered to be established principles.
the recognition of a gain at the time of the sale of an asset is generally considered to be a reporting of true conditions, while the reporting of an appraisal increase in the value of an asset prior to sale as ordinary income is generally thought to lack truthfulness.
Thus, the established rule regarding revenue realization is the guide.
But the truthfulness of the financial reports depends on the fundamental validity of the accepted rules and principles on which the statements are based.’ Established rules and procedures provide an inadequate foundation for measuring truthfulness.
The concept of “fairness” has long been a basic objective in the presentation of audited financial statements.
The generally accepted accountant’s short-form report or certificate states, in part: “In our opinion, the accompanying statements present fairly the financial position of the company as of — and the results of its operations for the year then ended…..”.
Mautz and Sharaf indicate that this statement expresses the faithfulness in reporting the realities of the firm’s operations and financial condition.
In discussing the concept of fairness, they include three sub-concepts: accounting propriety, adequate disclosure, and audit obligation.
AICPA Statement on Auditing Procedure No.33 implies a similar concept of “fairness.” In a section entitled “Fairness of Presentation,” the topics discussed include
- Conformity with generally accepted accounting principles,
- Consistency, and
Thus the concept of fairness is related closely to compliance with traditional and conventional practice.
In this respect, it is similar to the second concept of “truthfulness” stated above. But Mautz and Sharaf imply that compliance is not enough.
If compliance with generally accepted practices does not permit the presentation of statements that report the realities, the auditor must develop his own principles.
These “realities,” however, are similar to the “facts” referred to in the first definition of “truthfulness” above. The determination of realities, like the determination of facts, depends on the viewpoint of the observer.
A different concept of “fairness” is implicit in the comments by Leonard Spacek on AICPA Accounting Research Study No.3. He states ‘….a discussion of assets, liabilities, revenue, and costs is premature and meaningless until the basic principles that will result in a fair presentation of the facts in the form of financial reporting are determined.
This fairness of accounting and reporting must be for and to people, and these people represent the various segments; of our society.’
Fairness, in this context, means impartiality and justice to the individuals and groups having an interest in the statements as well as a fair presentation of the facts.
The emphasis is on fairness to the readers of the statements rather than the fairness of the data being presented. Reports that are prepared in a fair manner may also be impartial but, according to Spacek, both are necessary.
In the United Kingdom, the Companies Act of 1967 requires that the auditors shall state in their report whether or not a true and fair view is given in the balance sheet of the company’s affairs as at the end of its financial year and in the statement of its profit and loss for its financial year.
While the statement of the auditors implies an ethical judgment, the practical interpretation of it results in the acceptance of traditional accounting procedures in most cases.
However, accountants in the United Kingdom generally have greater freedom than do those in the United States in the choice of accounting methods in order to present a true and fair view.
Few accountants would deny that truth and fairness are good objectives, in the presentation of financial statements. But as single objectives, they rely too heavily on subjective judgments.
Because of this subjectivity, there is a tendency to rely on traditional rules and procedures to provide an objective measurement of truth.
Unless these rules and procedures are soundly based on logic, however, the resulting statements may turn out to be monstrosities of misrepresentation.
In an attempt to present facts and realities, accountants may be likened to the three blind men reported by Confucius as describing an elephant as either like a wall, a tree, or a snake, depending on whether each was feeling the side, the leg, or the trunk of the elephant.
The question may be not whether certain information is true or false of fair but whether or not it is relevant and logical in describing the financial operations and condition of an enterprise.
Probably the greatest disadvantage of a primary reliance on the ethical approach to accounting theory is that it fails to provide a sound basis for the development of accounting principles or for the evaluation of currently accepted principles.
Principles must be evaluated on the basis of subjective judgments; or, as generally occurs, currently accepted practice become accepted without evaluation because it is expedient to do so.
An example of the application of the ethical approach is found in Pattillo’s The Foundation of Financial Accounting.
With respect to income, he concludes that the current operating concept produces results that are fair to all parties because with it there is full disclosure of extraordinary items so that distortion and confusion are avoided.
On the other hand, he finds that the use of historical cost is not fair to all parties because it “does not provide a basis for determining the relative positions of all interested parties.