Seminar Series

The Nature of Accounting Income Measurement (2)

Speaker

Dr Frederico Botafogo

Institute

Southern Institute of Technology

Time & Place

Thu, 12 Jul 2018 13:00:00 NZST in Law 411

All are welcome

Abstract

The year 2019 will celebrate the 40th anniversary of the famous paper by Beaver and Demski (1979) titled The Nature of Income Measurement. Their paper, published in The Accounting Review, marked the recognition by mainstream theorists of the Information Content approach to accounting. This approach is academically very important nowadays because it provides the conceptual basis for most of the current Market Based Research in Accounting.
 
Starting in the 1960s and early 1970s, theorists became increasingly concerned with measurement issues in accounting (e.g., the controversies opposing Historical Costing to Cocoa to CCA to CPPA). Working within the Representational Measurement framework formalised by Krantz et al. (1971), Beaver and Demski (1979) show that outside the neoclassical setting of general equilibrium (i.e., perfect and complete markets) income cannot be measured. This begs the question of what the concept of income entails. They respond by claiming that ‘more income is not better than less income’ because income should not be understood to measure performance but rather it should be interpreted as a signal that informs the prevailing economic conditions applicable to the firm. This is consistent with the intuitive understanding we all share about the market mechanism such that whenever a firm post unexpected accounting information, market participants read a signal with which they update perceptions that possibly lead to changes in share prices, for example.
 
Despite becoming the mainstream theory in accounting, particularly in American academia, the Information Content approach remains outside the Conceptual Framework preferred by standard setters, both the FASB and the IASB. Standard setters claim that income can be measured, in line with a 500 years old tradition dating back to Pacioli, which sees the scope of double-entry accounting to be the measurement of wealth creation by firms. On the 40th anniversary of their paper, we offer a re-conceptualisation of income that supports the reconciliation of both approaches, the information content approach preferred by Beaver and Demski and the valuation approach preferred by the standard setters.
 
Our contribution stems from changing the very basic assumption about the nature of the accounting attribute being measured. While Beaver and Demski (1979) rely on preferences’ satisfying the axioms of a strict order, we rely on decision-makers’ having goals that satisfy the axioms of a weak order. We associate the attribute of accounting with causal input-output relationships among bundles of resources such that both the input as the output bundles maintain costs and values constant over the duration of any economic process.

Biography

Frederico obtained his PhD degree from University of Otago on work in accounting theory and linear algebra to frame accounting information. This provides additional means for completing valuations within an economic setting posited to be outside general equilibrium. Frederico has more than ten years’ working experience as a manager and consultant in his native Brazil. He has been living in New Zealand for the past seven years and currently teaches accounting at the Southern Institute of Technology in Invercargill.