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The Accounting Theory

Definition of Accounting Theories

1. What is a theory?

the coherent set of hypothetical, conceptual and pragmatic principles forming the general

framework of reference for a field of inquiry (Hendriksen) theories are composed of words or

other symbolsthey are statements and do not have a physical form logical reasoning in

the form of a set of broad principles that: provide a general framework of reference by which

accounting practice can be evaluated and guide the development of new practices and

procedures (Hendriksen).

2. A set of basic concepts and assumptions and related principles that explain and guide theaccountants action in identifying, measuring and communicating economicinformation.www.staff.vu.edu.au

3. ACCOUNTING THEORY tries to describe the role of accounting and is composed of four

types of accounting theory: classical inductive theories, income theories, decision usefulness

theories, and information economics / agency theories: a. Classical inductive theories are

attempts to find the principles on which current accounting processes are based; b. Income

theories try to identify the real profit of an organization; c. Decision usefulness theories

attempt to describe accounting as a process of providing the relevant information to the

relevant decision makers; and, d. The information economics / agency theories of accounting

see accounting information as a good to be traded between rational agents each acting in

their own self-interest (http://www.ventureline.com/accounting-glossary/A/accounting-theory-

definition/)

4. Assumptions, methodologies and frameworks used in the study and application of financial

principles. The study of accounting theory involves a review of both the historical foundations

of accounting practices, as well as the way in which accounting practices are verified and

added to the regulatory framework that governs financial statements and financial reporting.

Accounting as a discipline has existed since the 15th Century. Since then both businesses

and economies have greatly evolved. Accounting theory is a continuously-evolving subject, as

it must adapt to new ways of doing business, new technological standards and gaps that are

discovered in reporting mechanisms. Organizations such as the International AccountingStandards Board help create practical applications of accounting theory, and professionals

such as CPAs help companies navigate accounting standards.

http://www.investopedia.com/terms/a/accounting-theory.asp

5.

There are different schools of thought on what represents accounting theory. The first school focuses

on the development of accounting principles and describes accounting theory as follows:

Thus, accounting theory may be defined as a logical reasoning in the form of a set of broad principles

that (1) provide a general frame of reference by which accounting practice can be evaluated and (2)

guide the development of new practices and procedures (Hendriksen

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1982:1). Accounting theory is the basic assumptions, definitions, principles and concepts that underlie

accounting rule making (Wolk et al.2008:2).

The other school of thought explains accounting theory as an activity to explain

and predict: the primary objective of accounting theory is to provide a basis for the prediction and

explanation of accounting behavior and events (Riahi-Belkaoui 2004:108).

The objective of accounting theory is to explain and predict accounting practice (Watts

& Zimmerman 1986:2).Theory attempts to explain relationships and predict phenomena (Wolk et al.

2008:28).

While the first school focuses on the principles of accounting, the second endeavours to evaluate

practice itself. Hendriksen (1982:1) expresses his preference for the first school as follows:

Accounting theory may also be used to explain existing practices to obtain a better understanding of

them. But the most important goal of accounting theory should be to provide a coherent set of

principles that form the general frame of reference for the evaluation and development of sound

accounting practices.

These two schools of accounting theory are grounded in the two main methodologies for the

development of theory in general that is, normative and descriptive methodologies. Normative

methodology questions existing theory to describe what the theory should be, while descriptive

methodology investigates the underlying phenomena to describe what they are

(Hendriksen 1982; Riahi-Belkaoui 2004). Normative methodology is more concerned with what the

outcome should be and is more prescriptive (Deegan & Unerman 2006:10). By contrast, descriptive

methodology describes, explains and predicts the underlying phenomena

(Deegan & Unerman 2006:8).

Normative and descriptive methodologies are also distinguished by the process followed to develop

theory.

Normative methodology is a deductive process in which objectives are formulated, from which

principles are developed.

Descriptive methodology is an inductive process that focuses on observations of the real world. The

aim of the inductive process is to record the underlying phenomena.

However, a third process, the predictive process, is sometimes identified. This process goes further

than the inductive process in that it not only records the observations, but also explains and predicts

them hence the fact that it is often referred to as a positive research methodology (Deegan &Unerman 2006:8). he second school of accounting theory, the explain-and-predict school, although

descriptive in observing the underlying phenomena, focuses more on

Importance of Accounting Theories

The first prerequisite is that accounting should agree or conform with the basic truths

according to which our economic system functions; the current economic and business

practices and the applicable law as embodied in legislative regulations or common law.

Consequently, it is important that uniformity is maintained in accounting practice; in

other words, a specific set of circumstances, wherever it may be encountered must be

dealt with by everyone in exactly the same way within the accounting process.

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Accounting theory creates a framework that ensures that accounting practice complies

with the requirements of conformity and uniformity. This theory is embodied in a set of

principles, policies, methods, procedures and conventions. The continuously increasing

scope and complexity of our economic system requires a corresponding process of

adaptation in accounting in order that the relevant information regarding economic

activities may be recorded. It is essential that everyone involved in accounting should

understand this process of adaptation; moreover, a prerequisite for such understanding

is a grasp of not only the theory of accounting, but also the structure of that theory.

Accounting theory is based on a set of basic economic truths that are of a dual nature.

First, accounting theory is based on propositions generally accepted in the economic

order of a particular society. For example, consider the concept of personal ownership: a

general accepted tenet of our society is the exclusive right of every person to own things

- they are his personal property and no one else's. This concept is a basic economic

truth.

Second, the basic economic truths have characteristics similar to those of natural laws in

the sense that specific causes generate specific consequences. If, for example, someone

derives greater value from a transaction than what was put into the transaction, his net

worth - his wealth - will have increased by the surplus amount. This, too, is a basic

economic truth. These economic truths are formulated as concepts and postulates. A

concept is a generally accepted view of a specific phenomenon, which is described in

specific terms. A postulate is a generally accepted hypothesis or supposition of a specific

condition or phenomenon, which serves as a basis for the formulation of principles.

In the development of accounting theory, concepts and postulates serve as formulations

of the basic truths or propositions upon which the theory is based. They do not attempt

to prescribe the working of the accounting process, but simply the foundation upon

which the structure of accountancy is based.

Michael Russe

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