Accounting theory definition
/What is Accounting Theory in Financial Reporting?
Accounting theory is the cluster of accounting frameworks and historical practices that is used to apply principles of financial reporting. The bulk of accounting theory is based on the applicable accounting framework, such as Generally Accepted Accounting Principles or International Financial Reporting Standards. These frameworks are based on a lengthy process of formulation and review by the top experts in the field, and so are designed to address the bulk of the accounting situations that the typical accountant is likely to encounter. In addition, there are historical precedents for how accounting issues have been dealt with, usually by specific industry. In the absence of instructions from an accounting framework, historical precedent is typically used. An especially good use for accounting theory is in dealing with entirely new areas of accounting, for which the rule-setting bodies have not yet provided any guidance.
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Understanding Accounting Theory
The rules set forth by the standard setting bodies are based on a conceptual framework of accounting. These conceptual frameworks have been devised by the Financial Accounting Standards Board and International Accounting Standards Board, which generally coordinate their activities, and so have issued similar conceptual frameworks. Accounting theory encompasses these conceptual frameworks, while also taking into consideration the logical reasoning that underpins the frameworks. The outcome is a logical approach to how accounting standards are to be interpreted, as well as how entirely new accounting practices should be designed.
It is essential to derive accounting solutions that maximize the usefulness of outcomes. For example, an organization’s financial reporting should provide useful information for the readers of its financial statements. This means that accounting theory needs to be sufficiently flexible that it can provide useful outcomes even when there are significant legal, regulatory, or operational changes that impact a reporting entity.
For accounting theory to provide workable solutions, it must also generate comparable, consistent, relevant, and reliable accounting information. For this to be the case, an organization’s financial statements must adhere to the applicable accounting framework. By doing so, the financials will be not only consistent from period to period, but can also be compared to the financials of other businesses that adhere to the same accounting framework.
Accounting theory is also based on a number of accounting principles. For example, the cost principle states that you should only record a transaction at its original acquisition cost, while the economic entity principle states that you should keep separate the transactions of different business entities. Examples of other accounting principles are as follows:
Accounting theory changes on an ongoing basis, in order to adapt to how business is done, and especially when there are gaps in the accounting frameworks that do not apply to current accounting practices.
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