Accounting theory definition
/What is Accounting Theory in Financial Reporting?
Accounting theory is the cluster of accounting frameworks and historical practices used to apply financial reporting principles. Most accounting theory is based on an applicable framework, such as Generally Accepted Accounting Principles or International Financial Reporting Standards. These frameworks undergo extensive formulation and review by accounting experts and address most situations accountants encounter. Historical precedents, often developed within specific industries, also guide accounting treatment. When a framework provides no guidance, accountants typically rely on precedent. Accounting theory is especially useful for entirely new accounting issues that rule-setting bodies have not yet addressed.
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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. The following sub-topics cover several key issues relating to accounting theory.
Usefulness of Information
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.
Reporting Outcomes
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 Principles
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.
Accounting Theory FAQs
What is the difference between positive and normative accounting theory?
Positive accounting theory explains and predicts actual accounting behavior, such as why managers choose certain policies. Normative accounting theory prescribes how accounting should be done based on ideal objectives like transparency, fairness, or decision-usefulness. The key difference is that one describes real-world behavior, while the other recommends preferred practices.
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