Accounting Theory - Explained
What is Accounting Theory?
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Table of ContentsWhat is Accounting Theory?A Little More on What is Accounting TheoryKey Elements of Accounting TheoryThe Origins and Evolution of Accounting TheoryAcademic Research on Accounting Theory
What is Accounting Theory?
An accounting theory is a notion that uses speculations, methodologies, and frameworks in the study of financial reporting (as well as how financial reporting principles are applied in the accounting industry).
Basically, accounting theories serve as a basis for the understanding of financial reporting and how companies channel their financial statements using the appropriate strategies.
An in depth study of accounting theory entails a look into existing accounting practices, how they evolved, and the modifications or additions done to them overtime. These accounting principles serve as framework for accurate financial reporting and statements.
Back to: ACCOUNTING, TAX, & REPORTING
How is Accounting Theory Used?
Accounting theories are basically the skeleton for accounting practices. That is, an accounting theory guides accounting practices.
All accounting theories rest on the tenets or framework of accounting provided by the Financial Accounting Standards Board (FASB). This board is responsible for stating the acceptable practices of financial reporting as well as the key objectives of financial reporting.
The FASB is an autonomous organization that oversees the preparation of financial statements by both private and public enterprises.
Key Elements of Accounting Theory
There are some crucial elements in accounting theory that makes it an indispensable framework for accounting practices. The key elements include the following;
- Relevance - this is a crucial element of an accounting theory. Information provided by accounting theories are relevant in all aspects.
- Usefulness - accounting theory is useful for the compilation of financial reports of statements. It helps corporate businesses make informed decisions as regards finance.
- Reliability - an accounting theory is reliable. It follows the standards of general accepted accounting principles (GAAP).
- Consistency - this is another key element of accounting theory.
Furthermore, accounting theory generally maintains that professionals in the accounting industry operate based on assumptions which are:
- Discrepancy between a business and its owner,
- continuity of the business, and
- preparation of financial statements using dollar representation and compilation of statements monthly, quarterly or annually.
The Origins and Evolution of Accounting Theory
The evolution of accounting theory can be traced to the inception of accounting as one of the major disciplines. Accounting as a discipline was developed in the 15th century and this birthed accounting theories used by corporate businesses. Due to the changes in accounting practices, a number of modifications and additions were also done to accounting theory. The Financial Accounting Standards Board helps to regulate and revise accounting theories. Certified Professional Accountants (CPAs) also help corporate businesses adjust to these modifications and new standards.
Academic Research on Accounting Theory
- Positive accounting theory, Watts, R. L., & Zimmerman, J. L. (1986). Positive accounting theory. This book reviews the theory and methodology underlying the economics-based empirical literature in accounting. An accounting theory theory is an explanation for observed accounting and auditing practices. Such an explanation is necessary for interpretation of empirical associations between variables. The book discusses the role of theory in empirical work. It then reviews accounting theories involved in empirical studies of the use of accounting in capital markets, contracting and the political process and the extent to which the theories are consistent with those studies' evidence. Empirical studies in auditing are also reviewed. The book finishes with a discussion of the role of accounting research and a summary and evaluation of the research up until the mid-1980s.
- Financial accounting theory, Scott, W. R. (2003). Financial accounting theory.
- Positive accounting theory: a ten year perspective, Watts, R. L., & Zimmerman, J. L. (1990). Positive accounting theory: a ten year perspective. Accounting review, 131-156. This paper reviews and critiques the positive accounting literature following publication of Watts and Zimmerman (1978, 1979). The 1978 paper helped generate the positive accounting literature which offers an explanation of accounting practice, suggests the importance of contracting costs, and has led to the discovery of some previously unknown empirical regularities. The 1979 paper produced a methodological debate that has not been very productive. This paper attempts to remove some common misconceptions about methodology that surfaced in the debate. It also suggests ways to improve positive research in accounting choice. The most important of these improvements is tighter links between the theory and the empirical tests. A second suggested improvement is the development of models that recognize the endogeneity among the variables in the regressions. A third improvement is reduction in measurement errors in both the dependent and independent variables in the regressions.
- An" events" approach to basic accounting theory, Sorter, G. H. (1969). An" events" approach to basic accounting theory. The Accounting Review, 44(1), 12-19.
- In search of management accounting theory, Malmi, T., & Granlund, M. (2009). In search of management accounting theory. European Accounting Review, 18(3), 597-620. In this article we discuss the motivation for and role of theory in management accounting. We argue that theories in an applied field such as management accounting research should provide explanations that are useful for those we study managers, organizations and society. We evaluate the nature of theories currently used and developed. Those theories that are considered theories by the research community are largely imported from other disciplines, but have hardly anything that makes them unique to management accounting. Those theories that are not currently regarded as theories by many of our colleagues attempt to explain how to apply management accounting to achieve superior performance. We argue that both forms of theories, at present, largely fail to provide valid support for practitioners. We contend that management accounting theory should help us to answer questions of what kind of management accounting systems we should apply, how, in what circumstances, and how to change them. We provide suggestions on how management accounting research could proceed to produce better theories in this regard.
- Accounting theory: Research, regulation and accounting practice, Gaffikin, M. J. (2008). Accounting theory: Research, regulation and accounting practice. It is contended early in this book that many accounting students dislike theory, but it is also asserted that for practice to be effective it must be reasoned practice. Theory provides this reasoning. However, in the past most accounting theory books have fallen well short of presenting a coherent explanation of the basis for theory and its relation to accounting practice. Some have simply described current research trends; some have described existing practices as if their mere existence was reason enough for their continued use; while others have deferred to restating current regulations with the implication that they were the theory of accounting! As the title implies, this book links theory to research and practice and indicates where regulation is necessary to substitute for independently derived theory.