The Structure of Accounting Theory

What is Accounting Theory?

Theory is defined as “ a set of interrelated constructs (concepts), definations and propositions that present a systematic view of phenomena by specifying relations among variables with the purpose of explaining and predicting the phenomena.”

It will be seen that accounting theory has been defined as a coherent set of logical principles that:

Ø Provides a better understanding of existing practices to practioners, investors, mangers, and other users;

Ø Provides a conceptual framework for evaluating existing accounting practices; and

Ø Guides the development of new practices and procedures.

Nature of Accounting Theory

Provide a general frame of reference by which accounting practices can be evaluated,

Guide the development of new practices and procedures.

Elements of the Structure

“While the elements of the structure may differ according to the methodologies used and the assumptionsmade, a consenus exists on the primacy of certain of the elements as essential foundations of accounting.”

The elements are:

v A statement of the objectives of financial statements.

v A statement of the postulates and theoretical concepts of accounting. These are derived from the stated objectives.

v A statement of the basic accounting principles. These are based on both the postulates and the theoretical concepts.

v A body of accounting techniques. These are derived from the accounting principles.

The Theoretical Concepts (Theories) of Accounting

Ø THE PROPRIETARY THEORY

THE PROPRIETARY THEORY seek to explain content and measurement principles underlying financial statements by placing the owner of the enterprise in the center of the accounting universe

Assets-liabilities = owner’s equity

Ø THE ENTITY THEORY

Under entity, net income does not belong to proprietor but to the entity, which is regarded as separate and distinct from providers of capital.

Assets = liabilities +shareholder’s equity

Ø THE RESIDUAL EQUITY THEORY

It excludes the holders of preference share capital from the proprietor group

Assets – specific equities= residual equity

Ø The enterprise theory

In this theory corporation is a social institution operated for the benefit of many interested groups

Ø The fund theory

Under the fund theory the basis is neither the proprietor nor the entity as a separate person. Instead activity oriented unit is basis of accounting. It consist of economic resources and related obligations and restriction in use of these resources

Assets = restrictions of assets

Basic Accounting Principles

v The Revenue Principle:

This concept emphasises that profit should be considered only when realised.The accounting is in conformity with the law and Recognises the principle of law i.e., the revenue is earned only when the goods are transferred. It means that profit is deemed to have accrued when property i goods passes to the buyer, viz., when sales are made.

v The Cost Principle:

This concept is closely related to the going concern concept. According to this concept, an asset in ordinarily recorded in the books at the price at which it was acquired i.e., at its cost price. The 'cost' should not be confused with 'value'.

v The Matching Principle:

The aim of business is to earn profit. In order to ascertain the profit the costs (expenses) are matched to revenue. The difference between income from sales and costs of producing the goods will be the profit. When business is taken as a going concern then it becomes necessary to evaluate the performance periodically.

v The Full Disclosure Principle:

The disclosure of all significant information is one of the important accounting conventions. It implies that accounts should be prepared in such a way that all material information is clearly disclosed to the reader. The term disclosure does not imply that all information that any one could desire is to be included in accounting statements.

Submitted by:

(58) Shveta Karwal (A),

(118)Seema Arora (B)

(185)Yuvika Narang (C)