Accounting Theories - Essay Example

Accounting Theories Accounting Theories The accounting function is a key business activity which is performed by accountants working for an organization. This function is responsible for recording and managing records of all business transactions and finally report on the company’s financial standing and its earnings and cash generating ability and position at a certain point in time. Other activities may include forecasting and budgeting which assists companies in planning their business activities for the future periods. This information is not only used for internal purposes but also a varied group of external stakeholders rely on this to undertake important financial decisions. It is therefore essential that this information is recorded and reported in such a way that it holds value for all its users. In this paper framework for accounting profession including different accounting theories would be discussed. Furthermore, an illustration of different accounting treatment based on different accounting approaches is also made in this paper. The accounting profession is based on values and conceptual framework that has been developed over the years. This conceptual framework incorporates different well established theories and principles which determine the methodology for recognising, measuring and recording of the company’s assets and liabilities. The framework also allows logical reasoning for addressing different accounting and financial issues and provides guidelines for incorporating the information related to these issues in the financial records. This ensures that a uniform approach could be applied to different classifications of assets and liabilities and the information that has been produced and verified can be depended upon for decision making. An accounting theory defined as “a coherent set of hypothetical, conceptual and pragmatic principles forming a general frame of reference for enquiring into the nature of accounting”(Hendriksen & Breda, 1992) therefore could be suggested to provide the necessary concepts, framework, principles, procedures, rules and regulations. Another way of looking at accounting theories is that they allow predicting accountants’ behaviour and provide basis for coherent accounting treatment of assets and liabilities. There are numerous accounting theories suggesting that there is no single comprehensive of accounting. They could be categorized into three broad areas that are 1) those providing explanation of accounting practices 2) those providing forecasts or predictions of impacts of future accounting practices and 3) those which present general guidelines and recommendations for application of accounting procedures. Over the years several accounting theories are developed, tested and are still subject to continuous discussions for their validity and implications as new classes of assets and liabilities are discovered. However, upon literary analysis it could be suggested that there are two basic accounting theories which could be distinguished on the basis of the research methodologies adopted namely positive and normative theories. Positive accounting theory implies the implementation of different accounting techniques to real life cases and estimating the role of accounting which would in fact help in decision making. This highlights the preferences of accountants in selecting accounting techniques over others (Hoque, 2006). Positive theory therefore could be suggested to have a current approach on accounting. While on the other hand normative accounting theory draws its footing on the basis on assumptions and generalized observations. By doing so this theory prescribes the ways in which accounting issues must be dealt with and what accounting techniques must be implemented to achieve the desired levels of credibility and accuracy (Belkaoui, 2004). This theory takes on an approach suggesting future changes in accounting procedures. It could also be suggested that both these theories are not independent of each other and in fact complement each other. However, both theories take on a different view of accounting and suggest a different approach to accounting practices that accountants need to follows. Porwal (2001) put forwarded a view that normative accounting theories are actually aimed at standardizing suggest accounting approaches and agrees on a coherent approach towards an accounting issue or problem whereas positive theories form an intellectual understanding and provides a descriptive explanation regarding a current issue (Porwal, 2001). Apart from these two accounting theories there are numerous other accounting theories which have been formulated by members of the regulatory bodies and are regularly used by accountants to deal with the situations and issues pertaining to them. These theories include pragmatic theories which evolve on the basis of accountants’ attitude and behaviour that is not judgmental in any way towards an issue which is to be addressed using most appropriate accounting procedures. Furthermore, there are syntactic theories which use semantic inputs which are not subject to independent empirical verification. Differences can be identified between these two theories as one is based on generalization of observations whereas the other one is based on factual inputs (Godfrey, 2007). Another theory referred to as proprietary theory or agency theory suggests that the managers of a company work as agents for different stakeholders and they are responsible for company’s asset utilization. In this way shareholders have delegated managers with decision making power in order to earn profits for them. (Chapman, Hopwood and Shields, 2007). This theory therefore separates capital providers from the business entity which is operating to generate profit for investors. The fund theory rejects agency theory by suggesting that company’s assets and liabilities are part of fund put in by shareholders which actually governs the use of assets. Thus both theories present a different view of the company and its operations. Additionally moral hazards theory deals with the risks of managers not acting honestly which could affect the company’s well being and therefore suggests limit to the role of the managers under agency theory. Ideal and Non Ideal theory relies on the certainty associated with the financial information disclosed in the company’ reports and suggests disclosures under different circumstances which could be opposed by another theory of decision usefulness theory that highlights the usefulness of information for decision making by shareholders (Porwal, 2001). From the above discussion regarding various accounting theories and core differences them it would not be not be wrong that without these theories the understanding of accounting would have no real value to it. It is crucial for those who wish to pursue career in accountancy must understand the basis for these theories which they would experience regularly while working for different organizations and dealing with different classes of assets and liabilities and new ones adding with the complexities of businesses rising. Without proper comprehension of these theories practical application will not be possible. However it should also be understood that these theories do not have a practical form and are comprising of principles, techniques and procedures based on words and statements. Accounting that is practical in nature and application of practical techniques is common one might ask regarding the need for knowing these accounting theories. A simple answer to this would be that without a solid understanding of the framework provided by these theories it is irrational thinking that one could perform his / her activities efficiently. Understanding the complex transactions and ensuring proper representation in the company’s financials it is important for accountants to form a logical reasoning and knowledge to assist them in achieving their tasks efficiently. It is widely understood that accounting theories provide a way to carry out various accounting functions in the most appropriate manner as they formulate the basic structure and theoretical framework which is deemed necessary for all those associated with the profession. These accounting theories not only provide general framework for the profession but also prescribe ways of developing newer theories and concepts which could deal with newer accounting issues. Turning to our example of how different approaches to the treatment of assets and liabilities could have varying outcome for financial accounting. The accounting standards allow recognition and measurement of assets and liabilities using two approaches namely historical value approach and fair value approach. These two approaches result in different reported values and on further examination using two theories including positive and normative this could be understood such as the use of historical costing under positive accounting theory is without any basis provided for the implications of its use and its further impact on future reporting. On the other hand the normative theory would evaluate the use of historical costing for its implications on the reported figures and if deemed important it would recommend the use of fair value accounting which could be considered as more relevant to a particular class of asset or liability. In a similar manner the theory for ideal and non ideal would support the use of historical costing as it removes the uncertainty in the reported statements whereas the decision usefulness theory would let the use of fair value accounting as more appropriate and relevant to the shareholders view of the company. In the end it could be surmised that the existence of different accounting theories that are presented in this paper is the outcome of efforts by accounting professionals to form a better understanding of accounting and financial tasks at hand. The theories that are discussed in this paper therefore relate to the current practices of accountants or how they should perform in the future. It is observed that some of these accounting theories have strong similarities but they are in fact very different from each other. In the last few decades accounting profession has experienced turmoil from time to time and accountants in general and regulators in particular are under constant pressure to devise approaches which could actually achieve better representation of financial reporting. Therefore, it is suggested here that without good understanding of the accounting theories it is impossible for practitioners to achieve what is expected from them and that is to protect the interests of stakeholders in all possible manner. References Belkaoui, A. R. (2004). Accounting Theory. New York: Cengage Learning EMEA . Chapman, C. S., Hopwood, A. G. and Shields, M. D. (2007). Handbook of Management Accounting Research. Oxford: Elsevier. Godfrey, J. (2007). Accounting Theory. New York: John Wiley & Sons, Inc. Hendriksen, E. S., & Breda, M. F. (1992). Accounting Theory. (D. Richard, Ed.) New York: Irwin Inc. Hoque, Z. (2006). Methodological Issues in Accounting Research: Theories, Methods and Issues. London: Spiramus Press Ltd. Porwal, L. S. (2001). Accounting Theory. New Dehli: Tata McGraw-Hill. Read More