Accounting Theory: Firms Disclosure of Information - Essay Example

Accounting Theory: Firms Disclosure of Information Contents Accounting Theory: Firms Disclosure of Information Contents 2 Introduction 3 AccountingTheories and Assumptions 3 Uses of Accounting Information 6 Conclusion 8 Reference 9 Introduction For sustaining in a market a firm need invest from the investors which they can get by winning the confidence of the investors. The investor confidence can be won by disclosing the information about the company in public. The information should be accurate and properly audited by the auditors. There are various accounting theories which are stated by the researchers. This paper is an attempt to analyze the reason of disclosing various type of information by the firm using the variety of accounting theories. Accounting Theories and Assumptions There are certain accounting assumptions which are the basic postulates of accounting means they are the base of accounting. The accountants face some difficulties when they are recording the business transactions. So the basic assumptions are made which are based on the experience. These accounting assumptions are the basis of the accounting theories. These are as follows. Business Entity Concept: This is the most basic concept of accounting. According to the concept the organization and the owners are two separate entities. If the business transaction also records the transactions of the individuals then the financial statements would not be accurate as the same transaction is recorded for the business and the owner’s personal account. The business entity concept is necessary to implied by the accountants to measure that what information is relevant to the business and which are not. But the entity concept is not so useful when the matter of valuation of entities and disclosure are concerned. Going Concern Concept: According to the going concern concept the accountants prepare the financial statements assuming that the business is not going to broke down or liquidate. The directors of the company should assess the information about the company and then make the disclosures clearly about the financial statements’ going concern. But the criticism of going concern arises when the uncertainty of the events related to the business is concerned, the doubts are there if the business would survive in a situation or not. Conservatism Concept: The conservatism concept leads accountants to anticipate losses or lesser value of assets. There are two alternatives which can be followed by the accountants. The accountants who follow the concept choose the conservative one between the two. The potential losses from the business are disclosed according to the concept, not the potential gains. Revenue Recognition Principle: The revenue recognition principle leads the accountants to identify the situations in which the income would be realized as revenue. The revenue can be recognized before or after cash is received depending on the policies followed by the concerned company’s accountants, and thus the disclosure of profit and loss in the financial statements are made. Full Disclosure Principle: The companies are bound to disclose the information important for the outside stakeholders in the footnote of the financial statements. The footnotes of the statements also include the information about the probable costs associated with the business. In the financial accounting practice some assumptions, frameworks and methodologies are needed which is called as accounting theory. The accounting theories are based on some basic assumptions which are discussed earlier. The accounting theories are known as the guide of accounting practices. Three disciplines are known as the roots of the accounting theories. Decision theory: The decision theory refers that how to make a decision. For taking a decision the accountants take the different alternatives in consideration. After considering the different alternatives and measuring their outcomes the management take the decisions about the future pathway. Measurement Theory: It means that the related entities or objects of the business are to be measured and the numerals assigned to them must be related to some common numeral system. The common unit for measuring is money. Information Theory: Information theory which is another base of accounting which makes the basis of decision making. The information makes the decision making of the company management easier and it is useful for the other stakeholders also ( Maharshi Dayanand University, 2004, p.60-61). Based on the three disciplines the accounting theories are constructed. The accounting theories are mainly of two type normative and positive theory of accounting. In the normative accounting theory the accountants opined that accounting based upon the opinion which is subjective, logic and the inductive methods. The measurement issues and the concept of income, the decision usefulness theories and the conceptual framework projects are the normative accounting theories. The positive accounting theory is there to explain and predict the accounting practice which is practical. The behavioural research, contracting theory and the capital market based research are the examples of positive accounting theory. Uses of Accounting Information The day to day transactions of a business is recorded in the respective journals and after step by step the final information is recorded in the financial statements which are used by the stakeholders of the company. The financial statements are properly audited by the auditors who assure that the information which is in the financial statements is accurate. From the information of the financial statements the investors and the creditors can know about the financial condition of the company and thereby take the decisions whether to invest in the company or to provide further credit to the company. If the company used to disclose the information which is transparent then the reputation of the company is good and the investor or the creditors get attracted if the financial condition of the company is good. The other user of the company’s financial statement is the management of the company who uses the information for the development of the company. They tend to found in which position the remedial measures should be taken and what to do for further improvement of the company. The disclosure of the information also includes the future cost likely to incur by the company. These steps also give information about the future planning of the company and the future probable costs. The type of information disclosed in the financial report of the company is the business transactions of the company took place in the last period for which the accounting is measured. The accounting procedures are based on the accounting assumptions and the accounting theories discussed earlier. The accountants always follow the procedures that they are used like the revenue recognition process, make it sure that the entity principle, going concerned principle is maintained. According to the positive accounting theory which is based upon disclosing of the actual cost of the incurred by the company the political cost, the social responsibility cost of the companies are take in account though it is not identified as the daily business transaction (Mline, 2002, p.2-3). In the paper of Healy and Palepu it is stated that in the new era of economic change for maintaining the stock performance of the company they need to report certain information like improved liquidity of the stock, the reduction in the cost of capital and the analysis of the financial analysts which are voluntary (Healy and Palepu, 2001, p.429-430). Though the daily transaction of the business doesn’t including the political cost or the social cost of the business the accountants should include the cost in the financial information. There are footnotes added in the financial statements. The footnotes should include the probable cost of the business which they may be incurring in the future. According to the positive accounting theory the accountants should include the cost which is practical which means the financial statements include the cost the company has incurred which is not normal apparently along with the daily transaction cost. The companies should disclose the information in their annual report which is transparent and properly audited by the auditors. The company should make it sure that the current and perspective investors find it important for making decision about investing. The transparent information about all type of cost disclosed by the company made it reliable for the investors and thus the company can get more investors and thus the can improve their market position or sustain the current market position. Conclusion The accounting theories are based on certain accounting assumptions like basic entity concept, going concern concept etc. Based on this many accounting theories are constructed by the researchers which are divided in two main categories normative accounting theories and positive accounting theories. The normative accounting theories are more subjective when the positive accounting theories are more practical. Positive accounting theory means that the accountants are disclosing the information which is market oriented. In the financial statements the accountants should include the costs which are the probable cost in the normal course of the business, the political cost, the social cost which are generally not included in the financial statements. The researchers have stated this type of cost should be included voluntarily by the company and along with this the information of stock liquidity, cost of the capital information, and analysis of the financial analysts should be included in the financial reporting for improving the stock performance and thus improving the reputation and market share of the company. Reference Healy, p. and Palepu, k. (2001). Information Asymmetry, corporate disclosure and the Capital Markets: A review of the Empirical Disclosure Literature. Available at: http://tippie.uiowa.edu/accounting/mcgladrey/winterpapers/kothari1.pdf. [Accessed on: December 6, 2011]. Maharsi Dayanand University. (2004). Accounting Theory. Available at: http://mdudde.net/books/Mcom/Mcom-f/Accounting%20Theory-final.pdf. [Accessed on: December 6, 2011]. Mline, M. (2002). Positive Accounting Theory, Social Costs and Social Disclosure Analysis: A Critical Look. Available at: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.195.8073&rep=rep1&type=pdf. [Accessed on: December 6, 2011]. Read More