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The Accounting Theory

Definition of Accounting Theories

1. What is a theory?

…the coherent set of hypothetical, conceptual and pragmatic principles forming the general
framework of reference for a field of inquiry (Hendriksen) theories are composed of words or
other symbols…they are statements and do not have a physical form …logical reasoning in
the form of a set of broad principles that: provide a general framework of reference by which
accounting practice can be evaluated and guide the development of new practices and
procedures (Hendriksen).

2. A set of basic concepts and assumptions and related principles that explain and guide the
accountant’s action in identifying, measuring and communicating economic
information.www.staff.vu.edu.au

3. ACCOUNTING THEORY tries to describe the role of accounting and is composed of four
types of accounting theory: classical inductive theories, income theories, decision usefulness
theories, and information economics / agency theories: a. Classical inductive theories are
attempts to find the principles on which current accounting processes are based; b. Income
theories try to identify the real profit of an organization; c. Decision usefulness theories
attempt to describe accounting as a process of providing the relevant information to the
relevant decision makers; and, d. The information economics / agency theories of accounting
see accounting information as a good to be traded between rational agents each acting in
their own self-interest (http://www.ventureline.com/accounting-glossary/A/accounting-theory-
definition/)

4. Assumptions, methodologies and frameworks used in the study and application of financial
principles. The study of accounting theory involves a review of both the historical foundations
of accounting practices, as well as the way in which accounting practices are verified and
added to the regulatory framework that governs financial statements and financial reporting.
Accounting as a discipline has existed since the 15th Century. Since then both businesses
and economies have greatly evolved. Accounting theory is a continuously-evolving subject, as
it must adapt to new ways of doing business, new technological standards and gaps that are
discovered in reporting mechanisms. Organizations such as the International Accounting
Standards Board help create practical applications of accounting theory, and professionals
such as CPAs help companies navigate accounting standards.
http://www.investopedia.com/terms/a/accounting-theory.asp

5.

There are different schools of thought on what represents accounting theory. The first school focuses
on the development of accounting principles and describes accounting theory as follows:

Thus, accounting theory may be defined as a logical reasoning in the form of a set of broad principles
that (1) provide a general frame of reference by which accounting practice can be evaluated and (2)
guide the development of new practices and procedures (Hendriksen
1982:1). Accounting theory is the basic assumptions, definitions, principles and concepts that underlie
accounting rule making (Wolk et al.2008:2).

The other school of thought explains accounting theory as an activity to explain

and predict:… the primary objective of accounting theory is to provide a basis for the prediction and
explanation of accounting behavior and events (Riahi-Belkaoui 2004:108).

The objective of accounting theory is to explain and predict accounting practice (Watts

& Zimmerman 1986:2).Theory attempts to explain relationships and predict phenomena (Wolk et al.
2008:28).

While the first school focuses on the principles of accounting, the second endeavours to evaluate
practice itself. Hendriksen (1982:1) expresses his preference for the first school as follows:
Accounting theory may also be used to explain existing practices to obtain a better understanding of
them. But the most important goal of accounting theory should be to provide a coherent set of
principles that form the general frame of reference for the evaluation and development of sound
accounting practices.

These two schools of accounting theory are grounded in the two main methodologies for the
development of theory in general that is, normative and descriptive methodologies. Normative
methodology questions existing theory to describe what the theory should be, while descriptive
methodology investigates the underlying phenomena to describe what they are

(Hendriksen 1982; Riahi-Belkaoui 2004). Normative methodology is more concerned with what the
outcome should be and is more prescriptive (Deegan & Unerman 2006:10). By contrast, descriptive
methodology describes, explains and predicts the underlying phenomena

(Deegan & Unerman 2006:8).

Normative and descriptive methodologies are also distinguished by the process followed to develop
theory.

Normative methodology is a deductive process in which objectives are formulated, from which
principles are developed.

Descriptive methodology is an inductive process that focuses on observations of the real world. The
aim of the inductive process is to record the underlying phenomena.

However, a third process, the predictive process, is sometimes identified. This process goes further
than the inductive process in that it not only records the observations, but also explains and predicts
them – hence the fact that it is often referred to as a positive research methodology (Deegan &
Unerman 2006:8). he second school of accounting theory, the explain-and-predict school, although
descriptive in observing the underlying phenomena, focuses more on

Importance of Accounting Theories

The first prerequisite is that accounting should agree or conform with the basic truths
according to which our economic system functions; the current economic and business
practices and the applicable law as embodied in legislative regulations or common law.
Consequently, it is important that uniformity is maintained in accounting practice; in
other words, a specific set of circumstances, wherever it may be encountered must be
dealt with by everyone in exactly the same way within the accounting process.
Accounting theory creates a framework that ensures that accounting practice complies
with the requirements of conformity and uniformity. This theory is embodied in a set of
principles, policies, methods, procedures and conventions. The continuously increasing
scope and complexity of our economic system requires a corresponding process of
adaptation in accounting in order that the relevant information regarding economic
activities may be recorded. It is essential that everyone involved in accounting should
understand this process of adaptation; moreover, a prerequisite for such understanding
is a grasp of not only the theory of accounting, but also the structure of that theory.

Accounting theory is based on a set of basic economic truths that are of a dual nature.
First, accounting theory is based on propositions generally accepted in the economic
order of a particular society. For example, consider the concept of personal ownership: a
general accepted tenet of our society is the exclusive right of every person to own things
- they are his personal property and no one else's. This concept is a basic economic
truth.

Second, the basic economic truths have characteristics similar to those of natural laws in
the sense that specific causes generate specific consequences. If, for example, someone
derives greater value from a transaction than what was put into the transaction, his net
worth - his wealth - will have increased by the surplus amount. This, too, is a basic
economic truth. These economic truths are formulated as concepts and postulates. A
concept is a generally accepted view of a specific phenomenon, which is described in
specific terms. A postulate is a generally accepted hypothesis or supposition of a specific
condition or phenomenon, which serves as a basis for the formulation of principles.

In the development of accounting theory, concepts and postulates serve as formulations


of the basic truths or propositions upon which the theory is based. They do not attempt
to prescribe the working of the accounting process, but simply the foundation upon
which the structure of accountancy is based.

Michael Russe
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