Formulation of accounting theory
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Accounting theories are basically logical reasoning which provides or forms a set of principles ,policies ,methods ,rules ,procedures & conventions.
Features of accounting theory
It provides framework for:-
Evaluating current financial accounting practices &
Developing new theory.
Accounting theory as a “pre” & “post” phase activity
Pre phase :- in pre phase accounting theory is basically formulated on a particular topic or point of view.
Post phase:- in the post phase accounting theory is tested whether it gives the same result for which it was formulated or not
i.e:- its evaluation is done.
Accounting theory at its end result
After its formulation and evaluation if it gives desirable results then it will act as a policy ,methodology or principle for the work of an organisation.
The need of accounting theory
For any practical work there firstly needed an theoretical approach.The application of a theory in general is practical of it.
So,for an application of accounting practices there the base is accounting theory.under the theory some rules & principles are given on which accounting practices are based.
Objective of accounting theory
The basic objective of accounting theory is to explain and make accounting practices.
For example:- as it explains why certain firms are using LIFO method of inventory rather FIFO method of inventory control.
So it acts as a justification that why a certain accounting practice is taken.
Concept of a good accounting theory
Characteristics of a good accounting theory:-
They explain or predict phenomena,they are empirical.
These are refutable by empirical testing.theories which are not capable of refutation by testing are speculative.
Theories are helpful in providing a focus for guiding & directing research into empirical problems.(in the sense what were the situations there)
Research methodology for formulation of accounting theory
There are two theories followed:-
It basically explains how financial information is collected,analysed & communicated.it justifies accounting practices.it has a user oriented approach.
Theory which attempts to state what financial information collected ,analysed & communicated.it depends on ones own judgement & thinking.it is basically subjective.
Methods of reasoning applied in research
The deductive theory makes reasoning from particular to general
The deductive theory is the method which makes reasoning from particular to general.
Research sequence cyclical pattern
Traditional approaches toformulation of accounting theory
Under this theory construction steams from need to provide a rationale for what accountants do or expects to do.
Most of these approaches are theoratical.
These theories basically assumes that accounting theories and techniques must be predicted on ultimate use of financial reports.
The concept of these theories is that these theories should not be discarded due to non practical base.these are necessary to any theory through an operational utility.
Under this theory accounting techniques & principles are choosen due to their usefullness to different catagories of users of accounting information & their relevence to decision making.
it provides practical solutions.so as practical approach it does not give any theory but tells about using it in real practice.
e.g.:- the impact of any information relating to the company on its share price.
This approach mostly used by professional organisations.it consists of issuing pronouncements for regulation of accounting practices.
The deductive approach
Under deductive approach theory construction begins with basic propositions & proceeds to derive logical conclusions which serves as guides for development of accounting techniques.
under this theory approach is from general to particular or specific.
all assets accounts have debit balance.
building & machine accounts are asset account.
building & machine accounts have debit balance.
Steps in deductive approach
Determining objectives of financial reporting.
Selecting postulates of accounting.
Developing a set of definitions.
Formulating principles of accounting or generalised statements of policy.
Applying the principles of accounting to specific situations &
Establishing procedures,methods & rules.
Advantage & disadvantage of deductive approach
It provide a basis for practical rules
If any postulate & proposition is false ,conclusions may also be wrong.
It involves reasoning from particular to general.
under this approach on the basis of particular observations & measurements, generalised conclusions are drawn.
Building account is an asset account & has a debit balance.
Machine account is an asset account & has a debit balance.
All asset accounts have debit balance.
Steps in inductive approach
Making observations & recording of all the observations.
Analysis & classification of these observations to determine recurring relationships, similarities, & dissimilarities.
Derivation & formulation of generalisations & principles of accounting from the recorded observations that reflect reccuring relationship.
Testing of generalisations & principles.
Advantage & disadvantages of inductive approach
It is not influenced by predetermined objects.
It is subjective.
Under this approach ethical aspect is always taken into consideration.
This approach emphasis on:-
This approach have 3 major basis:-
1:-accounting procedures must provide equitable treatment to all interested parties.
Financial reports should present a true & accurate statement without misrepresentation.
Accounting data should be fair ,unbiased & impartial , without serving special interests.
Example of ethical approach
A asset is sold at a price at which company makes profit but in accounts the value of asset before its sale was shown as it was increased before sale.
In today`s time corporates with financial point needs to give full consideration to the society also which includes many parties such as owners,creditors,consumers,labour unions,trade unions.the information is a public good.
Objective & need of sociological approach
Its objective is to encourage business enterprises to account for impact of their activity on society.
Need of sociological approach arise due to growing awareness corporate towards society.
Examples of sociological approach
Bonus to employees.
The economic approach
This approach focuses on concept of economic welfare.choice of different accounting techniques depends ,on their impacts on the national economic good.
The economic approach is of 2 types in nature
the micro economic approach
The macro economic approach
Influence of economic approach on accounting theory
At time of inflation valuation of inventory method shifts from FIFO method to LIFO method.
Companies also makes higher dividend payments & large capital expenditure in prosperity economic periods & discourage investment during period of inflation.
This approach is combination of all approaches.
The traditional theory consists of theory views more rather practical.it is able to give theoratical base to methodogies techniqes followed in accounting.it sets out accountings relationship with other fields of human knowledge.these theories constructed with some subjectivity also.under it sequence of events are made & after observing a phenomina lead to set up hypothesis & hypothesis tested accordingly test results a generalisation can be stated & after it principle is introduced.