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ACCOUNTING THEORY

AND

STANDARDS

Dr. BALAMURUGAN MUTHURAMAN

Chapter - 1

A THEORY: DEFINITION

A theory: ‘a set of interrelated constructs (concepts), definitions, and propositions that present a systematic view of the phenomenon by specifying relationships among variables with the purpose of explaining and predicting the phenomenon’

A theory includes propositions linking concepts in the form of hypotheses to be tested.

A THEORY: DEFINITION

Elements of a theory include: ◦ Concepts: the main units of a theory and it is

devised to refer to identifiable characteristics or phenomena.

: The better the concept, the better the theory.

: A formation of concept starts from the idea

or percept generating a concept designated by terms.

A THEORY: DEFINITION

Elements of a theory include: ◦ Propositions: Establish relation between the

concepts of a theory. : Designated by a sentence.

: Characterized by 1) The number and degree of

predicates; and 2) The degree of generality.

A THEORY: DEFINITION

Elements of a theory include: ◦ Hypotheses: a proposition about a relationship

whose truth or falsity is yet to be determined by an empirical test.

: Confirmation of a theory is the extent to which a hypothesis is capable of being shown to be empirically true, that is, of describing the real world accurately

: Falsification??

ACCOUNTING THEORY -

MEANING

“. . . a set of basic conceptsand assumptions and related

principles that explain and

guide the accountant’sactions in identifying,

measuring, and

communicating economic

information.”

WHY ACCOUNTING THEORY IS

IMPORTANT

Many individuals have to make decisions

about external accounting reports.

◦ Corporate managers

◦ Public accountants

◦ Officers of lending institutions

◦ Investors and financial analysts

◦ Individuals in accounting standard-setting

bodies

Accounting theory provides a logical framework

for accounting practice.

ASSUMPTIONS

PRINCIPLES

RULES

STRUCTURE OF ACCOUNTING

THEORY FORMAL APPROACH

FUNCTIONS OF A THEORY

Descriptive function: using the constructs

or concepts and their relationships so as to

provide the best explanation of a given phenomenon and the forces underlying it.

Delimiting function: selecting the favorite

set of events to be explained and assigning

a meaning to the formulated abstractions of the descriptive stage.

FUNCTIONS OF A THEORY

Generative Function: the ability to

generate testable hypotheses or to provide

hunches, notions, and ideas from which hypotheses could be developed.

Integrative Function: the ability to present

a coherent and consistent integration of the various concepts and relations of a theory.

ACCOUNTING THEORY: DEFINITION

Accounting theory: A set of broad principles that:

1) provides a general frame of reference by

which accounting practice can be evaluated; and

2) guides the development of new practices

and procedures.

ACCOUNTING THEORY: DEFINITION

Accounting theory should explain and predict accounting phenomena.

The primary objective of accounting

theory is to provide a basis for the

prediction and explanation of accounting behaviour and events.

ACCOUNTING THEORY: DEFINITION

Accounting theory should have Three

elements:

1) Encoding of phenomena to symbolic

representation;

2) Manipulation or combination according

to rules; and

3) Translation back to real-world

phenomena.

A ROLE OF ACCOUNTING THEORIES

GAAP Accounting Standards Accounting Policies

Accounting Techniques

Accounting Principles, Concepts and Postulates

A Conceptual Framework

Accounting Theories

GAAP

GAAP (Generally Accepted Accounting

Principles): a guide to the accounting

profession in the choice of accounting

techniques and the preparation of financial

statements in a way considered to be good accounting practice.

Conditions under which an accounting method will be deemed as generally accepted: ◦ The method will be in actual use; ◦ The method would have support in the

pronouncement of the professional accounting societies; ◦ The method would have support in the

writing of a number of respected accounting teachers and thinkers.

GAAP

ACCOUNTING STANDARDS

What are the differences between GAAP and accounting standards???

ACCOUNTING STANDARDS

Accounting standards consist of Three parts: ◦ A description of the problem to be

tackled.

◦ A reasoned discussion or ways of solving the problems.

◦ In line with discussion or theory, the prescribed solution.

ACCOUNTING STANDARDS

Reasons to establish standards are:

◦ To ensure quality of financial information

◦ To be guidelines and rules

◦ To be database for a government

◦ To generate interests in principles and theories.

ACCOUNTING STANDARDS

Who should set accounting standards?

◦ Theories of regulation: Public-interest theories

Interest-group or capture theories

The political ruling-elite theory of regulation

The economic theory of regulation

ACCOUNTING POLICIES

The specific accounting principles and the

methods of applying those principles that

are judged by the management of the entity

to be the most appropriate in the

circumstances to present fairly financial

position, changes in financial position, and

results of operations in accordance with generally accepted accounting principles.