The Definition of Theory
In my view the theory means a set of coherent principles, concepts, symbols and hypothetical principles which is a reference point in field of knowledge. The theories in general are composed of words and symbols and do not have a physical form.The Purpose of Theory
The purpose of theory plays an important part in any field. This applies to accounting also. The most important utility of theories in any field of inquiry is that it is a source of new knowledge as they change with new insights by continuous research in any particular field by the researchers who are acknowledged by the profession because of their expertise, integrity, experience and knowledge in that field. In this context, accounting needs theories so that it can develop new knowledge continually as in other fields such as science, social science, psychology etc.
Nature of Accounting
The nature of accounting is primarily a statement which has some basic principles and concepts. That is the nature of accounting is defined by an accounting theory. In essence the nature of accounting can be defined as follows:“The nature of accounting is a process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information”.
The Measurement-Communication System
In the measurement communication system the accountant is the transmitter of accounting information. He sends the message in a financial report form to the users or receivers of this crucial information. The accountant is influential in identifying economic information, objectives and in the same time he is also affected by the firm’s environment. The receivers of accounting information in the communication system interpret the information about the firm and then make economic decisions. In this communication system one can see the communication system is basically based on human behavior. As well, the accounting practitioners are governed by conventions and authority. That is their accounting procedures and accounting policies are largely determined by conventions and authority. In addition, the accounting researchers like in any other field develop accounting theories by systematic study in the accounting field.Functions of Theories
Basically theories have three functions. The first function of theory or theories is to explain. For example why an accountant do not do a particular accounting method because of ethical codes and accounting standards require him to use such methods and he uses these accounting methods to protect him from sanctions imposed by accountingbodies and for his own self interest of not being able to practice and earn an income if he does not obey to authority and sanctions. The second function of theory is to predict. For example in accounting a theory may predict cosmetic accounting changes may not affect share price if the capital market is efficient and share price is not based only on accounting information but other information as well and there fore accounting methods changes may not affect share prices. The third function of a theory is to prescribe or recommend. For example in accounting the accounting theory may recommend current cost accounting because of its utility or should be used to provide as it may provide useful information to users. However, all theories do not have all these functions. Some theories explain, some explain and predict, some predict only and some only recommend.
History of Accounting Theory
The history of accounting can be categorized in to descriptive theory period before 1955, normative theory period between 1956 and 1974 and positive accounting theory period after 1976.However, currently mostly many advanced countries at least one can say the accounting theories are based on conceptual frame work based on primarily by normative accounting theories as well as in some accounting issues positive accounting theories are used to explain behavior of managers and the impact of accounting on capital market performance in general.
The examples of descriptive accounting theories used before 1955 are based on observations and what is used in accounting a particular economic event mostly is adopted as a method for that transaction in a particular field. For example if depreciation is used in practice applying a certain method then that is accepted as a method of accounting if it is widely used. That is, descriptive accounting theories guide accounting methods, principles and conventions.
After 1956, the normative accounting theories governed to prescribe what should be done. For example, after 1956 norms of best practice was developed by the incorporation of usefulness of accounting information. This not necessarily based on observation. Due to Normative accounting theories decision usefulness theories were developed and also measurement issues and income concepts became important. As well, the normative accounting theories gave birth to conceptual frame works projects.
After 1975 on wards because of dissatisfaction with normative theories positive accounting theories became important. For example these theories enable the accounting profession to explain and predict that what should be done based not necessarily based on observation. That is the positive accounting theories are basically a specific scientific method of inquiry in to specific accounting issues. The in accounting the important positive accounting theories are capital market based research, contracting theory, behavioral research.
The hierarchical position of financial accounting objectives, postulates and theoretical concepts, principles of accounting and accounting techniques
In accounting, the financial accounting objectives determine the postulates and theoretical accounting concepts. The theoretical concepts and postulates determine accounting principles. The accounting principles determine accounting techniques.That is, the hierarchical positions of these related concepts are as follows:
- Financial accounting objectives
- Accounting postulates and Theoretical accounting concepts
- Accounting principles
- Accounting techniques, method, rules and procedures
Accounting Postulates, concepts and principles
The basic accounting postulates are accounting entity postulate, Going concern postulate, unit of measure postulate and accounting period postulate. Theoretical accounting concepts are propriety theory, fund theory, entity theory. The accounting principles are revenue recognition, cost and matching, uniformity and comparability, consistency and full disclosure, materiality and conservatism. Most of the postulates, theoretical accounting concepts and principles are derived from descriptive accounting theories.Critique of the development of accounting rules
The critique of the development of accounting rules mostly come from the insistence on descriptive accounting theories historically. The development applying this accounting theory gave birth to Generally Accepted Accounting Practice. They are piecemeal in nature and they produced inconsistencies as well they were incapable to handle unusual economic events. They also gave birth to creative accounting. These developments of accounting rules were due to problems of lack of general theory, permissiveness of accounting practice, inconsistency of practices, and defense against political interference.To address these deficiencies conceptual framework was proposed. This is a normative method of theory development. It is premised on the user needs driving the formulation of rules and other operational procedures for use in practice.
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