What is accounting theory?
Accounting theory is a set of assumptions, frameworks and methodologies used in the study and application of financial reporting principles. Studying accounting theory involves examining the historical foundations of accounting practices, as well as how accounting practices are changed and added to the regulatory framework that governs financial statements and financial reporting.
Key points to remember
- Accounting theory provides a guide to effective accounting and financial reporting.
- Accounting theory involves the assumptions and methodologies used in financial reporting, requiring an examination of accounting practices and the regulatory framework.
- The Financial Accounting Standards Board (FASB) issues generally accepted accounting principles (GAAP) which aim to improve the comparability and consistency of accounting information.
- Accounting theory is a constantly evolving subject, and it must adapt to new ways of doing business, new technological standards and the gaps discovered in reporting mechanisms.
Understanding accounting theory
All accounting theories are linked by the conceptual framework of accounting. This framework is provided by the Financial Accounting Standards Board (FASB), an independent entity that works to define and establish the main objectives of corporate financial reporting, both public and private. In addition, accounting theory can be viewed as the logical reasoning that helps assess and guide accounting practices. Accounting theory, as regulatory standards evolve, also helps to develop new accounting practices and procedures.
Accounting theory is more qualitative than quantitative, in the sense that it is a guide to effective accounting and financial information.
The most important aspect of accounting theory is utility. In the world of corporate finance, this means that all financial statements must provide important information that can be used by readers of financial statements to make informed business decisions. It also means that accounting theory is intentionally flexible so that it can produce effective financial information, even when the legal environment changes.
In addition to its usefulness, accounting theory states that all accounting information must be relevant, reliable, comparable and consistent. This essentially means that all financial statements must be accurate and comply with United States generally accepted accounting principles (GAAP). Adherence to GAAP allows the preparation of financial statements to be both consistent with the past financial statements of a company and comparable to the financial statements of other companies.
Finally, accounting theory requires that all accounting and finance professionals operate on four assumptions. The first assumption states that a business is an entity separate from its owners or creditors. The second affirms the conviction that a business will continue to exist and not to go bankrupt. The third assumes that all financial statements are prepared with dollar amounts and not with other figures such as production units. Finally, all financial statements must be prepared on a monthly or annual basis.
Accounting as a discipline has existed since the 15th century. Since then, businesses and economies have changed a lot. Accounting theory is a constantly evolving subject, and it must adapt to new ways of doing business, new technological standards and the gaps discovered in reporting mechanisms.
For example, organizations such as the International Accounting Standards Board help create and review practical applications of accounting theory by amending their international financial reporting standards (IFRS). Professionals such as Chartered Public Accountants (CPA) help companies navigate new and established accounting standards.