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THE STRUCTURE OF
ACCOUNTING THEORY
Submitted to:
Professor Dr. Suman Das (Adjunct)
Department of Accounting
Notre Dame University Bangladesh
Submitted by:
1412152 – Mickey Mathew D.Costa
1412141 – Hasan Jubaier
1412166 – MD.Imranul Haque
1412153 – Bonney Rebeiro
1412161 – Ashish Rebeiro
Letter of Transmittal
August 3, 2017
Dear Sir,
With due respect we would like to state that we have reported on “The structure of Accounting
Theory” under the course: “Accounting Theory”.
We are requesting you to check our report thoroughly. We would be highly grateful if you kindly
go through our report.
Sincerely yours,
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Acknowledgement
First of all, we would like to express my deepest gratitude to our respected Mr. Suman Datta sir,
for providing us the opportunity to do the report on “Accounting Theory”
We sincerely thank all the people who helped us in acquiring information for this report. Especially
to our classmates for all their support. Without their help, this report would be incomplete.
We would also like to thank my parents, brother, all friends and enemies who suggested us,
encouraged and discouraged us which enriched our knowledge and helped us as wells as gave us
strength in completing this report. Writing a report is not an easy task, but we would like to give
thanks to all these people who have helped us in every way. All their words and ideas resulted in
this report. So, we would like to give thanks to all of them from the bottom of our heart those who
made this report possible.
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Table of Contents
1. INTRODUCTION 1
iii
6.5 TIMELINESS 11
6.6 INDUSTRY PRACTICE 12
7. CONCLUSION 12
8. REFERENCES 13
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Abstract
The underlying purpose and theory of financial accounting and reporting is that financial
accounting information, should provide information that is useful for making business and
economic decisions. So, accounting theory and accounting practices are absolutely closely related.
In recent times, we see various accounting theories developed based on the needs of different
categories of users. Many more theories are yet to be developed because some theories are new
and still under infancy stage. Being an accounting student it is imperative that we should have idea
about what elements are taken into consideration while developing new theories or what are the
drivers in our existing theories that we use still now. This report goes through the core four
elements that are used as the basis for our existing theory. No matter what a theorist or accountant
use, these four elements are at the heart of accounting procedure. Without these elements,
everything we do will make no sense and accounting will no longer be able to serve its main
purpose; which is to provide useful information for sound decision-making.
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1. Introduction
1.1 Accounting Theory
Accounting theory is a set of interrelated concepts and definition that provides a systematic view
of a phenomenon by stating relationship among variables in order to explain and predicting the
phenomena. It serves as a guideline. As economic and social environments are rapidly changing
day by day accountants are faced with numerous new problems. This situation created the need to
develop a baseline for accounting, the term which we now regard as accounting theory. Accounting
theory, after development although provided a guidance to the accountants for accounting practice
and recordings, accounting at present, is not a matter for the accountants only. Various types of
people are now the users of accounting information. Even people, who are not even distantly
affected by the organization’s actions. As a result, careful presentation of the accounting
information started to get attention as well as the careful formulation of the accounting theory.
At present time, we see that there is no single perfect accounting theory, that can completely make
sense out of economic events. As a result, there are a lot of theories. All of them vary based on
who are the users of accounting information or who is given preference or even what data are being
used in preparation of financial information. All of these factors provide a baseline in structuring
accounting theory.
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Objectives
Techniques
A statement of A statement of A body of
Postulates
Principles
the postulates the basic accounting
A statement of and theoretical accounting techniques.
the objectives concepts of principles. These These are
of financial accounting. are based on derived from
Statement These derive theoretical accounting
from objectives. concepts. principles.
Here every element derived from previous one. The most important factor here is the formulation
of objectives. Because, every element depends on its construction. The total process will fail if
formulation is wrong. Accounting theory can be made effective only in a framework where
objectives are meet perfectly.
We will discuss Environmental postulates, Theoretical concepts and Principles in brief.
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There are four types of accounting postulates. These are:
Entity Postulates
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In the user-oriented approach the interests of the users are given more priority than the economic
activities and administrative control of the business unit. Here, the interested individual or group
is determined at first. Then the nature of their needs is determined.
The user-oriented approach is considered to be more broader than firm-oriented approach. Because
as its main concern is users, in order to serve the needs of the users, the accounting entity may
even go as far as including information of corporate social performance, reporting accounting
policies and financial forecasts. This attempts are made to meet the informational needs of the
potential and present users of accounting information.
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3.4 Accounting Period Postulate
The time period assumption states that the life of a business should be divided into equal time
periods. These time periods usually ranges from monthly, quarterly, to even annually. These are
known as accounting periods for which companies prepare their financial statements to be used by
various internal and external parties. Usually this time period is generally considered one year and
at the interval of each, for the sake of comparability and uniformity.
The time period assumption enables business organizations to stop and see how successful they
have been in achieving their objectives during a particular period of time and where the room for
improvement exists. Although businesses intend to continue in long-term, it is always helpful to
account for their performance and position based on certain time periods. This in turn, provides
timely feedback and helps in making timely decisions.
Under time period assumption, we prepare financial statements quarterly, half-yearly or annually.
The income statement provides us an insight into the performance of the company for a period of
time. The balance sheet (the statement of financial position) provides us a snapshot of the business'
financial position (assets, liabilities and equity) at the end of the time period. The statement of cash
flows and the statement of changes in equity provide detail of how the company's financial position
changed during the time period.
One drawback of the time period assumption is that we have to make estimates and judgments at
the end of the time period to correctly decide which events need to be reported in the current time
period and which ones in the next.
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The proprietoey theory adpts best to sole proprietorship and partnership, though corporations are
also influenced by this theory to some extent. The total of insiders’ equity, i.e. paid-up capital,free
reserves and surplus, and retained earnings, is the net wealth accruing to shareholders, i.e., owners.
Thus it is implied that the proprietary theory is also applied to corporations in this surplus in this
respect. The corporate income, i.e., earnings after interest and tax represent net income to
shareholders rather than to all providers of capital. Interest and tax are treated as expenses, which
decrease net income to shareholders. Also, term such as ‘ earning per share, (EPS) ans dividend
per share (DPS) connote a proprietary emphasis.
The primary objective of this theory is to determine the propreitor’s net worth (Wealth). This
theory , as the accounting equation reveals, is balance sheet oriented. According to this theory, the
entity is regarded as the ‘’the agent, representative or arrangement through which the individual
entrepreneurs or shareholders operate.’’
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The entity theory has uts main application in the corporate form of business enterprise because it
has a separate existence from the lives of individual owners.
Earlier, it was believed that the bases of valuation were different in case of the proprietary and
entity theories. In the former, assets were to be valued at current values because the owners’ equity
was considered to be their net wealth. In the latter case, ‘’the firm was not to the owners and other
equity holders. However, recent discussions of valuation have stressed the importance of current
values as relevant in the determination of the income to the enterprise as a measure of the future
services to the firm, and as a basis for future decisions of management. Therefore, the proprietary
and entity theories do not necessarily dictate different valuation bases.’’
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Assets = Restrictions of assets
The accounting unit is defined in terms of assets and the uses to which these assets are committed.
Assets represent prospective services to the fund or operational unit and liabilities represent
restrictions against specific or general assets of the fund.
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5.3 The matching principle
“A matching principle who's that all the expenses incurred in generating revenue should be
identified or matched with the revenue generated, period by period.” if the if the purpose was to
generate revenue, as is the usual case, the expenses should be identified with the period of which
that revenue was recognized as earned. The association between revenues and expenses depends
on one of the following criteria. The first applicable criterion is applied:
Direct matching of expired cost with a revenue, e.g. Cost of goods sold matched with
related sale.
Direct matching of expired cost with the period, e.g. President's salary for the period.
Allocation of cost about periods benefited, e.g. Depreciation
Expense in other cost in the period incurred, unless it can be shown that they have for the
benefit e.g. Advertising expense.
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6. The Exception or Modifying Principles
The objectives of financial reporting, the postulates and the concepts provide a general framework
for the development of accounting principles. But “limitations of the users of external financial
statements and reports put constraints on the logical derivations of principle from the principles
from the principle and postulate along Without certain specific qualifications, the principle might
not be fulfill the needs of the user of this reports. The users have limited capability to handle a
mass large data and interpret the same in order to make predictions. Consistency, uniformity,
comparability and other constraints should be taken into consideration while determining the basic
principles.
The two major constraints or exceptions principle applying the basic principles in applying the
basic principles are: (a) cost benefit principle and (b) Materiality principle
6.2 Materiality
The FASB has issued many statements of financial accounting standards (SFAS) during the past
twenty five years. Each SFAS issued by Board has concluded by saying that the provisions of this
statement need not to be applied to immaterial items. The SEC Regulation S-x states that a
materiality matter is one about which an average prudent investor ought reasonably to be informed
and that material information such as information as is necessary to make the require statement. In
the light of the circumstances under which they are made not misleading.
The FASB in response to the discussions on Discussion Memorandum on Materiality has stated
its passion as follows the essence of the materiality is clear. The essence of the materiality is clear.
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Materiality is an important guide for the accountant in deciding what should be disclose in financial
reports. it is essentially a matter of professional judgment. The concept materiality is relative.
6.3 Consistency
The consistency principle holds that in the accounting process, all concepts principles and
measurement approaches should be applied in a similar or consistent way from one period to the
next in order to assure that the data reported in the financial statements are reasonably comparable
over time. This principle does not allow changes at will from one accounting approach to another.
It, however, permits changes in accounting techniques if it is likely to improve the measurement
of financial results and positions. Switching over from the fifo methods to lifo method of inventory
valuation during inflation or charging depreciation. This modifying principle was necessary since
adopting the GAAP different financial results could be drawn from same accounting data for the
same period.
6.4 Conservatism
This is another user constraint in the application of basic accounting principles. This principle hold
that when then on accounting and more than one accounting and measurement alternative is
permissible for a transaction, the one having the least for favorable immediate on net income
owners’ equity should be selected.
It implies that the highest value of liabilities and expenses and lowest values of assets and revenues
should preferably be reported. The principle to ignore all unrealized gains and provide for all
anticipated losses, is usually applied. This shows a generally pessimistic attitude of the account.
this principle has been applied in the past as a way of dealing with uncertainty, the possible over
optimism of managers and owners and also as a way of protecting creditors against an unwarranted
distribution of the firm s assets as dividends.
This very much restrict the principle of objective and fair reporting. The rules of lower of cost or
market in valuing inventories is still applied. Now conservatism is regarded as a virtue of the past.
better techniques are available for reducing uncertainty. The interests and needs of the inventor are
given greater importance.
6.5 Timeliness
One of the primary qualities desired in useful accounting information is that it should be relevant.
Timeliness is an ingredient of relevance. The information that is given to the users of financial
reports should be current and supply frequently. If old and late information is presented it hampers
their ability to make rational decisions.
Timeliness is a user constraint. It puts restrictions on the application of the basic principles. In
order that the information is timely, it may be less reliable.
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The principle of uniformity is also useful to the users in making proper comparisons between
different comparable firms .Inter-firm comparison is possible if the firms adopt similar accounting
policies ,techniques and methods. Professional institutes have been issuing pronouncements from
time to time to ensure inter firm comparability by adopting uniform methods of reporting.
7. Conclusion
The quality of financial statement presented to external users of financial information depends
upon the theoretical structure of accounting. There is a need for constant review and upgrading of
the elements comprising accounting theory, viz objective postulates concepts, principles and
techniques.
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8. References
1. Notes for MBA, (2017). Approaches to the formulation of accounting theory. Retrieved
from
http://www.notesformba.com/topic/approaches-to-the-formulation-of-accounting-theory/
2. Jennifer Edwards. Accounting Postulates and Accounting Details. Retrieved from
http://www.accountingdetails.com/accounting-postulates.htmSimon Renshaw. AABRS.
What is Included in the Statement of Affairs for a Voluntary Liquidation?
3. Steven Bragg, (2017). Accounting principle. Retrieved from
https://www.accountingtools.com/articles/2017/5/7/accounting-principle
4. Manukriti Nandwani. Postulates in Accounting. Retrieved from
http://www.accountingnotes.net/accounting/postulates-in-accounting/5270
5. Fredd1e, (2011). International Financial Accounting and Theory. Retrieved from
https://worldthemes.wordpress.com/tag/entity-theory/
6. Harold Averkamp. What is going concern? Retrieved from
https://www.accountingcoach.com/blog/going-concern
7. What is a Going Concern? Retrieved from\
http://accounting-simplified.com/financial-accounting/accounting-concepts-and-
principles/going-concern.html
8. Money Measurement Concept in Accounting. Retrieved from
http://accounting-simplified.com/financial/concepts-and-principles/money-
measurement.html
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