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There are two aspects to the financial accounting theory; that is what is financial accounting and what is theory and let us quote here Henderiksen (1970) who defined theory as a logical set of theoretical, abstract and realistic principles creating the wide-ranging structure of reference for a field of inquiry. Theories in term are a rational system of interconnected intentions and essentials that can show the way to reliable and steady standards.
Defining Financial Accounting
Financial accounting is financial information in simple lay term. It can also be termed as in the study and application of financial principles various postulations, processes and frameworks used. The study of accounting theory engages in a review of equally, the historical foundations of accounting practices, as well as the method in which accounting practices are confirmed and augmented to the regulatory framework that rule financial statements and financial reporting.
Different researchers have varied viewpoint about the role of accounting theory.
Some researchers consider that the principal role of accounting theory must be to "explain and predict" particular accounting-related phenomena.
Other researchers think that the role of accounting theory is to "prescribe" spec approaches to accounting based on a perspective of the role of accounting. E.g. a theory that prescribes the assets should be valued on the basis of market values rather than historical costs.
Theories will include consideration of:
Prescribe how, asset should be valued for external reporting purpose (normative theories - Current cost accounting), based on a particular perspective of the role of accounting.
Predict that managers paid bonus on the basis of measures such as profits will seek to adopt those accounting method that lead to an increase in reported profit (i.e. Positive Accounting theory)
Predict that the relative power of a particular stakeholder group.
Seek to explain how an individual's cultural background will impact on the types of accounting information to provide to people outside the organization.
Predict that organization seeks to be perceived by the community as legitimate and that accounting information can be used as a means of gaining, maintaining or regaining the legitimacy to the organization (i.e. Legitimacy Theory)
Why do students of financial accounting need to bother with the study of 'theories'? Why not just study some more of the numerous accounting standards (and there are certainly plenty of them!) or other pronouncements of the accounting profession?
Why would (or perhaps 'should') accounting practitioners and accounting regulators consider various theories of accounting?
Do all 'theories of accounting' seek to fulfil the same role, and, if there are alternative theories to explain or guide particular practice, how does somebody select one theory in preference to another?
Importance of Research
The student of financial accounting will be needed to study how to create and interpret financial statements made ready in compliance with different accounting standards and other professional and statutory requirements. The research is important because it highlights the various activities involved in financial accounting theory and also how the theory has evolved and its significance in the financial matters of any corporation.
The research details our how students from the financial accounting stream can analyse financial statements that helps in making well informed decisions, accumulating financial statements and presenting it to the management. The research can make a student better prepared and equipped in order to succeed in your chosen career.
The research is able to designate how accounting theories offer a logical and methodical framework for investigating, comprehending and/or expanding various accounting practices. Without such a hypothetically knowledgeable comprehension, that we are conducting through the research it is not easy to assess the appropriateness of current accounting practices, to enhance improved accounting practices where present practices are inapt for changed business situations, and to defend the reputation of accounting where accounting practices are wrongly blamed for causing companies to fail. This is a key reason of the importance of the research.
Accounting theory provides a logical structure for accounting practice.
Though there are many theories of financial accounting there is no general or collective theory that is universally accepted. This is due to varied perspectives of individual researchers. The different type of financial accounting theories are as follows:
Inductive Accounting Theories
The inductive accounting theory is based on development of ideas or theories of accounting through observation. This theory puts into practice what the accountant observes in its day to day work life and also what the accountants used in practice. Practices that became common to many accountants were then codified as doctrines or conventions of accounting. This theory though were predominantly used in 1960 have become a little outdated by it.
Positive Accounting theory and normative research
Positive theories can at first be developed through some form of deductive reasoning. Their success in explaining or predicting particular phenomena will then typically be assessed based on observation -that is, observing how the theory's predictions corresponded with the observed facts.
Positive Accounting Theory was developed by Watts and Zimmerman, which looks to forecast and give details why managers choose to take on particular accounting methods in preference to others.
Normative accounting theory
Normative theories of accounting does not rely on observation and consequently be evaluated on whether they reflect actual accounting practice.
The conceptual framework of accounting is an example of a normative theory of accounting. Relying on various assumptions about the types or attributes of information useful for decision making, The CFA provides guidance on how assets, liabilities, expenses, income and equity should be defined, when they should be recognized, and ultimately how they should be measured.
Acknowledgement of a theory and its linked hypotheses must be tied to can the logic of the argument be accepted along with the underlying postulation and any sustaining evidence provided. An argument is rational to the degree that if the foundation on which it is based is true, then we can term that the conclusion will be true. That is, the argument even if logical will only provide a true account of the real world if the premises on which it is based are true.
The positive theories of accounting has a quantity of core suppositions, including an supposition that all people are opportunistic and will accept particular strategies to the extent that such strategies lead to an increase in the personal wealth of those parties making the decision.
For Conceptual Framework of Accounting model, it is based on a central premise that the objective of financial accounting is to provide information that allows users of general purpose financial reports to make and evaluate decision about the allocation of scarce resources. If we were not accepted this central premises then we could reject the guidance provided by the framework even if it could be considered to be logically structured.
While we must always consider the logic of an argument and the various assumptions that have been made, what we also must remember is that theories, as particularly those in the social science by nature are abstractions of reality. We cannot really expect particular theories about human factor to apply all the time.