Accounting Theory: Definition & Overview
Have you been wondering about accounting theory? Accounting is an important part of every business. It helps make sure financial transactions get recorded, and assists with things like payroll.
Accounting theory has the purpose of guiding accounting processes, so that everything is as accurate as possible. So, what are some of the accounting theory applications? What are some of the practices? There are some financial reporting principles to be aware of in the accounting industry.
We put this guide together to outline everything you need to know. Keep reading to learn all about the study of accounting theory and how it gets applied. You’ll be able to have effective accounting skills in no time.
Table of Contents
KEY TAKEAWAYS
- Accounting theory guides financial reporting and accounting processes.
- It involves methodologies, frameworks, and assumptions that get used in financial reporting.
- Accounting theory evolves and adapts to environmental changes and new trends.
What Is Accounting Theory?
Accounting theory works in a few ways, and is made up of different frameworks, assumptions, and methodologies. All of this gets put into place so reporting financials are correct and accurate.
There are some foundations in accounting theory that guide accounting practices. The Financial Accounting Standards Board (FASB) put together a framework of accounting theories to use.
The FASB is an independent entity. Their focus is on outlining the key objectives and framework for reporting financials that is used by both private and public businesses. It’s the logical reasoning behind accounting practices, and as new accounting practices and procedures develop, accounting theory evolves.
Key Elements of Accounting Theory
The first key element in accounting theory is usefulness. Its main intention is to ensure financial statements make important information available. This helps to make more informed business decisions.
This means that there’s also some flexibility to accounting theory. By being flexible, it can adapt to environmental changes. The framework of accounting theory also has a few other aspects to know about.
These include being consistent, reliable, relevant, and comparable. To help guide these aspects, the generally accepted accounting principles (GAAP) were created.
Following GAAP ensures financial statements, and how they’re prepared, are consistent. Consistency leads to higher accuracy and makes it so that past financials are comparable to the financials of other companies.
Accounting Theory Assumptions
Within the blocks of accounting theory, there are also some assumptions. Accounting professionals follow these assumptions:
- That a business needs to be separate from its owners or creditors
- That there’s a belief that the business won’t go bankrupt and will always exist
- That financial statements get prepared with dollar amounts, not units of production
- That all financial statements get prepared either monthly or annually
Are There Any Special Considerations?
The process of accounting dates back to the 15th century; however, economies and businesses have greatly evolved since then. This means that accounting theory also evolves and adapts when required.
This can include new practices, or discovering gaps in reporting mechanisms. It can also include the advancement of new technological trends. Professional accountants contribute their knowledge to help with these changes. For example, a certified public accountant (CPA) can lend their expertise.
When this happens, new methodologies can be created to stay up-to-date, and businesses can better navigate and understand new accounting standards. All of this leads to the evolution of accounting theory.
Summary
The elements in accounting theory consist of a few different things. These include certain frameworks, assumptions, and methodologies. All of these things get used when reporting financials. The purpose is to ensure financials are consistent, accurate, and comparable.
Accounting theory gets used by businesses to make more informed decisions. The main aspect of accounting theory is its usefulness. These frameworks get designed with a few other things in mind: being reliable, consistent, relevant, and comparable.
Following basic accounting theory makes for more effective and accurate accounting practices. This can come in handy for things like an income statement or statement of cash flows.
Frequently Asked Questions
There are five main principles of accounting. They include the accrual principle, the historic cost principle, matching principle, conservatism principle, and the principle of substance over form. Following these principles allows for better accounting practices and accurate financial statements.
This relates to a few different things. It starts with equal treatment for all interested parties. It also includes having true and accurate accounting statements that aren’t misrepresented. It also includes having a fair, unbiased, and completely impartial presentation.
With the positive approach in accounting theory, the goal is to explain a process. This means using knowledge and understanding of accounting, and implementing accounting policies to deal with certain conditions. Other accounting fundamentals are also implemented.
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