Role of Accounting Theories
Discuss about the Financial Accounting for Science of Classifying.
The accountancy is considered as science of classifying, recording and summarizing of data so that the relationship between the money, transaction and event is appropriately represented (Mdudde.net 2016). This will enable the user to calculate the financial results at the end of the accounting period. The accountancy is a process that helps the user in obtaining financial information relating to income and expenses, possible losses, actual losses, capital employed, liabilities etc (Arxiv.org 2016). The primary objective of accounting is to maintain records, provide timely information to management for decision-making, providing information to the external users so that it can aid them in making decision (Womlib.ru 2016).
Accounting deals with the financial information so the accounting practice is based on reasoning. Therefore, accounting theories are established to explain with logic the reasoning behind a particular practice (Kabir 2016). Accounting theory is a scientific way of explaining and solving the real world accounting problems. Accounting theory can be defined as the broad principles that helps in evaluation of the accounting practices and provides the way forward for developing the new standard (newagepublishers.com 2016). The accounting theory helps the accounting professional and users understand reason behind various accounting practices. The learning of this theories helps the professional to perform their work in a more skillful and flawless way (Assignmenthelpsite.com 2016). In recent times, the accounting has become very complex therefore accounting theories will help the professionals to solve the real world problems. It can be said that accounting theories helps to understand the accounting process in a more professional way (Ventureline.com 2016).
The accountants are guided by the accounting theories to represent the financial data in a professional way (Scribd 2016). The accounting theories have been developed using three common approach this are descriptive approach, usefulness approach and welfare approach. The decision usefulness approach is further classified into normative and empirical (Quora.com 2016). The accounting theories that are developed using descriptive approach relate to conduct of the accountants. The decision usefulness approach helped in developing two main theories normative theories and empirical theories (Swinburne.edu.au 2016). The important accounting theories that have been developed are proprietary theory, Entity theory, fund theory, residual equity theory and enterprise theory (Programsandcourses.anu.edu.au 2016). In this essay there are three accounting theories that are evaluated this are entity theory, fund theory and residual equity theory.
Assumptions of Accounting Theories
It is important that before the accounting theories are discussed the assumptions based on which the accounting theories operates are discussed earlier. There are four assumption based on which the accounting theories operates they are entity assumptions, going concern assumptions, periodicity assumptions and assumption of monetary units. In developing accounting theories it is assumed that the business is a separate entity. That means the activity of the business is separate from owners of the business. The accounting theories developed are based on this assumption of separateness. The second assumption for accounting theories is going concern. It is assumed that the business will continue for infinite period of rimes so the accounting theories developed are based on these assumptions. However if the business is performing poorly then this assumption can be revised so that the financial statement prepared gives true reflection of financial statement. The monetary unit assumptions require that all the financial transactions reflected in accounts should be based on some monetary value. The last assumption of periodicity states that the business activity should be broken into different periods so that they can be measures. This assumptions forms the basis of developing accounting theories. The three accounting theories are discussed and evaluated below.
The entity theory states that the business is a separate entity distinct from the owners or shareholders. It can be said that not the proprietor but the business unit is the centre of financial and accounting interest (Martin 2016). This theory states that the business is liable to both the owners and the creditors. The accounting equation stated in the theory is that asset is equal to liability (Investopedia 2016). This equation can also be put in a different way that is asset is equal to liability and equity of shareholders. The assets provided in the equation are the rights that are accruing to the entity and equity and liabilities are the source of those assets (Classificationofaccountingtheory06.wordpress.com 2016). The creditors and shareholders’ both have rights over the assets though they have different approach towards liquidation, risk, control and income. The income earned by a business is the property of the business unless it is distributed as dividends (Newagepublishers.com 2016). It is the responsibility of the business unit to fulfill the claims of the shareholders and creditors. The entity theory therefore has become more income centered so it is said to have become income statement oriented (Noble et al. 2016). The entity is accountable to the equity holders and it is accomplished by measuring the performance related to operation and other financial information. The income represents increase in equity after the demands of creditors are fulfilled (Classification of accounting theory 2016). In the similar way, the profits that are not distributed are the property of the business and it increases equity by increasing the reserves (Mdudde.net 2016). The strict compliance to entity theory requires that income tax and interest on debt be considered as distribution of profit and not as an expenses. In the corporate form of business enterprise, the entity theory is mostly applicable (Arxiv.org 2016). The corporate business considers business separate and distinct from the owners. The entity theory has greatly influenced various accounting techniques and its effect can be seen in various terminologies used in the accounting practice (Womlib.ru 2016). The entity theory favors that that last in first out (LIFO) method of valuation of inventories rather than the First in first out method (FIFO) (Kabir 2016). It is because according to this theory adoption of LIFO over FIFO helps in determining income appropriately. As the adoption of FIFO method helps in better valuation of inventories in the balance sheet so it can be considered as a better technique for determining the value of inventory under proprietary method (newagepublishers.com 2016). The common definition of revenue is that it is the product of enterprise. This definition of revenue is in accordance with the entity theory concept (Ventureline.com 2016). The expenses is commonly defined as services and goods that are consumed in obtaining the revenue. This definition is also obtained through the application of entity theory (Quora.com 2016). In preparing the consolidated balance sheet, the minority interest is recognized in addition to equity holders (Swinburne.edu.au 2016). This treatment of minority interest is in accordance with the entity theory. The entity theory puts emphasis on determining the income that is allocated to shareholders whereas proprietary theory evaluates the valuation of assets (Programsandcourses.anu.edu.au 2016).
Evaluating Entity Theory
The fund theory puts emphasis not on the entity but group of assets and related obligations (Martin 2016). It also emphasis on the restrictions that are imposed on the use of assets called fund (Investopedia 2016). The fund theory takes the business unit as economic resources and the obligations and in addition to this related obligations and restriction is put in the use of this resources (Newagepublishers.com 2016). The accounting equation of fund theory is an asset is equal to restriction of assets. The accounting unit is stated in terms of assets and the use in which the assets are used (Zaharah 2016). The legal obligations and economic restrictions on the use of assets are represented as liability. The fund theory is centered towards assets and it focuses on administration and appropriate use of assets (Mdudde.net 2016). The primary objective of financial reporting is not the balance sheet or the financial statement but the statement showing the source and use of fund is the most important (Arxiv.org 2016). In this statement, operation of the fund is measured in relation to disposition and sources of funds. The nonprofit organization and government primarily uses the fund theory (Womlib.ru 2016). The public institutions have several operations therefore, it uses several funds for conducting its operation (Kabir 2016). In order to compare financial statement information the use and application of fund is very useful.
The concept that is between the proprietary theory and entity theory is residual equity theory (newagepublishers.com 2016). The equation in this theory is that specific equities are deducted from assets and it comes to residual equity (Ventureline.com 2016). The equities of preferred shareholders and the claim of creditors are known as specific equity (Quora.com 2016). In case of large losses and bankruptcy proceeding the common shareholders may disappear so the preferred shareholders and bondholders will become the residual equity holders (Swinburne.edu.au 2016). The main objective of residual equity approach is to provide better information to the shareholders so that they can make better investment decision (Martin 2016). If it is assumed that, the company is a going concern and will continue for infinite period then in such case the current value of equity shares is dependent on the expected divided to be received in future (Investopedia 2016). The expected future dividend is dependent on total receipt. From the receipt specific contractual obligations, payment made to equity holders and requirements of reinvestment is deducted (Newagepublishers.com 2016). In investment value, the trends can be measured by noticing the trend of residual equity measure based on current values. The statement of income and the statement of retained earring are required to mention the income that is available to residual equity holders after adjustments of all prior claims (Noble et al. 2016). This claim includes dividend paid to preference shareholders. In balance sheet, the equity shares should be separately represented from the preference shares (Classification of accounting theory 2016). The statement of fund should represented funds available to the business for making payment for common dividend and other purposes (Zaharah 2016). There are certain significant difference between residual equity theory and proprietary theory. In residual equity approach, the preference share capital is not included in the shareholders fund. In this methods the dividend that are payable to preference share holders are deducted before the dividend per share of equity shareholders are calculated. It should be remembered that both this theories are based on the same assumption that the economy in which the entity operates is free and both are concerned about the treatment of their assets and liability.
Evaluating Fund Theory
In this section of the research paper, the usefulness of accounting theory is critically evaluated (Mdudde.net 2016). The accounting theory provides the foundation for practice and it can be said that theories are developed so that a proper meaning is given to the practice (Arxiv.org 2016). The accounting theories helps in narrowing the problem area range by identifying the facts of the studies. It is helpful in selecting the aspects of the phenomenon (Womlib.ru 2016). The accounting theory also provides a conceptual framework for studying the accounting problems. This provides a standard by which the accounting practice can be evaluated (Kabir 2016). The knowledge that is already available about the subject is organized in a body of knowledge known as accounting theory. The accounting theories are mainly the summaries of the current accounting policies (newagepublishers.com 2016). The accounting theory helps in attaining uniformity in practice. The goal of the accounting theory is to provide uniformity in practice (Ventureline.com 2016). The generally accepted accounting principles are the current accounting theories that are used for practice. The aim of uniformity is to increase credibility about the information provided by the accounting system (Scribd 2016). The accounting theories have an advantage of predictive ability (Quora.com 2016). The future facts can be predicted by theoretical generalization (Swinburne.edu.au 2016). It is because of this predictive ability of the accounting theory it has given rise to various empirical research that can be used for decision making (Classification of accounting theory 2016). The accounting theories are helpful in development of new practice. The accountancy operates in a dynamic environment therefore with the change in social environment therefore there is a need for replacing the existing practice (newagepublishers.com 2016).
The above discussions have shown that accounting theories is a complicated process. The theories of accounting are held together by conceptual framework for accounting. The accounting theories fit the conceptual framework and it helps to determine the financial principle and rules. It can be said that accounting theory is a definitive accounting principle. These accounting theories are framed after analyzing the practices of accounting. It can be said from above discussion that the accounting theories are based on logic and reasoning therefore, it can be considered as scientific. The accounting theories cannot help in understanding the financial position of the business or the profit and loss account during the particular period. It can also be said that an accounting theory cannot be considered as means of conveying information to the external users. The accounting theories act as a guide so that complicated problems arising from in day to day operation of the business can be solved.
Reference
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