Page 1 :
3, ACCOUNTING THEORY, 3.1. Concept of Accounting Theory, "Accounting theory' is an amalgam of two words-firstly, we will study both these, words-'accounting' and 'theory', then the meaning of accounting theory will be discussed., (1) Accounting. Accounting is an ancient art, but in ancient age this activity was not so, developed as it is today. Nowadays, every businessman wants to know whether his business, is earning profits or not. Hence, it is essential that businessman should keep record of his, daily business transactions according to accounting rules so that he may know the correct, position of his business., Accounting is the language of business through which a business concern may have, interaction with the outside world. This language has its own rules and regulations. In case,, these rules are not followed while recording, the objectives of accounting can't be achieved., We mean that daily business transactions must be recorded in the books according to the, accounting principles. Its main objective is to know the amount of profit or loss of the, business during a particular period and to present a true and fair picture of the financial, position of the business on a particular date. This makes various business information, available to various stakeholders e.g., management, lenders, shareholders, employees,, consumers and government, etc., (2) Theory. Logically and serially arranged and rule-based statements are called 'theory, with which important relationships can be established with available data. Rules are applied, like scientific laws or applied rules in accounting. According to our own knowledge, to, provide recognition comes into the purview of theory. Imagination and certainty are the, basis of theory. By imagination, we mean, the analysis of any event on the basis of acquired, knowledge whether the event is true or false. If the imagination is certain, it will take the, shape of theory. Within it various cause and effect interrelationships are established. This, can be explained with the help of one example that if an apple falls from the tree, it will, certainly fall on the earth due to the law of gravitation of Newton., “A set of interre!lated constructs (concepts), definitions and propositions that present a, systematic view of phenomena by specifying relations among variables with the purpose of, explaining and predicting the phenomenan.", -Kerlinger FN., Scanned By Scanner Go

Page 2 :
Accounting Theory, 43, The Process of Theory Construction, The following are the steps in the process of theory construction:, (1) Observation. Many controversies creep in the theory construction but the theories, are constructed on the basis of experience and past events. These theories are also known, as 'laws of nature'. Its example may be of Newton's ctc., (2) Defining the Problems. If correct and fair enquiry is not received about problems,, the true meaning can't be revealed and a lot of difficulties have to be encountered with in, reaching to the conclusions., (3) Hypothesis. All types of theories may be constructed by service but for hypothesis, the knowledge of facts and proofs is necessary., (4) Testing of Hypothesis. For reaching to a logical conclusion of a problem, testing is, necessary. For testing, appropriate method and terms must be taken into consideration., (5) Verification. Verification of theories is a must. How does hypothesis effect the, events, this knowledge comes from theories., Accounting Theory, Accounting theory is that branch of accounts which consists of the systematic statement, of principles and methodology, as distinct from practice. Theory explains about practices-, how they should be applied in practice. Accounting theories explain how accounting, treatment may be used in practice., "Accounting Theory is that branch of accounting which consists of the systematic, statement of principles and methodology, as distinct from practice.", -Most, Kenneth, 3.2. Approaches in Accounting Theory, (1) Deductive Approach. Under it, firstly the objectives of accounting are determined, and then the theory and process are decided. Tis approach starts with the objectives of, accounting and provides basis for the development of accounting technique. It is necessary, to decide the objectives in it because different objectives require different organizations, and, as a result of which, separate theories are needed. For example, the calculation of, taxable income is calculated on the basis of various principles. This ideology depends on, what is needed by us and what is good and what is bad, we have to take decisions about, these questions. The following steps are included therein :, (1) Determination of general and specific objectives of financial reporting., (2) The selection of postulates of accounting must be taken into consideration under, economic, social and political environment., (3) Selection of logical process., (4) Preparation of structure and introductory symbol to express various concepts, in, which these may be materialised., (5) Developing the group of definitions., (6) Construction of theories for applying the process., (7) Construction of theories to apply theories under certain specific conditions., In this approach, it is very necessary to determine the objectives since there are various, different results and theories therein. In general theories, taxable income is different from, Scanned By Scanner Go

Page 3 :
44, determined financial income. For every objective, theories must be determined but it shout., also be taken into consideration that there should be freedom of application of theor, introductory symbols may be used. With the help of algebraic formulae the postulates should, be developed., Many authors adopted this approach and Paton, Canning, Sweeney, Macqueal, ete, are important of them. According to this approach, “The users of financial reports must usa, current cost only in economic decisions.", The main drawback of this approach is that the construction of these applied theories is, very difficult. If postulates are wrong the result will certainly be wrong. In fact, many, theories are being used nowadays., (2) Inductive Approach. Under this approach, firstly, the accounting process in use is, studied and accounting theories are constructed thereafter. It consists the following steps :, (a) Testing and their accounting., (b) Classification and analysis of tests., (c) Construction of accounting theories., (d) Testing of theories., According to Gaulter and Underdown. "In the inductive approach of accounting, theories general statement may be under specific conditions but this original position gives, no assurance for a fair conclusion. This theory reaches to the conclusion that accounting is, what accountants do and is applied by their behaviour.", Many authors appreciated this thesis and some famous authors are-Hatfield, Paton, Gilman, Littleton, Ifiri, etc. According to them, accounting must be on the basis of historical, cost, not on current cost, since historical cost can be easily tested. This approach starts with, the testing of financial information of the business and on the basis of relationships and, accounting theories principles are constructed., Its main limitations are that inspectors are effected by the individual ideologies while, inspection and during different accounting periods the financial data of various firms differ,, e.g., for a limited period the production cost of business may match with the total income, but can't be made basis for valuation in future. In it, the construction of general theories is, a difficult task., (3) Event Approach. In the development of accounting theories the following, diachtomies came into the picture :, 1. Can the financial statements completely express the specific user and his needs as, well as general user and his unexplained needs?, 2. How much accounting record is needed to explain certain specific accounting, information?, 3. What type of accounting information must be collected to express such information?, This approach clearly explains the answer of these questions. According to this approac, only economic event must be reported so that it may be used for better decision-making. 1t, depends on the accountant how he provides information in a better way since such at, economic information effect the interests of various stakeholders, such as, shareholders., managers, creditors, customers and the government, etc., Scanned By Scanner Go

Page 4 :
45, Accounting Theory, The following are the limitations of this approach :, (i) There is a personal capacity of an individual to collect data i.e., how much data a, person may collect at a particular time., (ii) The expansion of data may become burdensome for its users., (iii) It is very difficult to decide what type of data must be collected regarding financial, statements., of, (iv) Full availability of data is not possible since personal interest comes in the, collection of data., way, (4) Pragmatic Approach. The contribution of those authors and thinkers is included, in this approach which is more relevant in real life situations. Accounting conventions and, methods are selected on the basis of their utility. This approach consists a lot in the, development of newer methods which can be applied widely. Its object is to construct such, principles which are really being applied i.e., according to this approach accounting, information should be of such type that may convey some meaning., There may be many limitations of this approach. Firstly, it does not include fundamental, rules which may provide certainty to the utility of thoughts. Secondly, it must include the, subject of the utility of principles. Some principles may be useful from the point of view of, management but from the point of shareholders they are not relevant. Stock is valued either, at cost or market price, whichever is lower. This valuation may be good from the point of, view of the owners since this valuation may squeeze profits and due to lower profits workers, may not demand higher salaries or bonus., (5) Social Approach. The utility of accounting depends on this fact that it must be, socially useful, not individually useful. According to this approach, there must be maximum, utilisation of available resources and equal distribution of business income by the accounting, methods so that society may benefit a lot. This approach indicates towards social, responsibility accounting. Its main objective is to know that uneconomic activities for, example, how much individual faith effects the society. Traditional accounting methods, were considered insufficient for social interests., With the changes in the modern social problems and international political environment,, more and more importance is given to social approach. Under traditional approach, no, business reports the unhealthy atmosphere, unemployment, faulty work environment and, other social evils to the public. But in nodern approach, the cost related with these factors, is born by the firm in the form of taxes or in any other form. The main objective of social, accounting is to judge the effect of the activities of the firm and production on the society., The main limitation of this approach is that the effect over the society level cannot be fairly, measured. But, having a thorough study of this approach, fair control may be established., The accounting methods must be flexible for the resolution of problems and it must, include the non-monetary measures., (6) Economic Approach. According to this approach, the real position must be made, clear by the accounting theories, policies and techniques and their selection must be based, on economic conclusions., Scanned By Scanner Go

Page 5 :
16, Accounting Theory, (7) Value Apprmach. This is a traditional approach in which the balance sheet denict., the financial position of a business on a fixed date. Similarly, profit and loss account exhibits, the profit or loss during the year., (8) Ethical Approach. The approach throws light on justice and clarity. The following, suggestions were given by D.R. Scott, in this connection:, (i) Equal treatment must be given all the parties related with accounting methods., (ii) Financial statements must depict the true and accurate picture of the business., (iii) Accounting data must always be independent., (iv) Accounting-related theories must be flexible according to the needs of the situation., In the accounting reports and statements, the effects of individual or group must not be, expressed. They must be prepared while taking into account the interests of all the individuals,, and must never give preference to owners or managers. Taking into consideration the formal, and informal standards, the reprts and statements should be prepared., To adopt fairmess in accounting is a difficult task. By 'fairness' we mean, 'facts expressed, on the basis of reality.'Accounting on historical cost is considered more close to truth. But, on the basis ofcurrent values this may be considered as more near to truth. It is very difficult, to decide to show the assets and income-expenditure either at historical cost or at current, cost., To show profit at the point of sale of an asset depicts truth, but changes in the value of, an asset at the time of sale may lack truth. In this connection, the rules of income and, expenditure may become guidelines but acceptability of rules and the principles on the, basis of which accounting is performed become more relevant. Investors may take sound, decisions for their investments when all the information is made available by the business., To bring about comparability in financial statements, international accounting standards, were framed., The main limitation of this approach is that it is lacking in explaining the development, of accounting theories and the theories followed in modern age. Principles can be applied, on certain specific decisions., (9) Authoritarian Approach. This approach is applied by professional bodies. In this, approach rules are framed regarding accounting treatment. This approach is useful only, where accounting theories are different. Under this approach, declaration of accounting, standards by different countries and formation of international accounting standards are, included., (10) Mathematics (Axiomatic) Approach. Mathematical approach was developed to, know about the accounting facts. In this approach, mathematical signs (symbols) are assigned, and mathematical models are formed., (11) Eclectic Approach. This approach is individually based on the authors, researchers,, business organizations, government policies, etc. In this approach many, ideologies are, involved. In USA, Arthur Anderson & Company, Arthur & Young Company, Cooper and, Librand, Earnest and Whiney, Price Water House Company, Michell and Company, etc., various companies, AICPA (The American Institute of Certified Public Accountants), SEC, (Securities and Exchange Commission) and many other organisations joined their hands m, Scanned By Scanner Go