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A Presentation on

Structure of
Accounting Theory
Accounting Theory
Elements of
Accounting
Theory

Postulates Techniques

Objectives Principles
Accounting
Postulates

Entity Going Monetary Accounting


Postulates Concern Unit Period
Postulates Postulates Postulates
THE THEORETICAL CONCEPTS OF
ACCOUNTING

• The nature of the entity and the interest in the entity may classiefied
according to :
• the proprietary theory,
• the entity theory,
• the residual theory,
• the enterprise theory and
• the fund theory.
The Propriety Theory

• The primary objective of this theory is to determine the propreitor’s net worth (Wealth).
• 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.’’
• the proprietary theory is also applied to corporations in this surplus in this respect.
The Entity Theory

• The business entity is the centre of interest in this theory


The accounting equation in this case is:
Assets = Liabilities + Shareholder’s Equity
∑A = ∑L + SE

It can also be stated as:


Assets = Equities
Because equities are equal to liabilities plus shareholder’s equity.
• Unlike the proprietary theory, where earnings ahter interest and tax belong to the
owners, in the entity theory, only the dividends declared belong to shareholders.
• According to this theory, out of the net income, if some earnings are retained in
the business, they are not considered thr income of the shareholders, i.e., owners.
• The entity theory has its main application in the corporate form of business
enterprise because it has a separate existence from the lives of individual owners.
The Residual Equity Theory
• The residual equity theory seems to be very much akin to the proprietary theory.
The difference is that residual theory excludes the holders of preference share
capital from the proprietor group. Preference dividends are deducted from the net
income when calculating the earnings of the proprietor or ordinary shareholder.
The earnings per share of the residual equity holders is computed by excluding
preference dividend.
• The prine ‘’objective of the residual equity approach is to provide better
information to ordinary shareholders for making investment decisions. In a
corporationwith indefinite continuity, the current value of common stock is
dependent primarily upon expection of future dividends.
The Enterprise Theory
• This theory is a broader concept than the entity theory.
• is not so well defined in its scope and application.
• Measurement and reporting methods are still in the process of
development.
• can be thought of as a ‘social theory of accounting’
The Fund Theory
• the basis of accounting is neither the proprietor nor the entity as a separate
person.
• This theory is based on the accounting equation:

Assets = Restrictions of assets


Accounting Principles

• Revenue should be recognized in the period when the sale is made

• Revenue should be measured as the case received plus the cash


Revenue equivalent
Principles

• Cost is the amount, measured in money , capital stock , liability


incured
Cost
Principle • Expenses are the using or consuming of good and services
s
• Revenue should be identified or matched with the revenue
generated

Matching • Expenses should be identified when revenue was recognized as


Principles earned

• Accouting must be carried out on an objective and factual


basis

• Data should be verifiable and bias free


Objectivity
Principle

• Financial statements be designed to potray accurately

Full disclosure • Disclosure should be full,fair and adequate


Principle
The Exception Principles
The objective of financial reporting, the postulates and the concepts
provide a general frame work for development accounting principles.
But limitations of the users of external financial statements and reports
put constraints on the logical derivations of principles from these
objectives and postulates alone.
The two major constraints or exceptions /modifying principles in applying
the basic principle are:
(a) cost- Benefit principle and (b) Materiality principle.
Six principle constraints of accounting
Constraints of accounting are actually the limit or boundaries that are
necessary for providing information with the qualitative in characteristics.
To make the information useful, the basic assumptions and principles
discussed earlier’, have to be modified and find their limitation. Thus
creation of constraints of accounting. The six constraints of accounting are;
• Cost-Benefit Principle,
• Materiality Principle,
• Consistency Principle,
• Conservatism Principle,
• Timeliness Principle, and
• Industry Practice.
Cost Benefit principles
According to this principle, the cost of applying an accounting principle
should not be more than its benefits. If the cost is more, this principle
should be modified. they must considered the costs of providing the
information against the benefits that can be derived from using it. Rule-
making bodies and governmental agencies use cost-benefit analysis before
making final their informational requirements.
The costs are of several kinds: costs of collecting and processing, of
disseminating, of auditing, of potential litigation, of disclosure to
competitors, and of analysis and interpretation. Benefits to preparers may
include greater management control and access to capital at a lower cost.
Users may receive better information for allocation of resources, tax
assessment, and rate regulation. As noted earlier, benefits are generally
more difficult to quantify than are costs.

.
Materiality Principle

This principle is basically an exception to the full disclosure


principle.
The full disclosure principle requires that all facts necessary to
ensure that the financial statements are not misleading, must be
disclosed, whereas the materiality principle requires that the items
or events having an insignificant economic effect or not being
relevant to the user’s need not be disclosed.
According to the materiality principle, all relatively relevant items,
the knowledge of which might influence the decision of the users of
the financial statements, should be disclosed in the financial
statements. Which information is more relevant than others is
largely a matter of judgment.
Conservatism Principle

According to this principle, the principle of ‘anticipate no profit but


provide for all probable losses’ should be applied.
The valuation of stock-in-trade at a lower cost or net realizable
value and making the provisions for bad and doubtful debts are the
applications of this principle.
Timeliness Principle

• According to this principle, timely information (though less


reliable) should be made available to the decision makers.
• If the quarterly reports are made available on half-yearly basis, the
information contained in the quarterly report would not be very
useful to the decision makers since the information has lost its
capacity to influence the decision during the period of half year,
after the expiry of which the quarterly report had been submitted.
Industry Practice

The peculiar characteristics of an industry may require departure


from the accounting guidelines discussed above.
For example, in case of an agricultural industry, it is a common
practice to disclose the crops at market value rather than at a cost
price since it is costly to obtain accurate cost figures of individual
crops. Such differences from basic theory are rare, but they do exist.
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.