Chapter 6

The structure of
accounting theory
 The structure of an
accounting theory
The structure of an accounting theory contains
the following elements:
• a statement of the objectives of financial
statements
• a statement of the postulates and theoretical
concepts of accounting concerned with the
environmental assumptions and the nature
of the accounting unit
• a statement of the basic accounting
principles
• a body of accounting techniques
 STRUCTURE OF
ACCOUNTING THEORY
OBJECTIVE OF
FINANCIAL STATEMENT

POSTULATE THEORTICAL
CONCEPT

ACCOUNTING
PRINCIPLES

ACCOUNTING
TECHNIQUES
POSTULATE

• Going concern
• Periodicity
• Monetary unit
• Entity
 THEORITICAL CONCEPT

• PROPRIETARY THEORY: ASSET=LIAB+OWNERS EQUITY

• ENTITY THEORY; SEPARATE ASET OWNER AND ENTITY
• FUND THEORY: ASSET=RESTRICTION OF ASSET
(PUBLIC SECTOR/GOVERNMENT)
• STOCKHOLDER THEORY; A=L+STOCKHOLDER EQUITY
• STAKEHOLDER THEORY: A= L + STAKEHOLDER EQUITY
ACCOUNTING PRINCIPLES

• Historical Cost
• Revenue dan Expense Recognition
• Matching
• Uniformity
• Materiality
• Consistency dan Comparability
• Full disclosure
ACCOUNTING TECHINIQUES

• IFRS
• SFAS
• PSAK
The going-concern postulate

• This postulate holds that the business

entity will continue its operations long
enough to recognise its projects,
commitments and ongoing activities
• The postulate assumes that the entity is
not expected to be liquidated in the
foreseeable future or that the entity will
continue for an indefinite period of time
 The unit of measure
postulate
• Accounting is a measurement and
communication process of the activities of the
firm that are measurable in monetary terms
• Limitations apply:
– accounting is limited to the prediction of
information expressed in terms of the
monetary unit
– accounting does not record or communicate
other relevant information
• Should units of money or units of general
purchasing power be used?
 The accounting-period
postulate

• This postulate holds that financial

reports depicting changes in the wealth
of a firm should be disclosed
periodically
• This postulate imposes accruals and
deferrals
 The proprietary theory

• According to Coughlan, the entity is the

‘agent, representative or arrangement
through which the individual
entrepreneurs or shareholders operate’
• The proprietor group as the centre of
interest is reflected in the ways in which
accounting records are kept and
financial statements are prepared
 The entity theory

• This theory views the entity as

something separate and distinct from
those who provide capital to the entity
• This view sees the business unit, rather
than the proprietor, as the centre of
accounting interests
 The fund theory

• Under the fund theory, the basis of

accounting is neither the proprietor nor
the entity, but a group of assets and
related obligations and restrictions
called a ‘fund’
• Fund theory is useful primarily to
government and non-profit
organisations
 The cost principle
• The acquisition cost or historical cost is the
appropriate valuation basis for recognition of
the acquisition of all goods and services,
expenses, costs and equities
• The cost principle is justified both in terms of
its objectivity and the going-concern
postulate:
– acquisition cost is objective, verifiable
information
– the entity will continue indefinitely,
therefore current values or liquidation
values for asset valuation are not
necessary
 The revenue principle
The revenue principle specifies:
1. the nature and components of revenue
2. the measurement of revenue
3. the timing of revenue recognition
 The nature and components
of revenue
• An inflow of net assets resulting from
the sale of goods or services
• An outflow of goods or services from
the firm to its customers
• A product of the firm resulting from the
mere creation of goods or services by
an enterprise during a given period of
time
The measurement of revenue
• Measured in terms of the value of the
products and services exchanged in an
arms-length transaction
• Two interpretations:
– cash discounts and any reductions in the
fixed prices should be deducted when
computing revenue
– for non-cash transactions, the exchange
value is set equal to the fair market value
of the consideration given or received
 Timing of revenue
recognition
According to the American Accounting
Association Committee on Concepts and
Standards, specific criteria for revenue and
income recognition are:
• it must be earned in one sense or another
• it must be in distributable form
• it must be the result of a conversion brought
about in a transaction between the enterprise
and someone external to it
• it must be the result of a legal sale or similar
process
 Timing of revenue recognition
(cont’d)
• it must be severed from capital
• it must be in the form of liquid assets
• both its gross and net effects on
shareholder equity must be estimable with
a high degree of reliability
 The matching principle
• Expenses should be recognised in the same
period as the associated revenues
• The association between revenues and
expenses depends on one of four criteria:
1. direct matching of expired costs with a
revenue
2. direct matching of expired costs with the
period
3. allocation of costs over periods benefited
4. expensing all other costs in the period
incurred, unless they have future benefit
 The objectivity principle
• This principle holds that the usefulness of
financial information depends on the reliability of
the measurement procedure used
• There are different interpretations of this
objectivity:
– an objective measurement is an impersonal
measure
– an objective measurement is a very viable
measurement
– an objective measurement is the result of
consensus among a given group of observers
– the size of the dispersion of the measurement
distribution may be used as an indicator of the
degree of objectivity
 The consistency principle

• This principle holds that similar

economic events should be recorded
and reported in a consistent manner
from period to period
• The consistency principle makes
financial statements more comparable
and more useful
 The full-disclosure principle

• This principle holds that no information

of substance or of interest to the
average investor will be omitted or
concealed
• This principle is enforced by various
disclosure requirements within the
AASB and AAS standards
 The conservatism principle
• This principle holds that when choosing
between two or more acceptable
accounting techniques, some preference
is shown for the option that has the
least favourable impact on
shareholders’ equity
• At present, the emphasis on objective
and fair presentation has lessened the
reliance on conservatism
 The materiality principle
• Transactions and events having
insignificant economic effects need not
be disclosed
• According to AAS 5, an item of
information is material ‘if its omission,
non-disclosure or mis-statement would
cause the financial statements to mislead
users when making evaluations or
decisions’
 Two basic criteria for
determining materiality
• The size approach relates the size of the
item to another relevant variable such
as net income
• The change criterion approach
evaluates the impact of an item on
trends or changes between accounting
periods
 The uniformity and
comparability approach
• This approach refers to the use of the
same procedures by different firms
• The objective of this approach is to
achieve comparability of financial
statements by reducing the diversity
created by the use of different
accounting procedures by different firms
 Principle supports for
uniformity
Principal supports for uniformity are that it:
• reduces the diverse use of accounting
procedures and the inadequacies of accounting
practices
• allows meaningful comparisons of the financial
statements of different firms
• restores the confidence of users in the
financial statements
• leads to governmental intervention and the
regulation of accounting practices
 Principle supports for
flexibility
Principal supports for flexibility are that:
• the use of uniform accounting procedures poses
the risk of concealing important differences
among cases
• comparability is a utopian goal that ‘cannot be
achieved by the adoption of firm rules that do not
take adequate account of different factual
situations’
• ‘differences in circumstances’ or ‘circumstantial
variables’ call for different treatments so that
corporate reporting can respond to circumstances
in which transactions and events occur