Accounting Principles Frameworks and Assumptions

Accounting theories refers to the discipline study that helps to examine the methodologies, frameworks and assumptions of the various kinds of accounting principles. Accounting is the process of collecting, processing and recording the financial information of an organization that helps the organization in various ways to make the financial statements of the organization, to assist in the process of decision-making and others (Archive.org 2016). Hence, there is a deep relation between the accounting process and the accounting theories. On a more precise note, accounting theories can be described as coherent set of hypothetical, pragmatic and conceptual framework of accounting principles that give the necessary direction to the process of accounting (Wiley.com 2016). There are a lot of vies about regarding the usefulness of the accounting theories all over the world. According to some people, accounting theories are essential tools that help to accomplish the accounting goals of an organization. On the other hand, there are a lot of people all over the world who have doubts regarding the usefulness of accounting theories as they consider the study of accounting theory is a waste of time for the accounting students and professionals (Ventureline.com 2016). This study takes the attempt to establish the usefulness of accounting theories by discussing three of most important theories of accounting. They are the theory of Historical Cost, the Matching theory of accounting and the Business Entity theory. All these theories are discussed below in details with their advantages and disadvantages (Changingminds.org 2016).

Historical Cost is a measurement that is used to value the various assets of a business concern. As per the theory of historical cost, the price of an asset in the balance sheet should be based on the nominal cost of or original cost at the time of acquisition. A vast use of the historical cost method can be seen in the United States of Ame

The current market value is not reflected in the historical cost of the assets. As per the historical cost method, all the assets and liabilities are recorded based on their value at the time of acquisition (Academia.edu 2016). Various items of an organization are measured in different ways under the historical cost method. In case of the measurement of inventories, the values of the inventories are written down. In case of the valuation property, plant and machinery, there are some costs that are added to the original cost under the historical cost method. They are import duties, non-refundable tax of purchase, rebates, trade discounts, installation charges, maintenance charges and many others. There are certain financial instruments that are recorded based on historical cost. The International Accounting Standard Board (IASB) has introduced an alternative to the historical cost accounting that is Capital Maintenance in Units of Constant Purchasing Power (Quora.com 2016).

There are many advantages of the historical cost method. Objectivity is the most important advantage of historical cost accounting as it helps to record the original cost of the assets at the time of purchase. As a reason of this process, there is not any scope of manipulation as all the data and information about the asset can be verified by original documents. Secondly, historical cost accounting is easiest and cheapest method of valuation of assets and liabilities. As the original value is already recorded, the accountants have to do less estimation for the values. Reliability is the most important advantage of historical cost method as per IASB. All over the world, historical method is considered as more reliable than any other valuation like fair value. As any coin has two sides, historical cost methods also has some disadvantages. The first disadvantage is that historical cost does not reflect any recent change in the current value of the assets or liabilities. Secondly, historical cost method does not keep any record of any opportunity cost in the use of the old assets. The third disadvantage is that historical cost method does not record any kind of loss of real value of nominal monetary items. In spite of the presence of disadvantages, it can be said that the historical cost method is an effective way for the valuation of assets and liabilities as the proportion of advantage exceeds the proportion of disadvantages (Responsive.co.nz 2016).

As per the Matching Theory, all the expense of an organization must be recorded at the time of the occurrence of those expenses. This process does not depend on the transfer of cash. Generally Accepted Accounting Principles (GAAP) develops the matching principle. Four main organizations have developed the principle of matching. They are Securities and Exchange Commission (SEC), the American Institute of Certified Public Accountants (AICPA), the Financial Accounting Standard Board and the Government Accounting Standard Board (GASB). The matching principle assists the accountants in recognizing the expense of the organization. On a short note, it can be said that the expense should match the revenues. However, it has been seen that there are many costs that are not easily matched. Hence, there are mainly two categories where expense fall; they are period and product cost. Period costs are recorded at the in the financial statement at the time of occurrence. On the other hand, products costs are associated with the revenue of the organization (Eli.ctas.tennessee.edu 2016).

There are many advantages of the matching principle of accounting. In the process of matching, all expenses are matched with the expenses of the organization. Expenses are incurred in order to generate the revenue of the organization on a cause-and-effect basis. The most important benefit of the matching principle is that it assists in recognizing the source for which the specific amount of money is spent (Brighthub.com 2016). Secondly, it is an important method for the optimization of the resources of an organization. There are three aspect of matching principles. They are accrued expenses, deferred expenses and depreciation. The main advantage of accrued expenses is that it assists the accountants to tally the future cost of the products with their sales before the payment of such costs. The advantage that deferred expenses provide is that it helps to match the costs or products for which the payment is not received yet. The most crucial importance of depreciation is that it helps to match the cost to purchase with the revenues that they are generating. Along with the advantages, there are some disadvantages of matching principles, but the portion of limitation is less than the portion of advantages. The main and crucial disadvantage is that sometime this process creates distortion in the revenue recognition process. For example, a company is producing its monthly journal on the month of January, but the subscribers are getting it at the month of March and they are considering it as current income. This total process creates distortion in the accounting process of the organization. These are the advantages and disadvantage of the matching principles (Rusnauka.com 2016).

According to the Business Entity concept, a business or the organization and the owners of that business are two completely different entities. One business can be considered as a separate economic unit from another business organization. This theory states that it is necessary to keep the records of the business separate from the records of the owners in order to make the business a completely separate entity (Accountingtools.com 2016). This assumption helps to determine the correct financial condition of the business organization. For example, one can take the example of a sole proprietary business. The owner of that business withdraws money from it by showing the withdrawal as drawings. He is the sole proprietor of the business and he can easily withdraw the money taking them as his own money, but still there are two concepts like taking the money from the business and giving the money to the business. Despite of the existence of the fact that there is not any kind of legal obstacles to take the money from the business, the owner shows it as the business transaction so that he can track all the expenses of the business. The main assumption of the entity theory is that all the economic activities that are conducted by the business are totally separate from its owners (Svtuition.org 2016). As per the rules of this theory, the owners of the business are personally responsible for the loans and liabilities of the business (Equity/top-5-theories-of-equity 2016).

There are many advantages of the business entity concept and each advantage is crucial for the organizations. The first advantage of business entity concept is that this process helps to evaluate the performance of the organization. In this process, each transaction of the business is recorded in the books of both the owner and the business and the owner has the access to every information about the business. This process helps to recognize the weak as well as strong areas of the business. The second advantage is that it assists the owner of the business in tracking all the transactions of the business. These are the main advantages of entity theory. In this regard, it needs to be mentioned that there is not any disadvantage of business entity theory (Caknowledge.in 2016).

As per the discussed three basic accounting theories, it can be said that there are many advantages of the accounting theories in the process of accounting. The financial information presented in the various financial documents must be accurate, consistent and must be presented in the correct time. The accounting rules and regulations based on the accounting principle ensures that the above mentioned factors are rightly promoted in the financial documents. For the accumulations of the accounting methods and principles, various accounting theories provides the necessary fundamental assumption. Accounting theories and principles make it easier for the user of the accounts to understand the various difficult aspects of accountancy. The absence of these accounting rules and regulation makes it difficult for the users to interpret the various financial documents of the organization in the proper manner. One can take the example of matching principle as it states that all the incomes and expenses need to be recorded at the same time together based on the nature of their relationship (Softhard-solutions.com 2016).

Now, the absence of this particular rule makes it difficult for the users to compare and trust the source of the income and expense of the business. On the other hand, the entity theory is helpful for the users to evaluate the performance of the business. This is possible as they have record of all the transactions of the business that give them an insight of the financial position of the business. Similarly, the historical cost method is useful to track the original price of any assets at the time of acquisition. Hence, it can be said that these are the basic accounting theories that helps to create the foundation of accounting in a business organization. The absence of these accounting theories will make it difficult for the users to analyze, interpret and develop accounting and financial documents (Scielo.org.za 2016).

Accounting theories are certain assumptions, methodologies and frameworks that help in the smooth running of all the accounting works in an organization. This study says that accounting theories are logical framework that helps to set different rules and regulations of accounting. This study shades light on the basic accounting theories. The historical cost theory says that the value of an asset in the balance sheet should be based on the acquisition cost. According to the matching theory, all the expense of a business should match all the incomes of the business. Lastly, the business entity theory says that a business organization should be treated as a separate entity from the owner of the business. From the analysis of these three theories, it can be observed that these are the basis theory that is needed to carry on the regular accounting operation of a business and accounting will not be possible without the help of these theories. This situation clearly indicates the importance and usefulness of accounting theories for the users of them. Accounting theories are needed to formulate new rules and regulations of accounting; to develop the error free accounting documents; to evaluate the performance of the business and many others. Thus, from the above study it can be concluded that accounting theories are useful in every aspect of accounting in a business organization.

References

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