Accounting Theory

The beginning of the ‘trade’ era marked the birth of one of the most significant concepts of business world known as Accounting. In simplest terms, accounting can be defined as the art of ‘systematic recording, reporting and analysis of financial transactions of a business’  [WebFinance Inc.].

This practice can be traced from thousands of years back when people relied on primitive accounting methods to record the growth of crops and herds. Today accounting is considered as the ‘backbone’ of most successful businesses. Since old days, a number of theories have been tested and incorporated that have lead to the evolution of accounting practices over the years.

The growing demand of globalisation in the business world marked the necessity to use accounting with ‘specific rules and regulations’ in order for it to be ‘reliable and comprehendible.’ It would be complete chaos if each business follows its own rules, grammar and vocabulary to record transactions.
As stated by Michael Russel in his paper ‘The Origin of Accounting Theory’, ‘The first prerequisite is that accounting should agree with the basic truths according to which our economic system functions. Accounting theory (therefore) creates a framework that ensures that accounting practice complies with the requirements of conformity and uniformity.’
[Russel] Like any other theory, accounting theory is also based on a set of rational ideas which in this case is ‘the economic truths’; and these ideas and principles have evolved over time depending on the need of the business. However, the common elements or in other words, the fundamental backbone of accounting is still the same which includes ‘bookkeeping’ (Gaffikin, 2008, pg. 16).
What has actually changed is the techniques employed in carrying out this task and this is mainly due to the drastic advancement in information technology. ‘Many accountants are now involved with the provision of financial advice rather than mechanical recording and reporting procedures. In addition, the form of this advice has also changed.
‘It once involved cost reporting and analysis of financial statements; it now involves modern information technology media.’ (Gaffikin, 2008, pg. 18)
Despite these developments, the evolution of accounting theories has faced some major challenges. First one deals with reporting of non-financial ‘events’ such as performance of employees in the firm. ‘Should their performance be measured based on educational backgrounds, work experiences or the expenditure that their employers pay on them?’
(Yu, Zhang, 2005) Traditional accounting in olden days had mostly dealt with only financial events; however as more businesses realised the role that non-financial factors such as employee motivation and customer satisfaction play in its success, theorists diverted their attention towards what is known as managerial accounting today.  This was derived from the ‘events’ approach.
Moreover, the ‘events’ approach also identified the challenges of incorporating Information System for reporting of economic events. This mainly included the security and integrity of economic data and the degree of detail to be included in the report because ‘reporting too detailed economic events may cause business secrets (to be) disclosed’.
It is important to distinguish events that won’t let business secrets disclosed and report them in detail, such as ‘revenue, intangible assets, human resource etc.
But other information like core technologies and main customer resource may be concerned with business secrets and hence can be reported with aggregated forms’ (Yu, Zhang, 2005, pg.13). This led to the development of materiality and money measurement concepts later.
In the later years theorists such as Hopwood related accounting to social science;
‘Accounting is coming to be regarded as an interested endeavour. Rather than being seen as merely residing in the technical domain, serving the role of neutral facilitator of effective decision-making, accounting is slowly starting to be related to the pursuit of quite particular economic, social and political interests.’ (Hopwood,1989, p 141)
In 1960s, there were major changes in attitudes to research in the social sciences. A famous theorist named Comte proposed that the methods of science could be applied in the social sciences and hence it became the standard for social science theorising, including accounting, in which it was held that to be considered meaningful, knowledge had to be empirical, objective, scientific, inductively derived and verifiable.’
This gave birth to the idea of objectivity which insists that accounting is ‘purely independent of technical activity which does not involve any personal opinions of those practising it.’ (Gaffikin, 2008, pg. 13)
There have been a number of examples of corporate failure and success that hold effective accounting responsible for their survival. Therefore a comprehensive knowledge of accounting theory is necessary to guide and inform about fair accounting practice, thus produce transparent reporting which is the foundation of earning public’s confidence.
References
1)      Gaffikin, M.J.R., 2008, Accounting Theory: research regulation and accounting practice
            Frenchs Forest N.S.W. Pearson Education
2)      Hopwood, Anthony (1989), Accounting and the Pursuit of Social Interests,
            in Chua et al (1989), pg 141 – 157.S
            Found in ‘The Critique of Accounting Theory’ by M. Giffikin, 2006
            (http://ro.uow.edu.au/cgi/viewcontent.cgi?article=1040&context=accfinwp)
3)      Russel, Michael, The Origin of Accounting Theory
            Extracted from (http://ezinearticles.com/?The-Origin-Of-Accounting-          Theory&id=378705) [last accessed Aug 26th,2010]
4)      Yu Fusheng, Zhang Min, 2005, “Events” Approach to Basic Accounting Theory: How Far            Away Can It Go* (online),
            Extracted  from (http://www.bmibourse.org/ReportFilesacc20051202.pdf)
               [Last Accessed Aug 25th,2010]
5)      WebFinance Inc., (http://www.investorwords.com/48/accounting.html)
             [Last accessed Aug 25th,2010]