The Imporance of Accounting Theory to the Field of Accounting

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The Importance of Accounting Theory to the Field Of Accounting

The objective of theory is to explain and predict. One of the basic goals of the theory of a particular discipline is to have a well-defined body of knowledge that has been systematically accumulated, organized, and verified well enough to provide a frame of reference for future actions. The Webster’s definition of theory is the systematically organized knowledge, applicable in a relatively wide variety of circumstances, a system of assumptions, accepted principles and rules of procedure to analyze, predict, or otherwise explain the nature of behavior of a specified set of phenomena. Theories may be described as normative or positive. Normative theories explain what should. Positive theories explain what is. The goal of accounting theory is to provide a set of principles and relationships that explains observed practices and predicts unobserved practices. Meaning, accounting theory should be able to both explain why business organizations elect certain accounting methods over other alternatives and predict the attributes of firms that elect various accounting methods. Accounting theory should also be verifiable research. As stated in the Financial Accounting Theory and Analysis, the development of general theory of accounting is important because of the role accounting plays in our economic society, which is characterized by a self-regulated market that operates through the forces of supply and demand. The role of accounting is to report how organizations or companies use those scarce resources and on the status or resources and claims to resources. Because accountings have to report these organizations, the reports are done in a formal way called financial statements. The financial statements that are the main focused in this paper is the income statement, the balance sheet and the statement of cash flows.

An income statement is a financial statement for companies that indicate how net revenue is transformed into net income. The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported. Income statements should help investors and creditors determine the past performance of the enterprise; predict future performance; and assess the risk of achieving future cash flows. However, information in an income statement has several limitations for instances, items that might be relevant but cannot be reliably measured are not reported, some numbers depend on accounting methods used, and some numbers depend on judgments and estimates. In the operating section of the income, net revenue are inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations, which is usually presented as sales minus sales discounts, returns, and allowances. And Expenses are outflows or other using-up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations. Under the non-operating section in the income statement are other revenues or gains and other expenses or losses. Other revenues or gains are revenues and gains from other than primary business activities. It also includes unusual gains and losses that are either unusual or infrequent, but not both. Other expenses or losses are expenses or losses not related to primary business operations. They are reported separately because this way users can better predict future cash flows - irregular items most likely won't happen next year. These are reported net of taxes. Discontinued operations are the most common type of irregular items. Shifting business location, stopping production temporarily, or changes due to...
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