Accounting is a complete system, which includes every activity related to the measurement and recording of different economic and financial information pertaining to an organization, which can then be used by the normal people for analyzing the business and for making decisions. The American Institute of Certified Public Accountants (AICPA) defines accounting as “the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events, which are, in part at least, of a financial character and interpreting the results thereof.” (Corina, et. al 2012)
Accounting is a vast system, which includes innumerable computations, problem solving, digging out of information and presenting the same in a specified format so that it can be read, analyzed and interpreted by people. Accounting has several major objectives to follow. Below discussed are some of the major objectives of accounting:
Recording Data in a systematic manner: For an investor or decision maker, analyzing only the present information or scenario of a company is not enough and it is crucial for them to even examine the past performances and information of a company. And that is what accounting aids by recording data and information in a systematic manner. Such systemized recording of information helps investors in analyzing options and information for any previous year as well. ( Laughlin, 2006)
Determining Financial Positioning: Every organization, big or small is required to prepare its financial statements on the basis of the given information. All this information then helps companies and the stakeholders in analyzing the financial position of the company. Different entries in the financial statements represent different aspects of financial position of a firm, hence giving a clearer picture. (Laughlin, 2006)
Aid in Decision-Making: The very first step of the decision making process is to collect, analyze and interpret information related to the topic to make informed decision. And this is exactly what accounting does. The information it provides help owners, creditors, management, employees and even investors make informed decisions related to the firm. (Haka, et. al 2004)
An accounting theory is nothing but a framework or a set of defined rules and principles that define and guide an accountant about what should be done and what should not be done. These theories include several logical reasoning and some practical proof to demonstrate the way an accountant can best present the accounting information or the way investors can best interpret the given accounting information. There are several international boards that develop these accounting theories that are then used by the accountants in different countries.
The most important step when it comes to accounting theories is their formulation. There are numerous approaches that go into the study and formation of these theories. We would thus now look at the different approaches that are used for the formulation and development of these different accounting theories:
Theoretical approach includes the adoption of different theories and qualitative analysis for the development of different theories. The policy makers make use of different theories and theoretical contexts for the development of different accounting theories. The theoretical approach to the formulation of accounting theories includes several different approaches and contexts. Some of the commonly used theoretical approaches for the formulation of accounting theories are discussed as below: (Cluskey, et. al 2007)
In addition to the theoretical approach, the policymakers also make use of several different non-theoretical approaches for the formulation and development of the different accounting theories. This approach includes different non-theoretical contexts according to which new and different accounting theories are developed and then implemented by the accountants. Different non-theoretical approaches developed towards formulation of accounting theories are discussed below: (Gaffkin, 1987)
The normative approach to accounting theories is a special approach, which is based on defining the things that should be instead of defining what actually is. Different approaches to accounting theories include the analysis of different elements and carrying out studies in different ways, which the help in the formulation and development of different accounting theories that define the basis and construct of accounting practices. In the normative approach, the policymakers discuss their opinions and judgment on different accounting practices and explains what a theory should include. The theorists make use of their past experiences and analyses and thus depending on that they explain and define the things that the accounting theories should include. Some of the main things included in the normative approach are the personal outlooks, deductive reasoning and use of inductive techniques. (Mattessich, 1992)
A very common and well versed example of the normative approach to accounting theory is the Contextual Framework of Accounting. Conceptual framework of accounting is nothing but the definition of different rules and regulations that are established by different accounting boards and institutions to define the different methodologies and rules that are to be followed for the purpose of accounting. The Financial Accounting Standards Board (FASB) defined a set of rules based on the problem on problem approach and developed a conceptual framework. The contextual framework of accounting includes several approaches to be used for the recording of assets, liabilities etc. in the financial statements on the basis of logic and personal opinions. The framework explains the different ways in which the elements of financial statements, like income, expenses and income can be defined and expressed and also the tools that can be used for measuring the same. Another commonly used normative approach theory of accounting is the current-cost accounting theory. The current-cost accounting theory defines the different ways in which the accountants can calculate the income that if taken away from the entity, would not affect its physical capital. Basically, the theory helps in determining the real and true measure of the income of any given entity. (Miller, et. al 2010)
The normative approach has been there since long time and has been adopted for the formulation of different accounting theories. Theorists make use of the approach because of one main reason and that is to match up to the changing world environment and the accounting procedures. The world, operations of businesses and everything else related to an organization are highly dynamic in nature and nothing remains stagnant after a point of time. And hence normative approach is expected to help the accountants keep up with the current changes and make changes in the established accounting theories according to current observations and analysis. But at the same time, there is also a possibility that there may occur some major changes in the existing theory without any sound basis. The accountants may analyze the changing environment in different ways, thus causing major impact on the existing practices and theories. (Demski, 1976)
Despite of using logics and logical reasoning for the development of different theories, one question that always arises while using the approach is if it actually reflects the actual accounting practices. Most of the normative theories are completely based on observations and hence it is not always possible to determine if they actually make sense in the accounting world. For example, a simple methodology of the valuation of assets would be interpreted and seen in different ways. Some accountants would focus more on the social and environmental impacts whereas some would focus more on the historical costs.
Some theorists believe that the normative approach is the most logical way because it is not based on what is happening but provides a clear picture of what and how the accounting practices should be. But then again the assumptions behind each accounting theory and the development of practices would depend on the policymaker’s opinions. One wrong assumption or one loophole in the reasoning and logical analysis can cause serious problems and hence this demonstrates the possibility of manipulating accounting theories. (Hakansson, 1969)
Thus, it is clear that though the normative approach presents an extremely practical way and methodology for the development and formulation of the accounting theories, it still has some severe drawbacks and hence whether to be used or not is still a question that needs to be answered.