Established rules and procedures provide an inadequate foundation for measuring truthfulness. Asset valuations, for example, are the result of following a specific method of inventory valuation and depreciation. Over the years, interest in this sub-discipline has increased as a result of the social responsibility trend espoused by organizations, the government, and the public. Consequently, given that important contracts depend on accounting variables, managers may be tempted to bias or otherwise manage reported earnings and working capital valuations if they perceive this to be for their own benefit. Explanation provides reasons for observed practice.
If a given theory does not act in practice and fails to produce the expected results, it is replaced by a new better or more useful theory. Different theories will point to different policies. The most important users of accounting reports presented to those outside the firm are generally considered to include investors, creditors, customers, and government authorities. For good corporate governance, these contracts should be efficient. Accounting theory may also be used to explain existing practices to obtain a better understanding of them. The role of interpretational theories is to build a correspondence between the interpretations of producers and users as to accounting information.
Some aspects of this relationship may threaten the validity of the experiment. However, according to proponents of market level research, there are factors that are difficult to stimulate in individual level research such as competing information sources, incentives, and user interactions that are important in study of groups; those factors thus prohibit a simplistic extension from the individual to the aggregate. It also assumes that the user should be able to select the desired information from a broader list and also to decide the amount of aggregation. In other words, it is similar to conditions of certainty except that the future expected cash flows are known conditionally on the states of nature. Control it by timely and credible conversion of inside information into outside information.
Under the events approach because of a disaggregation of data provided to users, the data are expanded. Indeed, they may be so significant that theories about individual behaviour and theories about market behaviour becomes, in fact, theories about distinctly different things. The decision model emphasis has now achieved professional recognition and broad exposure through publications of different accounting bodies all over the world. Littleton, An Introduction to Corporate Accounting Standards 1940. This approach emphasises on drawing generalized conclusions and principles of accounting from detailed observations and measurements of financial information of business enterprises.
Events may be characterised by one or more basic attributes or characteristics and these characteristics can be directly observed with feasibility. Probably the greatest disadvantage of ethical approach to accounting theory is that it fails to provide a sound basis for the development of accounting principles or for the evaluation of currently accepted principles. In adopting this approach, 2 major questions must be addressed. In this view, company directors occupy a position of responsibility and trust in regard to shareholders, and the discharge of these obligations requires the publication of annual financial reports to shareholders. Accounting is assumed to be action-oriented—its purpose is to influence action, that is, behaviour; directly through the informational content of the message conveyed and indirectly through the behaviour of preparers of accounting reports. The theory is not specific with respect to the information set, and technical problems arise when it is admitted that the price actually reflects the underlying information.
But the truthfulness of the financial reports depends on the fundamental validity of the accepted rules and principles on which the statements are based. It is helpful to categorize them into broad groups, such as investors, lenders, managers, employees, customers, governments, regulatory authorities, suppliers etc. The first approach examined the relative importance to investment analysis of different information items to both users and preparers of financial information. Accounting practices followed in this way may not reflect the real business situation and real world phenomena. They should not be prepared with the objective of serving any particular individual or group to the detriment of others. Whenever the need for a new application of practice arises, the accounting theory should provide accountants with guidance on the most appropriate procedures to adopt in the circumstances.
Noreen, Managerial Accounting, McGraw Hill, 2000. For any Query, you can Contact us via Comment Box. The meaning of efficiency By assumption, information is free under ideal conditions since state realization is publicly observable and the process of arbitrage would make the market efficient. Outside investors will protect themselves by bidding down the price of securities and hence this will increase the cost of capital for those firms. For example, to argue that current cost values should be the method of valuing assets, one might adopt the objective of operating capability and specify how certain variables affect operating capability the objective functions.
A set of such desirable qualities is used as criteria for evaluating alternative accounting methods. The role of financial reporting for debt and compensation contract purposes is to generate trust. For example, a user will use the accounting theory that increases his welfare the most, through making decisions. In setting accounting standards, therefore, the considerations implied by the economic approach are more economic than operational. A fourth set of studies has focused on materiality judgements that affect financial reporting. Also, recording unrealized losses may motivate early manager action to correct operating policies that have led to such losses and, if not, alerting Boards of directors to take timely steps to correct management lack of action.