Accounting Theory: Importance of Accounting Concepts in Constructing Financial Information

Running head: ACCOUNTING THEORY
Accounting Theory
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ACCOUNTING THEORY
Accounting concepts are central to the construction of accounting information. Critical
evaluation:
Communication of financial information of corporate and non-corporate entities by
measuring, processing and classifying financial transactions is what accounting is all about.
Accounting as a subject has evolved over the years to improve its ability to provide useful
information to the users of accounting information. It is based on the concept that the financial
transactions must be properly classified and recorded in the books of accounts to keep record of
all financial transactions to provide useful information to the stakeholders of an organization.
Communicating true and fair picture of an organization is the objective of accounting however,
there are number of limitations in accounting which make it almost impossible to achieve the
ultimate objective with 100% precision. Accounting concepts are the accumulation of
accounting rules and regulations to be followed in recording financial transactions in the books
of accounts to improve the ability of the financial statements to portray true and fair picture of
business organizations (Schrader and William, 1962). According to Walton, P (1993), “True and
fair representation of financial performance and position of an entity is essential to the
construction of accounting information”. As an example the financial information disclosed in
the financial statements of Enron did not reflected the actual financial state of the company
immediately prior to its collapse. Thus, it is important to ensure that financial statements reflect
the true and fair picture of an entity to be useful to the users of financial statements (Walton,
1993).
Knowledge is gathered and acquired over a period of time and it is the experience that one
receives from practical implementation of theoretical knowledge that helps the person to
understand about the subject better. Accounting is the underlying foundation on the basis of

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ACCOUNTING THEORY
which the financial information about an organization is provided to different stakeholders.
Financial statements include Balance sheet, profit and loss account, cash flow statement and
notes to accounts (Tinker, 1991).
Sources of knowledge is equally important to the proper accumulation of financial information.
PRIMFIT analysis shall be helpful in understanding knowledge and the sources of knowledge.
Accounting is a mix of arts and science and thus, there are certain characteristics of both
which makes it neither completely scientific nor completely artistic. Accounting is a process
which helps in recording financial transactions properly. It creates a perception about an
organization and its performance by constructing reality by recording all financial transactions
(Trochim and Donnelly, 2006).
The observation made from various financial data provided about an entity helps the
users of such financial data to make assertion about the entity and its financial performance as
per the induction process. The assertions are made on the basis of generalized theory and
concepts of accounting. Inductive approach enables the users of accounting information to create
perception about an entity by using the monetary information of the entity. Deductive reasoning
on the other hand does not allow the imaginations of the users of financial information to create
perception as the approach starts with established theory. The approach of deductive reasoning
allows the users to ascertain the true and fair nature of financial information with its logical
explanation and reasoning.

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ACCOUNTING THEORY
The conceptual framework in accounting is essential to the understanding of users of
financial statements as it is based on the theoretical aspect of accounting. The objective of
accounting information to correctly disclose the financial information of an organization is
possible to be achieved only if the core principles of accounting developed in the conceptual
framework are followed in preparation and presentation of financial statements. The
inconsistency in financial reporting standards and accounting policies have been reduced
significantly subsequent to the development of conceptual framework in accounting. Morgan, G.,
1988 stated that “the importance of conceptual framework in accounting is immense to enhance the
quality of financial information”.
Financial statements are prepared in accordance with financial information accumulated
in the books of accounts as per accounting concepts include Balance sheet, profit and loss
account, cash flow statement and notes to accounts. According to Atrill & Mclaney (1995, page
21), “The purpose of the b/s is simply to set out the financial position of a business at a
particular moment in time” (Atrill and Mclaney, 1995). The accounting concepts if not