What Are the Basic Accounting Theories

All accounting theories revolve around a double entry system, which states that every debit entry must have an off-setting credit entry; or in simple terms, assets of businesses, individuals or organizations must equal the amount of their liabilities and stockholders’ equity. This is an important assumption for book keeping purposes where the left-hand-side must equal the right hand-side.

Instructions

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    Characteristics

    The underlying theory is that all financial information must be prepared in the form of the financial statements, which can be reviewed for decision making purposes. Moreover, any reporting must be done in accordance with the political, legal and economic environment a company is operating in.

    The information must depict quality in terms of relevancy, reliability, comparability and consistency. The latter two refer to being consistent with the general accepted accounting principles (GAAP).

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    Assumptions

    There are four basic assumptions followed by accounting theories.

    The economic entity assumption states that all business related dealings must be kept separate from their owner’s own dealings. However, this category excludes those entities which can subsidiaries of the parent company where the financial statements can be presented in a consolidated manner.

    Going Concern is one of the critical assumptions in accounting which assumes that businesses will operate or stay in operation for a longer term. This allows them to depreciate or amortize their assets over a long period of time. If the liquidation is imminent, then accountants preparing and analysing financial reports must state their opinion clearly by including a disclaimer.

    Monetary Unit assumption simply states that all details must have a numerical value attached to them for better understanding, and publicly acceptable purposes. Moreover, the unit of currency must be consistent, for e.g. US Dollar is a universally accepted currency measure.

    The Time Period Assumption states that all information must be presented in a timely manner, i.e. at the end of the fiscal period, monthly, weekly etc.

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    Accrual Concept

    The matching principle which is derived from accrual accounting, states that every transaction must be recorded as soon as it occurs rather than when the cash is in the bag. For instance, if you sell something, your revenue increases but regardless of whether you get the money at that particular moment, you must record the transaction for accounting purposes.

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