Accounting Theory

Summary :

This chapter surveys the underlying assumptions, major principles, and modifying conventions that govern accounting practice, and describes the conceptual framework project of the Financial Accounting Standards Board. It also discusses what a company's own summary of significant accounting policies typically covers in its published annual report.

Assumptions and principles in accounting theory

Accounting rests on underlying assumptions, such as treating the business as a separate entity and assuming it will continue operating, and on major principles that guide how transactions are measured and recorded, including matching revenues with the expenses that produced them. Together these form the conceptual basis for the more detailed accounting rules applied to individual transactions day to day.

Modifying conventions

Alongside the formal principles, a set of modifying conventions, or practical constraints, shape how strictly those principles are actually applied, including considerations of materiality and conservatism in everyday practice. These conventions exist because rigid application of every principle to every transaction, however small, would not always produce useful or cost-effective financial reporting for a business.

The conceptual framework and disclosure

The Financial Accounting Standards Board's conceptual framework project sets out the objectives and qualitative characteristics that financial reporting should meet. In practice, a company communicates the specific choices it has made, among the acceptable alternatives that theory and principle allow, through a summary of significant accounting policies included in its annual report, so readers can judge one company against another.