islamic theory accounting

8/11/2019 Islamic Theory Accounting

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Accounting TheoryAccounting Theory Defined as:

A set of broad principles that provides a generalframe of reference by which accounting practice

can be evaluated and guides development of new

practices and procedures. (Hendrickson, 1982) or A cohesive set of conceptual, hypothetical and

pragmatic propositions explaining and guiding the

accountants action in identifying, measuring andcommunicating economic information.


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Needs and Importance of AccountingNeeds and Importance of Accounting

TheoryTheory

To provide a basis for prediction and explanation ofaccounting behaviors and events and help to understand

current development in accounting practice.

Provide general frame of reference by which accounting

practice can be evaluated.

Guide the development of new practices and procedures.


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Purposes of Accounting TheoryPurposes of Accounting Theory

Helps to evaluate existing practice. E.g. are methods andtechniques used by accountants valid or correct in terms ofwhat it should be?. This is to eliminate unnecessary diversitiesin accounting treatment for similar items.

From the evaluation of existing practices, reasons for diversitythat cannot be eliminated may be discovered and explained.This will enhance our understanding of current practice andfacilitate in the regulating the profession by policy makers.

Theory also assist in the development of future practice whereit serves as basis in the development of accounting standards.As business practices becomes more sophisticated , newaccounting problems may arise that require development of

new techniques and procedures. The goal of theory is to provide coherent set of logical

principles that form the general frame of reference forevaluating and developing new accounting practices.


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Benefits of Accounting Theory

To guide the body responsible for establishingaccounting standards.

To provide a frame of reference for resolvingaccounting questions in the absence of a specific

promulgated standard.

To determine bounds for judgment in preparingfinancial statements.

To increase financial statements usersunderstanding of and confidence in financialstatements.

Enhance comparability.

Improve the image of theprofession.


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Theory ConstructionTheory Construction

1. Descriptive inductive theory whichderived from factual empirical observation,describe what reality is like.

2. Normative deductive theory whichdescribe what the empirical world should be

regardless of its reality.


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Approaches to theApproaches to the

Construction/Development of AccountingConstruction/Development of Accounting

Theory.Theory.

Three basic approaches:

1. Descriptive approach

2. Decision usefulness approach

3. Welfare approach


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Descriptive Approach

Theories developed are concerned with what accountants do,that is the practice of accounting.

Making observation to look for similarity and recurrence anddrawing generalized conclusions from those observation or

practices. (E.g. observed how accountants record assets) The focus of the theory is to explain what accountant do or the

functional tasks of an accountant and enable prediction to bemade and hence its treatment in the book.

In standard setting the setter are concerned with discussing thevaried practices used by accountant and reaching a consensuson the most feasible basis to reduce diversity of practices withinwhich descriptive theory has developed.

Involves the process of specifying the objectives of financial

statements, selecting the postulates of accounts, deriving theprinciples of accounting and developing the techniques ofaccounting.


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Decision Usefulness Approach

Emerged due to the expansion of behavioral research intoaccounting based on the thought that the purpose of accountingreports is to influence action or behavior of users (e.g. usersmake investment decision based on information in the F/S).

Two types of theories in this approach are empirical andnormative theories.

Empirical Approach employs statistical technique (research) to

make accounting research more rigorous and to improve thereliability of results.

Normative Method concerned with specifying the manner inwhich decision to be made serves as a precondition to

considering the information requirement. It focus on decisionmodels used by decision maker and provides insight oninformation needs of decision makers as a basis for developingaccounting theory. (Refer to page 34)


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Welfare Approach

An extension of decision making approach

which consider the effects of decisionmaking in social welfare due to the effects of

the decision made base on the accounting

information do have effect to the externalsociety.

It resulted in a social welfare dimension to

accounting theory Social Responsibility

Accounting.


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Accounting Theory and Policy MakingAccounting Theory and Policy Making

The two groups that determine accountingpolicy are the government and theaccounting profession.

The government employs legislativeprocess to ensure minimum level

information disclosed in companys report. Accounting profession as a regulatory body

deals with problems of accounting standards

implied in financial reports.

Refer to page 35 Figure 3.2


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Relationship Between Theory and PracticeRelationship Between Theory and Practice

Influence of policy makers in setting up rules in the form ofaccounting standards.

Practice may be changed to accommodate theory.

The form of accounting information reported depends onpractices adopted, i.e. practices imposed by policy maker inresponse to the needs of users.

Theory provides an abstraction of needs and serves as a basis toprovide value judgment in accounting policy making.

If deficiencies occur in either accounting theory or policymaking or accounting practices, it will impair usefulness of

accounting information. Usefulness of accounting information may be improved via

research findings in policies devised bypolicy makers.


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Structure of Accounting Theory

The structure of accounting theory serve as frame ofreference that is use to judge the extend to which a

particular accounting technique of accounting is adequate.

Based on a set of elements and relationship that govern thedevelopment of accounting technique.

The five elements in the structure of an accounting theoryare:

Objectives of Financial Statement

Accounting postulates ( assumptions)

Accounting concepts

Accounting principles

Accounting techniques

Refer to page 36 Figure 3.3


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Objectives of Financial StatementsObjectives of Financial Statements

To present fairly and conformity with GAAP,the position, results of operation and changes in

financial position for investors to make relevantinvestment and credit decisions.

The objectives contain three areas:

User of information; specifically the investorsgroup, to whom the information is directed.

Purpose to which accounting information is

generated, that is for making investment and creditdecisions.

Nature of content of information specified, that is onperformance, position and changes in position of anenterprise.


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Accounting PostulatesAccounting Postulates

Entity Postulate entities are separate and distinctfrom owners entities. Accountants report transactionsof enterprise itself, not of owners of enterprise. It

applies to sole proprietorship, partnership andcorporation.

Going Concern Postulate business entity is

assumed not to be liquidated in the foreseeable future. Unit-of-measure Postulate information expressed in

terms of monetary unit.. This postulate is also a stablemonetary postulate where the purchasing power of

money is assumed to be stable over time.

Accounting Period Postulate the financial reportsdepicting changes in the wealth of firm should be

disclosed periodically.


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Theoretical ConceptTheoretical Concept

Proprietorship Theory - proprietor, the owner,is the focus of attention.

Assets belong to the proprietor and liabilities are

his obligation, the resulting outcome is the networth of owner or the proprietor.

ASSETS LIABILITIES = PROPRIETORSHIP EQUITY


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Entity Theory

entity to be separate and distinct from those who providecapital to the entity.

It is the entity and not the owner to be the centre ofaccounting interest.

All accounting procedures are conducted from the viewpointof the entity.

Does not focus on net worth of owner, but the business thatowns the assets and liable to all obligations.

Equities represent rights or claim on assets of the entity.

As provider of funds, shareholders have no claim to anyparticular assets or income of the company, except thosedividends declared by the company.

ASSETS = EQUITIES + LIAB


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Fund Theory do not focus on owner or theentity but the groups of assets and relatedobligations and restriction that governs the use of

the assets.

Fund is directed for specified purpose via servicesderived from the use of the assets.

Focuses on the administration and appropriate use

of assets. Fund theory is applicable for government and non-

profit organization.

ASSETS = RESTRICTION ON ASSETS


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Accounting PrinciplesAccounting Principles

Cost Principle

Revenue Principles

Matching Principle

Objectivity Principle

Consistency Principle Full Disclosure Principle

Conservatism Principle Materiality Principle


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Accounting TechniquesAccounting Techniques

Accounting techniques are specific rulesderived from the accounting principles that

account for specific transactions and events

faced by the accounting entity.


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TutorialsTutorials Harvey and Keer, Financial Accounting Theory

and Standards: Chapter 3:The Role of Accounting

Theory.

Harvey and Keer, Financial Accounting Theory

and Standards: Chapter 1:The Construction of

Financial Accounting Theory.

Glautier, M.W.E and Underdown, B., Accounting

Theory and Practice, Chapt. 4.

Ahmed Belkaoui, The Nature of an Accounting

Theory, pp. 56-57.

islamic theory accounting

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