The accounting theory provides a set of principles that explains the prevalent practices and predicts unobserved practices. Hence it explains the companies’ choice of accounting method and enables the users to predict those companies’ attributes (Schroeder, Clark & Cathey, 2010, p. 1). The ‘ theory’ in accounting can have two meanings- positive which explains the ‘ what’ and ‘ why’ about a thing and normative i. e. a set of invented conventions evolved over time as to how the things should be (Nobes, 1997, p. 4). The conceptual framework of accounting theories stems not from accounting literature but from the economics, sociology and behavioural literatures.
The accounting profession functions on the basis of a conceptual framework which aids the accounting professionals in communicating the relevant information. This conceptual framework is the foundation of accounting theory. The debate over the need of theoretical framework in accounting began in 1900s when the first attempt to provide the accounting theory was made by W. A. Paton where he expressed his views on fair valuations of assets and liabilities, distributions of income and entity concept. Canning in 1929 developed a conceptual framework for measurement and asset valuation.
Following the Great Depression in 1929, GAAP, which was a set of accounting practices emerged and has evolved over time in SAS (Statement of Auditing Standards) (Schroeder, Clark & Cathey, 2010, p. 17). In 1958 a committee set up to examine accounting assumptions identified 4 levels for financial accounting development: postulates, research, principles and rules for the principles to be applied in the specific situations. Since then the major accounting theories developed are Efficient Market Hypothesis (EMH), Signalling theory, fundamental analysis model, CAPM, positive accounting theory and critical perspective model.
EMH talks about the market efficiency and that the investors cannot earn excess returns by employing fundamental as well as technical analysis. Accountants believe that this theory fails to explain the current accounting practices as the theory holds no correlation between security prices and changed accounting practices, which has been proved false (Schroeder, Clark & Cathey, 2010, p. 120). Signalling theory examined the corporate disclosures expecting that the firms’ behaviour through their disclosures provide signal to the market.
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