Question

1.Conduct Applied Research on Accounting Theory and the Relevance to Financial Reporting.

Please provide 2 pages long and please post a post not already posted.

Answer 1

What is the 'Accounting Theory'

Accounting theory is a set of assumptions and methodologies used in the study and application of financial reporting principles. The study of accounting theory involves a review of both the historical foundations of accounting practices, as well as the way in which accounting practices are changed and added to the regulatory framework that governs financial statements and financial reporting.

Key Elements of Accounting Theory

While accounting procedures are formulaic in nature, accounting theory is more qualitative in that it is a guide for effective accounting and financial reporting. The most important aspect of accounting theory is usefulness, which, in the corporate finance world, means that all financial statements should provide important information that can be used to make informed business decisions. This also means that accounting theory is intentionally flexible so that it can provide effective financial information, even when the legal environment changes.

In addition to usefulness, accounting theory states that all accounting information should be relevant, reliable, comparable and consistent. What this essentially means is that all financial statements need to be accurate and adhere to the generally accepted accounting principles (GAAP). Adherence to GAAP allows the preparation of financial statements to be both consistent and comparable to a company's past financials, as well as the financials of other companies.

Finally, accounting theory requires that all accounting and financial professionals operate under four assumptions. The first assumption states that a business is separate from its owners. The second affirms the belief that a company will continue to exist and not go bankrupt. The third assumes that all financial statements are prepared with dollar amounts and not with other numbers like unit production. Finally, all financial statements must be prepared on a monthly or annual basis.

Importance of a Company's Financial Statements

A company’s financial statements provide various financial information that investors, creditors and analysts use to evaluate a company’s financial performance. Financial statements communicate past performance as well as future expectations.

A company’s financial statements provide various financial information that investors, creditors and analysts use to evaluate a company’s financial performance. Much of the information presented in a financial report is required by law or by accounting standards. Financial statements are important company management as a means of communicating past successes as well as future expectations. By publishing financial statements, management can communicate with interested outside parties about its accomplishments running the company.

Financial Conditions

A company’s financial conditions are of a major concern to investors and creditors. As capital providers, investors and creditors rely on a company’s financial conditions for both the safety and profitability of their investments. More specifically, investors and creditors need to know where their money went and where it is now. The financial statement of balance sheet addresses such issues by providing detailed information about a company’s asset investments. The balance sheet also lists a company’s outstanding debt and equity components, and so debt and equity investors can better understand their relative positions in a company’s capital mix.

Operating Results

Financial conditions shown in the balance sheet are snapshots of a company’s assets, liabilities and equity at the end of a financial reporting period; they don’t reveal what happened during the period from operations that may have caused changes to financial conditions. Therefore, operating results during the period also concerns investors. The financial statement of income statement reports operating results such as sales, expenses and profits or losses. Using the income statement, investors can both evaluate a company’s past income performance and assess the uncertainty of future cash flows.

Cash Flows

A company’s profits reported in the income statement are accounting income and most likely contain certain non-cash elements, providing no direct information on a company’s cash exchange during the period. Moreover, a company also incurs cash inflows and outflows during a period from other non-operating activities, namely investing and financing. To investors, cash from all sources, not just accounting income from operations, is what pays back their investments. The importance of the cash flow statement is that it shows the exchange of cash between a company and the outside world during a period, and so investors can know if the company has enough cash to pay for expenses and asset purchases.

Shareholders’ Equity

The statement of shareholders’ equity is especially important to equity investors because it shows the changes in various equity components, including retained earnings, during a period. The amount of shareholders’ equity is a company’s total assets minus its total liabilities, representing the company’s net worth. A steady growth in a company’s shareholders’ equity by way of increasing retained earnings, as opposed to expanding shareholder base, means the accumulation of investment returns for current equity shareholders.

Relevance to Financial Reporting

Relevance is the concept that the information generated by an accounting system should impact the decision-making of someone perusing the information. The concept can involve the content of the information and/or its timeliness, both of which can impact decision making. In particular, information that is provided to users more quickly is considered to have an increased level of relevance. This impact may be simply to confirm a decision that the reader has already made (such as to retain an investment in a company) or to reach a new decision (such as to sell an investment in a company). Here are several examples of how relevance is used in accounting:

• A company controller decides to accelerate the month-end close, so that she can issue financial statements in three days, rather than the old standard of three weeks. This improves the speed with which various internal and external parties receive the financial statements, which improves the relevance of the information they receive.
• The industrial engineering manager is considering the installation of a new, higher-capacity machine in the production area. If the sales department issues a new forecast that shows a decline in sales, this has great relevance to the engineering manager's decision, since it may no longer be necessary to acquire such a high-capacity machine.
• A company is contemplating the acquisition of another firm. If the acquiree reveals that it has a previously undocumented and material liability, this is relevant to the decision of the acquirer in regard to whether it should extend an offer to buy the acquiree, and the price it is willing to pay.
• A company has experienced a strong quarter; issuing these improved results to creditors is relevant to their decisions to extend or enlarge the amount of credit granted to the company.

Conclusion:

Accounting theories are required for effective Financial Reporting. As seen in various aspects above to ascertain the Financial Condtions, Operating Results, Cash Flows, Shareholder's Equity, to accelerate month end close, forcasting, acquitions,etc. which requires financial reporting, has to be done with applying Accounting Theories for best, efficient and effective output.