Role of Accounting theory

Accounting theory may also be used to explain existing practices to obtain a better understanding of them. But the most important goal of accounting theory should be to provide a coherent set of logical principles that form the general frame of reference for the evaluation and development of sound accounting practices.

Accounting theory is that branch of accounting which consists of the systematic statement of principles and methodology. However, theory cannot be divorced from practice. The theory underlies practices, explains and attempts to predict them. There is not and cannot be any basic contradiction between theory and facts.

A theory is an explanation. However, every explanation is not a theory in the scientific meaning of the word. The objective of accounting theory is to explain and predict accounting practice. Explanation provides reasons for observed practice. For example, an accounting theory should explain why certain firms use LIFO method of inventory rather than the FIFO method.

Prediction of accounting practices means that the theory can also predict unobserved accounting phenomena. Unobserved phenomena are not necessarily future phenomena; they include phenomena that have occurred but on which systematic evidence has not been collected.

It is significant to observe that accounting theory may be based on empirical evidence and practices as well as accounting theory may be formulated using hypothetical and speculative interpretations.

(1) Accounting theory has a great amount of influence on accounting and reporting practices and thus serves the informational requirements of the external users.

In fact, accounting theory provides a framework for:

(i) Evaluating current financial accounting practice and

(ii) Developing new practice.

(2) Secondly, accounting theory literature is useful to accounting policy makers who are interested in making the accounting information useful. The researches, empirical evidence and investigation can be used and incorporated by the policy makers in formulating accounting policies. Theories are helpful as they apprise policy makers of the underlying issues and clarify the trade-offs implicit in various theory approaches.