Elements of the theory of accounting can be found as far back as the ancient civilizations of Mesopotamia and Egypt. By the time of the Roman Empire, financial data was widely used, and the government kept detailed financial records. The accounting theory definition is fairly simple. It is a set of assumptions, frameworks and methodologies that are used in the study and application of financial reporting principles. Because businesses and economies are often changing or in flux, the theories of accounting, along with the government regulations that apply to financial institutions, have had to adapt, to a certain extent, with the times.
History of Accounting Theory
Although elements of accounting can be found much earlier, in 1494, Luca Pacioli created a system of accounting much like the one we know and use today. This Italian mathematician, who is said to have taught math to Leonardo DaVinci, started what's called the double-entry accounting system. He also introduced the use of ledgers, journals and bookkeeping, key elements of modern accounting. Pacioli is known as the first person to have used a balance sheet and income statement. Two chapters he wrote about bookkeeping, known as "De Computis et Scripturis" ("Of Reckonings and Writings") and now known as ‘The Method of Venice," changed the entire way accounting was seen and used.
So although businesses and governments had been recording business information long before the Venetians, Pacioli was the first to describe the system of debits and credits in journals and ledgers that is still the basis of today's accounting systems.
With the advent of the Industrial Revolution in the 1700s, more advanced cost accounting systems became necessary. Corporations created large groups who were not part of a firm’s management but had a vested interest in the company’s results. They were the first shareholders and bondholders who provided external financing. For the first time, accounting became a profession, first in the United Kingdom and then in the United States. And in 1887, 31 accountants created the American Association of Public Accountants. Ten years later, the first standardized test for accountants was given. In 1896, the first CPAs were licensed.
The history and development of accounting theory took a new turn after the Great Depression, which led, in 1934, to the creation of the Securities and Exchange Commission. The SEC was created to help the American public regain trust in the United States capital markets after the stock market crash of 1929. After the SEC was established, all publicly traded companies were required to file reports that were certified by accountants. This increased the necessity for and prestige of accountants.
Accounting Theory and Practice
The Stock Market Crash of 1929 and the subsequent Great Depression were caused, in part, by shady financial reporting practices by some publicly traded companies. To help set America on the right path, the federal government began working with professional accounting groups to establish standards and practices for consistent and accurate financial reporting. These came to be known as Generally Accepted Accounting Principles or GAAP. The Securities Act of 1933 and the Securities Exchange Act of 1934 were two key pieces of legislation that led to the formation of GAAP. These standards have evolved based on changing economic climates and established best practices.
Two key organizations in the accounting profession are The American Institute of Certified Public Accountants, which was founded in 1887. It set accounting standards until 1973 when the Financial Accounting Standard Board was established.
How Accounting Evolved
In the late 20th century, the accounting industry grew and thrived. Large accounting firms expanded their services beyond the traditional auditing function and added on many forms of consulting. However, this expansion sometimes led to unsavory places. As the responsibilities of accountants expanded beyond that of financial watchdog, some accounting firms got embroiled in corporate scandals.
Arguably, the biggest scandal was the Enron scandal in 2001. This had broad repercussions for the accounting industry. Arthur Andersen, one of the top U.S. accounting firms, went out of business as a result of Enron. And the Sarbanes-Oxley Act tightened restrictions on consulting opportunities for accountants.
However, accounting scandals generate more work for accountants, which is a paradox of the profession. Demand for accounting services continued to boom throughout the early part of the 21st century.
Key Elements of Accounting Theory
There can be a difference between accounting theory and practice. While accounting procedures are formulaic, accounting theory is more qualitative. It is used as a guide for effective accounting and financial reporting, and that guide needs to be more flexible than mere formulas allow.
An important aspect of accounting theory is usefulness. All financial statements should provide important information that can be used to make informed business decisions. This also means that accounting theory should be able to produce effective financial information, even when the legal environment changes.
Accounting theory also states that all accounting information should be relevant, reliable, comparable and consistent. This means that all financial statements need to be accurate. They should also adhere to the GAAP because this ensures the preparation of financial statements will be both consistent and comparable to a company's past financials, as well as the financials of other companies.
Four main assumptions guide all accounting and financial professionals. First, is that a business is separate from its owners. The second affirms the belief that a company will not go bankrupt but will continue to exist. Third, all financial statements should be prepared with dollar amounts and not with other numbers like unit production. Lastly, all financial statements must be prepared on a monthly or annual basis.
The Future of Accounting
As with almost all professions, technology is having a huge impact on accounting. A recent survey by Accountancy Age asked 250 accountants and bookkeepers what the future might be for the profession. Three things were predicted by those surveyed: First, that automation will take over tasks such as entering data, creating electronic documents and producing receipts; second, the cloud will change the way professionals store data, collaborate, and gather information; third, new developments in accounting software will have an impact.
While it may sound like these dire predictions will do away with the profession, 89 percent of accountants surveyed said advances in technology are a real positive for the accountancy profession and will create new opportunities for them. Seventy-five percent said the technology they have started using already has either made their job easier or freed up time for them to concentrate on adding further value for clients. For example, they can now spend more time analyzing accounts and giving business advice.
Consequently, this means the skills used by accountants will never become useless or obsolete. Those in the profession should continue to maintain their skills as well as keeping abreast of the new skills that could be required by new tools. As an accountant, it is important to keep up with developments in accounting technology and make sure you can adapt. The human brain and its powers of analysis as seen in the field of accounting are now, and in the foreseeable future, considered a necessity by business owners worldwide.
- Investopedia: Accounting Theory
- Famous mathematicians: Luca Pacioli
- Corporate Finance Institute: GAAP
- Accountancy Age: The future of accounting is tech
- American Institute of Certified Public Accountants. "CPA Licensure." Accessed Aug. 6, 2020.
- American Institute of Certified Public Accountants. "Frequently Asked Questions FAQs - Become a CPA." Accessed Aug. 6, 2020.
- Institute of Management Accountants. "CMA Certification." Accessed Aug. 6, 2020.
- Chartered Professional Accountants Canada. "Uniting the Canadian accounting profession." Accessed Aug. 6, 2020.
- Alliance for Responsible Professional Licensing. "AICPA, NASBA Help Launch New Coalition to Protect Professional Licensing." Aug. 6, 2020.
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- Gary J. Previts, Peter Walton, Peter Wolnizer. "Global History of Accounting, Financial Reporting and Public Policy: Eurasia, Middle East and Africa," pages 1-29. Emerald Group Publishing, 2012.
- Jane Gleeson-White. "Double Entry: How the Merchants of Venice Created Modern Finance," pages 28, 47 and 91. W. W. Norton & Company, 2012.
- The Institute of Chartered Accountants in England and Wales. "Timeline: 1853-1880." Accessed Aug. 6, 2020.
Heather Skyler is a business journalist and editor who has written for wide variety of publications, including Newsweek.com, The New York Times and Delta's SKY magazine. She has a bachelor's degree in English from Miami University and a master's degree in writing from the University of Washington in Seattle. Before writing for a variety of publications, she taught business writing in Seattle.