Philosophy of Accounting
The broad rules, concepts, and ideas underlying the production and auditing of individual or corporate accounts and financial statements
What is the Philosophy of Accounting?
The Philosophy of Accounting is essentially a set of fundamental rules and ideas that guide how financial accounts and statements for individuals and businesses are created and audited.
The necessity for openness is one of the most basic components of the ideology due to the legal repercussions of erroneous or fabricated financial documents.
Transparency is essential, as is fair and accurate reporting and accounting of revenue and expenses. This is especially true for companies that are publicly listed.
Fairness, honesty, openness, equity, and justice are all important concepts in accounting philosophy. But, in a practical sense, what do they imply?
They imply that accountants must present all of the data documented in their accounting records fairly and honestly, without skewing any of the numbers to make a firm appear better or worse than it is.
They are unable to conceal or fail to record any information (transparency). To be consistent across the board, every company's documentation and reporting practices must be the same.
The basic norms and ideals that govern the auditing, preparation, and dissemination of financial data are referred to as accounting philosophy.
When it comes to how to treat and disclose financial data, there are a variety of concerns and schools of thinking.
Governing bodies, such as the FASB, create principles and norms that must be followed globally when it comes to financial information to preserve a fair and accurate collection, analysis, and documentation of financial data.
Accounting philosophy is an idea or collection of principles and norms that should govern accounting practice.
However, several challenges occur when attempting to put these philosophical ideas into practice. These are some of the issues:
- The basis for maintaining confidentiality regarding a company's or an individual's private information while ethically and morally disclosing financial statistics and numbers.
- The challenges in establishing and sustaining a reasonable and fair value of a firm and its assets.
- Laws and standards, together with the ability to apply them consistently across the board to suit the interests of not only investors, employees, and other stakeholders.
Key Takeaways
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It encompasses the principles of transparency, fairness, honesty, equity, and justice in financial reporting.
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Accounting philosophy guides the creation of global standards to ensure accurate financial data.
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Assets are recorded based on the cost at acquisition, ensuring objectivity.
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Costs should be matched with revenues in the same accounting period, emphasizing accrual accounting.
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Generally Accepted Accounting Principles (GAAP) maintain consistency, honesty, and adherence to standards in financial reporting.
The Importance of Philosophy in Accounting
The combination of accounting and philosophy is not a novel concept. For example, Luca Pacioli, the inventor of the double-entry method, was a philosopher and mathematician.
Over 400 years from Luca Pacioli, there is Frank Moran, a philosophy major who helped found one of the largest accounting companies in the United States.
So, while this is not a new issue, the terms "philosophy" and "accounting" must be defined before the question "what in the world does philosophy have to do with accounting?" can be addressed.
'Philosophy,' according to the dictionary, is the study of the theoretical foundations of a particular branch of knowledge, whereas 'accounting,' according to the dictionary, is the system of recording and summarizing business and financial transactions, as well as analyzing, verifying, and reporting the results.
When someone combines the two phrases, one could obtain 'theoretical foundations of documenting and summarizing economic and financial activities.'
What is accounting's theoretical foundation? “Telos” is a Greek term used to denote purpose in philosophy. The Telos of anything is its ultimate aim, purpose, or reason for being.
So, what is accounting's Telos? In most philosophical discussions, the meaning of anything is found in its definition.
It just so happens that accounting is no different, as the definition states, "evaluating, confirming, and reporting the results," which is precisely what accounting is about.
Accounting's Telos is to take commercial and financial activities and transform them into usable outputs using a variety of approaches.
As a result, the question "what does philosophy have to do with accounting?" has been answered. "Everything" is the answer.
The rest of this article will merely argue the assertion that financial reporting's theoretical foundations have anything to do with the accounting profession.
Understanding the philosophical foundations of accounting will assist young accountants in negotiating a new world of dynamic situations, help accounting firms prepare for the effect of technological advancements, and be critical to the accounting industry.
Is Philosophy Of Accounting effectively achieved?
Accounting's major output is financial reports. They offer consumers historical information about a company's financial performance over time to assist various stakeholders in decision-making. Key stakeholders may include:
- Shareholders
- Potential investors
- Lenders
- State agencies
- Workers
- Other parties with a stake in the company are included.
In this regard, IASB (2010) emphasizes capital providers as the primary users of financial information.
As a result, one of the most important roles of accounting standard setters is to determine the relevant information that must be revealed and the amount to which it must be provided.
Furthermore, "reliability" was established as a core qualitative property of accounting data (IASB, 2010). This may have pushed stakeholders to place a greater emphasis on financial disclosures.
However, accounting scandals continued, resulting in significant losses for shareholders and stakeholders. Major accounting scandals in recent history include:
These have called into question the utility of accounting data and whether it can perform its intended function.
Furthermore, the efficacy of financial reporting in decision-making has been questioned, as has whether it should be the primary goal of financial reporting.
Even though the IASB has identified "decision usefulness" as a fundamental goal of financial reporting (IASB, 2010), there has been significant discussion over whether to disclose financial results as is or to drive the financial reporting process toward the decision usefulness target.
The choice is, therefore, between generating financial reports in a way that accurately represents the real outcomes, even if this does not aid decision-making, or directing financial reporting toward decision usefulness, even if this may result in biased and erroneous information being provided.
The first scenario is based on Searle's (1995) paradigm, which states that genuine value exists. However, there are difficulties with the precise definition of "true result" in this concept.
In addition, how can this real outcome be measured? The latter scenario, decision usefulness, is predicated on lowering uncertainty around a company's activities.
However, there is no consensus on which kind of data is the most beneficial. This view says that IFRS standards give a specific reality primarily created to meet the demands of finance providers, but other consumers of accounts may not find what they need.
As a result, decision-useful orientation in accounting might be seen as an acknowledgment of the profession's inability to portray economic reality accurately.
Furthermore, the growing amount of information disclosed outside of traditional financial statements raises concerns about accounting's capacity to assess and evaluate corporate performance.
On the other hand, pragmatists advocate the "decision usefulness" aim, arguing that the truth value of a statement is determined by how useful information is in improving users' involvement with the world.
Rebut this viewpoint by noting that, given the global economy's complexity and unpredictability, determining which accounting data items have more production value than others is extremely difficult, especially as decision usefulness is not an intrinsic quality of any accounting data.
Furthermore, it claims that accounting outputs are not supplied in a form understandable to intended consumers.
This might indicate that the role of accounting and how it can be beneficial is ambiguous.
The Five Basic Concepts in Accounting
The five basic concepts are:
1. Principle of Revenue Recognition
The Revenue Recognition Principle primarily concerns how revenue is recorded in an organization's income statement.
Revenue is the gross inflow of cash, receivables, or other considerations resulting from the sale of goods, performance of services, and usage of corporate resources by others, producing interest, royalties, and dividends in the regular course of business.
It does not include money collected on behalf of third parties, such as taxes. The amount of commission is the revenue in an agency partnership, not the total inflow of cash, receivables, or other considerations.
2. Cost Principle in the Past
According to the Historical Cost Principle, an asset is normally documented in accounting records at a price paid to acquire it at the time of purchase, and the cost becomes the foundation for accounts throughout the acquisition period and future accounting periods.
As a result, if no money is paid to obtain an asset, it is not frequently recognized as an asset, such as a great location or a growing reputation of the company, even though they are an important asset.
The cost notion is justified by the fact that it is objectively provable.
3. Principle of Matching
According to the Matching Principle, costs should be matched with revenues recorded in the same accounting period.
For example, if revenue is recognized on all items sold within a period, the cost of those sold should likewise be attributed to that period. It is incorrect to record revenue on all sales but only charge expenditures on those collected in cash up to that point.
This is an accrual notion since it ignores the time and quantity of real cash input or outflow and instead focuses on the occurrence (i.e., accrual) of income and costs.
Read more about Six Constraints of Accounting
4. Principle of Full Disclosure
According to this notion, financial statements should be used to convey information rather than to conceal it.
For the data to be valuable to the users, financial statements must provide all relevant and trustworthy information they purport to reflect.
This necessitates accounting for and presenting information in line with its substance and economic reality rather than just its legal form. As a result of the idea of full transparency, the practice of attaching notes to financial statements has evolved.
5. Principle of Objectivity
According to the Objectivity Principle, the accounting data should be precise, verifiable, and free of the accountant's prejudice.
To put it another way, the Objectivity Principle mandates that each recorded transaction/event in the books of accounts be backed up by sufficient proof.
Because transactions are documented based on source documents such as vouchers, receipts, cash notes, invoices, and so on, the accounting data in historical cost accounting are verifiable.
At the same time, the accounting data is 'bias-free,' as it is not influenced by management or the accountant who compiles the books.
Accounting data is not bias-free in value-based accounting (e.g., current cost accounting) since value might signify various things to different people.
Generally Accepted Accounting Principles (GAAP)
Generally accepted accounting principles (GAAP), the guiding set of basic principles that regulate accounting practice in the United States, are the standards that assist keep corporate accounting on a level playing field.
The principles assist in guaranteeing that financial transactions are reported fairly and truthfully.
GAAP provides the foundation for the methodologies and practices that the Financial Accounting Standards Board (FASB) certifies when collecting, analyzing, and public reporting a company's financial records.
When working with a publicly listed firm and its financial information in the United States, every accountant must follow 10 essential principles (or concepts) established in GAAP:
- Consistency
Throughout the reporting process, a consistent set of criteria is followed. - Sincerity
A dedication to being fair and accurate. - Regularity
A tight adherence to previously established norms and regulations (referring to the best practices published by the FASB). - Prudence
Reporting financial data does not influence the accountant's personal/professional conjecture. - Methods consistency
A consistent set of procedures is employed throughout the compilation of financial reports. - Non-compensation
A company's financial information is documented completely and properly; the accountant is not compensated for misrepresenting or skewing financial records. - Continuity
The value of a company's assets is based on the expectation that it will continue to function. - Materiality
All financial reports fairly disclose all essential aspects impacting the financial status of a firm. - Periodicity
A company's revenue is systematically split into previously specified standard accounting periods, such as fiscal years and fiscal quarters. - Good Faith
All parties participating in the accounting process (the corporation, record holders, and anybody who handles financial data) presumably act in good faith.
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