If it is to be comprehensible and reliable, accounting must be used in accordance with specific rules and regulations. It would be chaos of Babylonian proportions if each person used his own grammar and vocabulary – nobody would understand anybody else. Likewise, it is essential that accounting is used according to generally accepted rules.
The first prerequisite is that accounting should agree or conform with the basic truths according to which our economic system functions; the current economic and business practices and the applicable law as embodied in legislative regulations or common law. Consequently, it is important that uniformity is maintained in accounting practice; in other words, a specific set of circumstances, wherever it may be encountered must be dealt with by everyone in exactly the same way within the accounting process.
Accounting theory creates a framework that ensures that accounting practice complies with the requirements of conformity and uniformity. This theory is embodied in a set of principles, policies, methods, procedures and conventions. The continuously increasing scope and complexity of our economic system requires a corresponding process of adaptation in accounting in order that the relevant information regarding economic activities may be recorded. It is essential that everyone involved in accounting should understand this process of adaptation; moreover, a prerequisite for such understanding is a grasp of not only the theory of accounting, but also the structure of that theory.
Accounting theory is based on a set of basic economic truths that are of a dual nature. First, accounting theory is based on propositions generally accepted in the economic order of a particular society. For example, consider the concept of personal ownership: a general accepted tenet of our society is the exclusive right of every person to own things – they are his personal property and no one else’s. This concept is a basic economic truth.
Second, the basic economic truths have characteristics similar to those of natural laws in the sense that specific causes generate specific consequences. If, for example, someone derives greater value from a transaction than what was put into the transaction, his net worth – his wealth – will have increased by the surplus amount. This, too, is a basic economic truth. These economic truths are formulated as concepts and postulates. A concept is a generally accepted view of a specific phenomenon, which is described in specific terms. A postulate is a generally accepted hypothesis or supposition of a specific condition or phenomenon, which serves as a basis for the formulation of principles.
In the development of accounting theory, concepts and postulates serve as formulations of the basic truths or propositions upon which the theory is based. They do not attempt to prescribe the working of the accounting process, but simply the foundation upon which the structure of accountancy is based.
