Accounting Theory

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LECTURE NOTES ACCOUNTING THEORY

THEORETICAL FRAMEWORK

Accounting theory

Accounting theory is the logical reasoning in the form of a set of broad principles that provide a
general frame of reference by which accounting practice can be evaluated as well as guide the
development of new practices and procedures. The function of the theory is to assist in the
resolution of practical problems. The existence of theory would mean that we could say and explain
why a given a number of assumptions method A is to be preferred to method B

REGULATORY FRAMEWORK

The accounting profession is regulated worldwide. In many countries it is regulated by a private


body, which is usually supported by the government.

In Kenya, the institute of Certified Public Accountants of Kenya (ICPAK) regulates the accounting
profession through the professional standards committee that issues the accounting standards.

In general any regulatory framework derives from several sources. These sources include:
1. Legislation
2. Accounting standards
3. Accounting principles and conventions (or policies)
4. Stock exchange rules

1. THE LEGISLATION
All companies incorporated in Kenya must comply with the requirements of the companies Act
(Cap 486), irrespective of their size. The act imposes a requirement for all companies to prepare
regular accounts and provides detailed rules on minimum information, which must be disclosed
on production of financial reports.

Section 147 of the Act states in part that “every company shall cause to be kept in the English
language proper books of account with respect to:

(a) All sums of money received and expended by the company and the matters in respect of
which the receipts and expenditure takes place.
(b) All sales and purchases of goods by the company
(c) The assets and liabilities of the company

Furthermore, a company must comply with the rules stipulated in the specific Acts under which it
is operating e.g. Banking Act for banking companies, Insurance Act for insurance companies,
Building societies Act for building societies etc.

The accounting obligation imposed upon companies is contained in section 149 of the companies
Act. Every company is required to prepare and submit the following financial statements to the
Registrar of Companies and the general body of shareholders:

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(a) Profit and loss account or statement of comprehensive incomes
(b) Statement of financial position

Subsection 1 of section 149 (Cap 486) goes on to state that, every balance sheet of a company must
give a true and fair view of the state of affairs of the company as at the end of its financial year
and every profit and loss account of a company must give a true and fair view of the profit or loss
for the financial year.

2. ACCOUNTING PRINCIPLES AND CONVENTIONS (POLICIES)

Accounting is the language of business. To make the language convey the same meaning to all
people, accountants all over the world have developed certain rules, procedures and conventions
which represent a consensus view by the profession of good accounting practices and procedures
and are generally referred to as General Accepted Accounting Principles (GAAP). Accounting
statements are prepared in conformity with these principles in order to place more reliance on
them.
Accounting Principles refer to the fundamental beliefs, guides to action and a settled ground or
basis of accounting conduct and practice.
3. STOCK EXCHANGE RULES
Where companies are listed on the stock exchange, they comply with additional requirements laid
down by the stock exchange. The rules require the provision of both greater and more frequent
information than that required by law e.g. those companies listed on the Nairobi securities
Exchange publish an interim report which contain minimum information. The interim report must
be circulated to shareholders or published in at least one newspaper.

4. INTERNATIONAL ACCOUNTING STANDARDS (IAS)

Introduction:
The law by its very nature is not dynamic. It will usually fall behind new ideas and developments
and will not always cover the technical aspects of financial reporting. Thus, in addition to the legal
stipulations, accounting practice is heavily influenced by the pronouncements issued by
professional accounting bodies in the form of accounting standards.

Companies not only need to meet the requirements of the law but must also comply with the
requirements detailed in these statements of Accounting Standards operating in their countries. In
Kenya, these standards were issued by the Institute of Certified Public Accountants of Kenya
(ICPAK) which is also a member of the International Accounting Standards Committee.

However, with effect from 1.1.1999, Kenya adopted International Accounting Standards issued by
the International Accounting Standards Committee.

Definition:
Accounting Standards are methods or approaches to preparing accounts which have been chosen
and established by the bodies overseeing the accounting profession.
They are essentially working rules established to guide accounting practice.

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These are rules, regulations and guidelines formulated and issued by accountancy regulatory
bodies i.e. International Accounting Standards Committee (IASC) in order to guide accountants in
the preparation of the financial statements. Examples includes IAS, ISA, IPSAS and IFRS.

The purpose of the standards is to reduce the number of acceptable alternative treatment of an
accounting issue and facilitate comparison in financial statements.

The Need for and objectives of Accounting Standards.


Financial statements can hardly be said to be useful if they are produced on numerous acceptable
basis. There is great need for uniformity. In an attempt to reduce the range of choice of acceptable
accounting principles, to improve the user’s confidence in the accounting figures and make
accounting reports more understandable it was deemed necessary to introduce accounting
standards.

The prime objective of accounting standards is to improve the quality and uniformity of reporting
and introduce a definitive approach to the concept of what is true and fair.
Benefits of the Standards

1. Uniformity
The standards promote the harmonization of the information presented in the financial statements
since all accountants prepare such financial statements under the guidance of the IAS.

2. Quality
The standards promotes the quality of the information presented in the financial statements . They
normally takes a lengthy procedure to be formulated which involves a thorough discussion of all
the issues related .The outcome is therefore said to be fairly balanced.

3. Saves time
It is easier and faster to check up in the standards for the best treatment of a problematic issue.
Standards provide reference to the accountants and it therefore reduces the research and reference
time. The financial statements can therefore be prepared and presented to the users in good time.

4. Growth in Accountancy Methodology


The formulation of the standards brings in innovation in accountancy methodology. This is
because the standards are introduced and revised each and every time to take into account the
current accounting needs and practices. This promotes the growth of accountancy as a field.

5. Objectivity
Standards eliminate personal subjectivity to the preparation and presentation of the financial
statements. i.e. the same interpretation and conclusion of the financial statements will be arrived
at by different users or persons.

6. Guidance of accounting practice


Standards are basically rules and guidelines which in essence guides the accounting practice.

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Formulation of the Standards.

This takes a lengthy procedure which involves several stages that ensures the interest of all
interested and affected parties and their views are incorporated in the process. The following
procedure is normally adopted in the formulation of the IAS.

1. Formation of a steering committee


2. Identification and review of all accounting issues associated with the topic of discussion.
3. Receipt of comments from the board and all interested parties
4. Review of the comments received from the board.
5. Preparation of an exposure draft.
6. Preparation of the final draft/ IAS
1. Formation of steering committee
The IASC board sets up a steering committee chaired by the board representative. The committee
includes at least three representatives of accountancy bodies in at least three countries. It may also
include representatives of other organizations that are represented on the board. These may also
be experts in the particular topic. The purpose of the committee is to spearhead the whole process
of standard development.

2. Identification and review of all accounting issues associated with the topic.
The committee considers the application of the IAS committee’s framework for all the preparation
and presentation of the financial statements to those accounting policies. The committee also
studies the national and regional accounting requirements and practices that may be appropriate in
different circumstances. It then presents its findings to the board.

3. Receipt of comments from the board and all interested Parties


After submitting its findings to the board, the steering committee then receives comments from
the board and all interested parties. The committee then prepares and publishes a draft statement
of principles out of which the accounting principles that will form the basis for the preparation of
the exposure draft is developed. It also indicates the alternative solutions considered and the
reasons for their recommendations and rejections. The comments are invited from all interested
parties during a three months exposure period.

4. Review of comments received


The committee then reviews the comments on the draft statement of principles and agrees on the
final statement of principles which is submitted to the board for approval. The statement is availed
to the members of the public on request but it is not formally published.

5. Preparation of an Exposure Draft


The committee then prepares an exposure draft for approval by the board after revisions if any and
with the approval of at least two thirds of the board members. After approval the exposure draft is
published and comments are again invited from all interested parties for a period of 1-3 months.

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6. Preparation of the final draft/IAS
After review of the comments from all the interested parties a draft standard is prepared for review
by the board. After final adjustments if any and with the approval of at least three quarters of the
members, the final draft is published and becomes applicable or operational.

Advantages of Accounting Standards


1. They provide the accounting profession with useful working rules.
2. They force improvement in the quality of the work of accountants.
3. They strengthen the accountant’s resistance against pressure from directors to use an
accounting policy which may be inappropriate in the circumstances.
4. They ensure that users of financial statements get more complete and clearer information
on a consistent basis from period to period.
5. They assist in the comparison users may make between the financial statements of one
organization and another.
6. They provide a focal point for debate and discussion about accounting practice.
7. They are a less rigid alternative to enforcing conformity by means of legislation.

Disadvantages of Accounting Standards


1. They are bureaucratic and lead to rigidity. The quality of the work of accountants is
restricted since firms and industries differ and change as do environments within which
they operate.
2. The official acceptance of accounting standards reduces the accountant’s power to resist
the use of accounting applications of inappropriate standard when the directors wish to
follow it.
3. They reduce the scope for profession judgment of accountants. Accountants are thus
reduced to technicians rather than being professionals.
4. Most users of financial reports are made to believe that financial statements produced using
accounting standards are infallible. This is misleading.
5. They have been derived through social or political pressure which may reduce the freedom
or lead to the manipulated of the profession.
6. They inhibit the development of critical though i.e. why think when the standards are there?
7. The more standards there are the more costly the financial statements are to produce.

Application of Accounting Standards in Kenya


They are intended for application to all financial statements issued by public companies,
parastatals companies and organizations including: co-operative societies, sole proprietorships,
partnerships, non-trading concerns, estates and trusts and other business entities reporting to the
public.
Government ministries apply international standards referred to as International Public Sector
Accounting Standards.

Have the accounting standards improved the usefulness of accounting information?

(a) They make financial statements more understandable by requiring increasing disclosure of
accounting policies.

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(b) They are not objective because there is no universally agreed theory of accounting and a
universally conceptual frame work of accounting.
(c) They have improved comparability as they call for consistency and disclosure of the effect
of any deviation from the existing practice or standards.
(d) They help financial statements to be more complete as they call for the production of such
additional figures as those in the cash flow statements, of changes in equity and notes to
the financial statements.
(e) They make information more relevant but some standards are said to make financial
statements less relevant.
(f) They improve reliability of financial statements.
(g) There is now greater consistency in the application of accounting concepts and policies.
(h) They have not improved timeliness of accounting reports and may in fact have largely
contributed to the late production of reports.
(i) They have been criticized by writers as introducing bias into accounts and therefore should
not be regarded as a desired characteristic of financial reports.
(j) They in fact call for extra information and therefore result in extra cost.

On the whole, accounting standard setting is an attempt to improve the reporting system and
generally, the standards have improved the quality of financial reports.

Problems encountered in the global harmonization of the standards

1. Different legal systems


Different countries or regions practice different legal systems with different legal requirements.
The legal requirements may at times conflict with the requirements of the standards making it
difficult to effectively apply the standards.

2. Different user groups


Different countries have different opinions about the users of the account i.e. the target group of
the financial statements. The requirements of the users may not all be catered for by the IAS.

3. Needs of developing countries


Developing countries have peculiar needs to their circumstances which are not usually catered for
by the standards.

4. Nationalism
Most countries are reluctant to adopt the standards developed by other countries purely because of
nationalism i.e. they consider themselves superior and therefore should set the pace and others
follow.

5. Cultural and Political differences


Political and cultural differences among countries will limit the harmonization of the standards
due to poor relation between the countries.

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Reasons for change from Kenya Accounting Standards (KAS) to International Accounting
Standard (IAS)

1. National flow of income


Foreign countries started establishing their local branches in Kenya. This necessitated the
harmonization of the accounting practices.

2. Wide application of IAS.


IAS gained wide acceptance and Kenya felt to lag behind if did not adopt the IAS.

3. Regional pressure
Kenya being a regional player felt the need to harmonize its accounting practice since most of the
countries with in the region were adopting the IAS.

4. Resource scarcity to develop own KAS.


Standards are expensive to develop and Kenya felt to save the scarce resources available to
interpret the already developed standards.

5. Need for objectivity and Uniformity


Due to the need to harmonize the financial statements Kenya had to adopt the IAS.

REGULATORY BODIES IN KENYA


THE ACCOUNTING PROFESSION IN KENYA

The accounting profession in Kenya began formation when the government established the Kenya
Accountants and Secretaries National Examinations Board (KASNEB) in 1969 to conduct local
examinations for candidates interested in joining the accounting profession. Subsequent
developments culminated in enactment of the Accountants Act (CAP 531) in 1977, forming the
legal framework within which the profession now operates. The following is an outline of the
framework in order in which the pillars came into existence.

1. Kenya Accountants and Secretaries National Examinations Board (KASNEB)


The Kenya Government set it up in 1969. The board conducts examinations in three successive
stages, each containing two sections. The sections are broken down into examination papers that
run from 1 through 18. The certificate of CPA is awarded on passing CPA Part III. When a
candidate has passed all the 18 papers and has been awarded the final accountancy certificate one
becomes eligible for registration as an accountant. However, candidates who wish to take the CPA
examinations must first register as student’s event through the board does not offer any tuition.

Functions of KASNEB
Sec. 17(1) of the Accountants Act, 2008 (Acts No. 15, 2008) of the laws of Kenya defines the
functions of KASNEB. These functions are:
(a) To prepare syllabuses for professional and technician examinations in accountancy,
company secretarial practice and related disciplines.
(b) To make rules with respect to such examinations.

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(c) To arrange and conduct examinations and issue certificates who have satisfied examination
requirements;
(d) To promote recognition of its examinations in foreign countries;
(e) To investigate and determine cases involving indiscipline by students registered with the
Examination Board.
(f) To promote and carry out research relating to its examinations;
(g) To promote the publication of books and other materials relevant to its examinations
(h) To liaise with the Ministry of Education in accreditation of institutions offering training in
subjects examinable by the Examinations Board and;
(i) To do anything incidental or conducive to the performance of any of the preceding
functions.

Aims and Objectives of the Examinations of KASNEB


The aims and objectives of the examinations of KASNEB are to produce:
(a) Competent professionals with the ability to analyze and advice on matters relating to
investments and securities.
(b) Qualified accounts and auditors with competency to present financial in oral and written
forms.
(c) Qualified corporate secretaries capable of advising matters relating to corporate secretarial
practice governance and ethics.
(d) Information communication technology professionals who are capable of designing,
developing, implementing and maintaining modern information systems.
(e) Competent professionals who are able to make sound decisions in credit management.
(f) Qualified managers with the ability to make sound managerial decisions.
(g) Professionals who uphold high ethical standards and professional values in the discharge
of their duties.
(h) Professionals who are creative, innovative and able to communicate effectively and adopt
to the dynamic business environment.

2. Registration of Accounting Board (RAB)


It was formed in 1977 under the Accountants Act CAP 531. The major task of the board is the
registration of accountants and the issuance of practicing certificates. In order to be registered,
those who consider themselves qualified apply for registration by completing a prescribed form.
The form asks for personal details e.g. approved qualifications, to enable the board to reach a
decision whether or not to register the applicant.

3. Institute of Certified Public Accountants of Kenya (ICPAK)


It was formed in 1978. On being registered, an accountant becomes eligible for membership in
the institute. Active membership however, is maintained by the annual payment of prescribed fee.
It is assumed that all registered accountants are active of the institute.

According to Section 7 of CAP 531, the functions of this institute are:


(a) To promote standards of professionals competence and practice amongst members of the
institute;
(b) To promote research into the subject of accountancy and finance, and related matters, and
the publication of books, periodicals, journals and articles in connection herein;

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(c) To promote the international recognition of the institute;
(d) To advise the examinations board on matters relating to examination standards and
policies;
(e) To carry out any other functions prescribed for it under any other written law and;
(f) To do anything incidental or conducive to the performance of any of the preceding
functions.

Conceptual Framework.

There are many ways to explain a conceptual framework. It can be any or all of the following:

 A set of coherent ideas or concepts organized in a manner that makes them


easy to communicate to others.
 A set of assumptions, values, and definitions under which we all work together
The framework sets out the concepts that underlie the preparation of financial statements for
external users.
The document covers the following:-
i. The objective(s) of financial statements, including details of the relevant user groups,
their information needs and the financial statements (and their underlying assumptions)
required to meet those needs.
ii. The qualitative characteristics that make financial statements of value to users, e.g.
relevance, reliability etc.
iii. The elements of financial statements and how these elements interact to form a basis
on which financial statements could present information in a structured manner, this
includes definitions for assets, liabilities and equity interest.
iv. The criteria that an item should attain if it is to be recognized and therefore
incorporated, in financial statements.
v. Details of how elements of financial statements should be valued and measured.
vi. The discussion of the various possible concepts of capital and capital maintenance.
Advantages of a conceptual framework of accounting.
i. It assists the IASB in the development of new accounting standards and in the review of
existing ones.
ii. The IASB has a base when attempting to reduce the number of alternative accounting
treatments permitted by an accounting standard.
iii. Prepares of financial statements have some guidance in dealing with topics and transactions
that do not form the subject of an accounting standard.
iv. Assistance is given to auditors in forming an opinion on whether or not financial statements
comply with accounting standards.
v. Users of financial statements may find it easier to interpret the information contained in
financial statement prepared in conformity with accounting standards.
vi. It provides those who are interested in the work of the IASB, with information about
approach to the formulation of accounting standards.

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