Financial Accounting Theory and Analysis: Text and Cases, 11th Edition

In its simplest form, theory may be just a belief, but for a theory to be useful, it must have wide acceptance. Webster defined theory as:

Systematically organized knowledge, applicable in a relatively wide variety of circumstances; a system of assumptions, accepted principles and rules of procedure to analyze, predict or otherwise explain the nature of behavior of a specified set of phenomena.¹

The objective of theory is to explain and predict. Consequently, a basic goal of the theory of a particular discipline is to have a well-defined body of knowledge that has been systematically accumulated, organized, and verified well enough to provide a frame of reference for future actions.

Theories may be described as normative or positive. Normative theories explain what should be, whereas positive theories explain what is. Ideally, there should be no such distinction, because a well-developed and complete theory encompasses both what should be and what is.

The goal of accounting theory is to provide a set of principles and relationships that explains observed practices and predicts unobserved practices. That is, accounting theory should be able to explain why companies elect certain accounting methods over others and should enable users to predict the attributes of firms that elect various accounting methods. As in other disciplines, accounting theory should also be verifiable through ...