Chapter 5:

Postulates, Principles and Concepts

Accounting Research
Studies: 1 and 3
Basic concepts of
postulates and
principles that underlie
historical costing
Equity theories of
accounting
Postulates, Principles and Concepts
Postulates are
basic assumptions that can not be verified
sometimes called axioms in formal logical systems
Principles are
rules that empirically tested can become laws
general approaches used in the recognition and
measurement of accounting events
Concepts
are generic ideas generalized from particular instances
are not part of the formal theory formulation
Accounting Research Studies 1& 3
Were not accepted
Were milestones in the
attempt to provide a
unified theoretical
underpinning for
financial accounting
rules by the APB
The Basic Postulates of Accounting (ARS 1)

Postulates stemming
from the economic
and political
environment
Postulates stemming
from the field of
accounting itself
The imperatives
ARS 1’s Release
Profession responded
with silence
Profession awaited the
appearance of the
broad principles study
(ARS 3)
A Tentative Set of Broad Accounting
Principles for Business Enterprises (ARS 3)
Basic postulates of
accounting developed
in ARS 1 are integral
parts of ARS 3
Accounting draws its
real strength from its
neutrality as among
demands of competing
special interests
Eight Principles Developed in ARS 3:

Any rule or procedure Changes in resources

which assigns profit to should be classified
a portion of a business among the amounts
activity should be attributable to
continuously re- Price-level changes
examined to determine Changes in
the extent to which it replacement cost
introduces bias into Sale or transfer
reporting Other causes
Eight Principles Developed in ARS 3:

All assets should be Asset measurement is a

recorded in the accounts problem of future services
and reported in the Determine if future services
financial statements actually exist
Existence of an asset is Estimate the quantity of
independent of the means services
by which it was acquired Choose a pricing method
Whether obtained by that considers
investments by owners, • Past exchange price
creditors, or others • Current exchange
(replacement) cost
• A future exchange price
Eight Principles Developed in ARS 3:
All liabilities should be In a corporation
recorded in the accounts stockholders’ equity
and reported in the should be classified into
financial statements Invested capital
Liabilities which call for Retained earnings
settlement in goods or Statement of the results of
services should be operations should give
measured by their agreed sufficient detail to allow
to selling price analyses and comparisons
Cash settlements should be Revenues
measured using NPV Expenses
Use terms discount and Gains & Losses
premium
ARS 3 Criticisms

At least three of the Lack of additivity of

principles dealt with assets values
the problems of
changing prices; cause A set of postulates
for profession should be complete
rejection enough to allow no
Principle of revenue conflicting
recognition not conclusions to be
reasoned from any of derived from them
the postulates
Failure of ARS 1 & 3
Lack of rigor in reasoning
Little attention given to the politics of rule making
(the process)
Moonitz-Sprouse were commissioned to find
those postulates and principles that would lead to a
”true income”
We now know that this concept of a single superior
income does not exist
Inability of profession to abandon historical costs
Postulates & Principles
Postulates are basic assumptions that can not be
verified
Principles are general approaches used in the
recognition and measurement of accounting events
ARS 7 reasons that principles are postulates derived
from ”experience and reason” that have proved useful
Principles are postulates that have been successful in
practice
Historical Costing Underpinnings
Postulates Input-Oriented Principles
Going Concern Rules of Operation
• Recognition
Time Period • Matching
Accounting Entity Constraining Principles
Monetary Unit • Conservation
• Disclosure
• Materiality
• Objectivity
Output-Oriented Principles
Applicable to users:
Comparability
Applicable to Preparers:
Consistency & Uniformity
Historical Costing Postulates
Going Concern
Unless there is evidence to the contrary, it is assumed
the firm will continue indefinitely
Reporting of liquidation values is in violation of the
postulate
Time Period
Creates definite time segments out of what is a
continuing process
For business entities this time period is the business
year
Historical Costing Postulates
Accounting Entity
The business entity is separate from its owners
Monetary Unit
Financial statements are expressed in terms of
money
The monetary unit is stable
Historical Costing Principles-Input
Rules of Operation
Revenue recognition is
• the output of goods/services
• not dependent on the flow of cash or other assets
Matching is
• the recognition of expenses with the revenues
generated by the expenses
• not dependent on the flow of cash
Historical Costing Principles-Input
Constraining Principles
Conservation
• slower revenue recognition,
• faster expense recognition,
• lower asset valuation,
• higher liability valuation
Disclosure
• Relevant financial information both inside and outside the financial
statements
Materiality
• The importance of an item to users when making decisions
Objectivity
• The degree of consensus among measurers
Historical Costing Principles-Output
Output-Oriented Principles
Applicable to Users
• Comparability: the degree of reliability users should
find in financial statements when evaluating
financial condition
Applicable to Preparers
• Consistency: refers to use of same accounting
methods over time
• Uniformity: refers to similar accounting treatments
in similar situations
Equity Theories of Accounting
Proprietary Theory
Entity Theory
Residual Theory
Fund Theory
Commander Theory
5 Equity Theories of Accounting
Proprietary Theory Residual Equity
Assumes owners and Theory
the firm are virtually
Residual equity holders
identical
are that group of
SA – SL = SOE
claimants whose rights
Entity Theory are superseded by all
The firm and the other claimants
owners are separate SA – SSpecific Equity =
beings RE
SAssets = SEquities
5 Equity Theories of Accounting
Fund Theory Commander Theory
Assumes a group of Commander is a
assets and related synonym for
obligations devoted to management
a particular purpose Assumes the manager
SAssets = transposes the
SRestrictions of Assets commander view to the
investor
Chapter 5:
Postulates, Principles and Concepts
Accounting Research
Studies: 1 and 3
Basic concepts of
postulates and
principles that underlie
historical costing
Equity theories of
accounting