THEORY
OF
ACCOUNTING
CHAPTER OUTCOMES
 Meaning of Government & Non-Profit
Organization
 Theoretical Concepts of Accounting
DIFFERENCES BETWEEN GOVERNMENT &
NON - PROFIT ORGANIZATIONS VS.
BUSINESSES
 Serve entirely different purposes.
 Govt. & Non-Profit organizations are generally financed by
taxpayers, donors, and others who do not expect to receive
proportional benefits.
 Govt. &Non-Profit organizations focus on benefits/services
while businesses focus on revenues/profits.
Accounting is a service activity. Its function is to
provide quantitative information, primarily financial
in nature, about economic entities that is intended to
be useful in making economic decisions, in making
reasoned choices among courses of actions.
TYPES OF GOVERNMENTS
 General purpose governments
– States, counties, municipalities
– Police and fire protection, sanitation, streets, roads,
bridges, etc.
 Special purpose governments
– Provide only single function or a limited number of
functions
– School districts, public colleges and universities, public
utilities
NONPROFIT ORGANIZATIONS
 Exist in many forms and serve many functions
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Private colleges and universities
Various kinds of health care organizations/hospitals
Professional and trade organizations
Fraternal and social organizations
Religious organizations
Foundations
THEORETICAL CONCEPTS OF
ACCOUNTING
 Theoretical concepts of accounting: self-evident
statements that portray the nature of accounting
entities operating in a free economy characterized by
private ownership of property.
 The Proprietary Theory
 The Entity Theory
 The Fund Theory
THEORETICAL CONCEPTS
Proprietary Theory
 The proprietary theory adapts best to sole proprietorship and
partnership , though corporations are also influenced by this
theory to some extent.
 Proprietor group as the center of interest which accounting
records are kept and financial statement are prepared.
 Directed to serve the owners and maximize their profits.
 Proprietary Theory
 Is the determination and analysis of the proprietor’s net
worth
 Accounting equation is ;
ASSETS-LIABILITIES=PROPRIETOR’S (owners)
EQUITY
 More assets center and balance sheet oriented.
 Net income (Revenue – Expenses ) is the change in
owners’ equity during a given period.
 Limitations: The development of nature of business
and laws
 Entity Theory
 The entity theory adapts best to Cooperation's.
 Entity is separate and different from those who provide
capital
 Business unit owns the resources of the enterprise and is
liable to claim of the owner and the creditors.
 Directed to serve the shareholders and creditors , to maximize
their profits.
 Two versions of the entity theory:
 Traditional view: the business firm operates for the benefit of the
equityholders, those who provide funds for the entity.
 New interpretation: the entity is seen as in business for itself and
interested in its own survival.
 Entity Theory
 Net income dose not belong to the proprietor (owners) , but
to the entity.
 Accounting equation is;
 ASSETS= EQUITIES
 ASSETS=LIABILITIES + STOCKHOLDER’S EQUITY
Fund theory:
 Basis of accounting, neither the proprietor nor the entity as
separate person, is on group of assets and related obligations
and restrictions.
 Business (accounting) unit as consisting of economic
resources (funds) and related obligations/restrictions
regarding the use of the resources.
Equation: Assets = Restrictions on Assets
The broad concept of fund theory introduce the
cash flow statement.
NEED FOR PUBLIC ACCOUNTABILITY
• To help stakeholders assess
– How public resources are acquired and used
– Whether current resources were sufficient to meet
current service costs
– Whether some costs were shifted to future
taxpayers
– Whether the government's ability to provide
services improved or deteriorated
FINANCIAL REPORTING OBJECTIVES FOR
STATE AND LOCAL GOVERNMENT
• Financial reporting is used in making economic, social, and
political decisions and in assessing accountability primarily by
– Comparing actual financial results with the legally adopted
budget
– Assessing financial condition and results of operations
– Assisting in determining compliance with finance-related
laws, rules, and regulations
– Assisting in evaluating efficiency and effectiveness
FINANCIAL REPORTING OBJECTIVES
FOR CENTRAL GOVERNMENT
• Financial reporting should help to achieve
accountability and is intended to assist report users in
evaluating:
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Budgetary integrity
Operating performance
Stewardship
Adequacy of systems and controls
FINANCIAL REPORTING OBJECTIVES
FOR NONPROFIT ORGANIZATIONS
• Financial reporting should provide information useful
in:
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Making resource allocation decisions
Assessing services and ability to provide services
Assessing management to care of project and performance
Assessing economic resources, obligations, net resources
and changes in them