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Proprietary and Entity Theory

The document discusses two main accounting theories: proprietary theory and entity theory. [1] Proprietary theory focuses on the owners' interests and views accounting as determining the owners' net worth, while entity theory views the firm as a separate entity from its owners. [2] Entity theory sees the firm having its own identity and operating for its own survival rather than the owners' interests. [3] Both theories influence accounting practices today, though entity theory forms the basis of conventional accounting standards.

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Regina Aurellia
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2K views

Proprietary and Entity Theory

The document discusses two main accounting theories: proprietary theory and entity theory. [1] Proprietary theory focuses on the owners' interests and views accounting as determining the owners' net worth, while entity theory views the firm as a separate entity from its owners. [2] Entity theory sees the firm having its own identity and operating for its own survival rather than the owners' interests. [3] Both theories influence accounting practices today, though entity theory forms the basis of conventional accounting standards.

Uploaded by

Regina Aurellia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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PROPRIETARY AND ENTITY THEORY

• Proprietary theory is based on the idea that the owner is the centre of attention
-accounting is done with the owners’ interests in mind
• Entity theory focuses on the firm as the centre of attention
PROPRIETARY THEORY

• Proprietorship = net worth of owners = capital


• P = A-L
• The objective of accounting is to determine the net worth of the owners
• Profit is the increase in net worth
 includes operating profit
 includes changes in the values of assets
PROPRIETARY THEORY

• Present accounting is largely based on this theory


 dividends
 salaries
 equity accounting
 consolidation accounting

• Has a financial view of capital


 emphasis on the financial investment of the owners and changes in owners’
wealth
PROPRIETARY THEORY

• With the advent of the company the theory has proved inadequate as a basis
for explaining company accounting
 developed when businesses were smaller
 a company is separate from its owners
 a company is a legal entity in its own right
 shareholders rely on managers for information
 no longer so relevant
ENTITY THEORY

• Martin outlined two assumption as the idea in accounting :


• 1. separation
• 2.Viewpoint.
ENTITY THEORY

• The company is viewed as a separate entity with its own identity


 separation of owners and managers
 accounting views the entity as an operating unit
 accounting principles and procedures not formulated in terms of an ownership
interest
 can also be applied in proprietorships, partnerships and not-for-profit
organisations
ENTITY THEORY

• The objective of accounting may be either stewardship or accountability


 entity seen as being in business for itself
 interested in its own survival
 sees owners as outsiders
 reports to owners to meet legal requirements and maintain good relationships
with them
2 VERSION OF ENTITY THEORY

• Traditional Version
• Newer Interpretation
ENTITY THEORY

• Focuses on the assets


• Assets are resources controlled by the entity
• Liabilities are obligations of the entity
• Profit increases net assets and accrues to the entity
• The owners only have a residual claim on the net assets of the entity
ENTITY THEORY

• Both proprietary and entity theories are still influential in practice


 entity theory
1. conventional accounting theory based on it
2. financial reports reflect it
 proprietary theory
1. interest charges are an expense
2. dividends are a distribution of profit
LIABILITIES DEFINED

• IASB Framework definition of liabilities:


A present obligation of the entity arising from past events, the settlement of
which is expected to result in an outflow from the entity of resources embodying
economic benefits
PRESENT OBLIGATION

• The actual sacrifices are yet to be made


• Obligation is already present
• Planned obligation included if to an external party
• Legal enforceability
• Settlement of liability in various ways
• Equitable and constructive obligations
PAST TRANSACTION

• A past transaction (or event) ensures that only present liabilities are recorded
and not future ones
• What kind of past transaction or event is acceptable?
wholly executory contracts
LIABILITY RECOGNITION

• Recognition criteria:
1. Reliance on the law
2. Determination of the economic substance of the event
3. ability to measure value of the liability
4. Using conservatism principle

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