POSITIVE ACCOUNTING THEORY: APPROACH & COMPARATIVE STUDY BETWEEN POSITIVE AND NORMATIVE THEORY (SM40)

Introduction:

Accounting theory provides some specific rules and regulations for accounting work. On the basis of the structured norms different accounting activities are done. It refers to the application of accounting principles. Theory in respect to ‘Accounting’ makes a guideline for upgrading existing practices and helps to implement some new framework. In this study numerous accounting theories and their implications are discussed. Considering the influence of accounting theory in accounting practices the essay is focused on different aspects of accounting. The ultimate objective of accounting theory is to make focus on a set of fundamental truth. Actually accounting theory reveals some financial incidents which are highlighted in the statements of accounting. ‘Positive’ and ‘Normative’ theory is highlighted here. It exerts the economic relationship among different business enterprises. Accounting theory is involved in continuous improvement and assessment processes of some consistent practices. All facts are not clarified by theory but it helps to generate a systematic way to make different books of accounts.

Discussions:

The accounting theory shows reality. Selection of right theory completely depends on the standards of interventions and procedures. Management requires some essential information for some specific strategy making process (Glover, 2014). Different parties like the government, shareholders, and creditors’ need information in respect to the performance of the organization on the basis of which they will take their decision. These aims can be fulfilled by following a set of principles. This is why the concept of accounting theory has come to provide some certain rules. As per specifications, all business enterprise will continue their bookkeeping work. For formulating theory some approaches are also needed to be considered because nothing is the universal truth in this business world. The Same concept is considered in different countries in different aspects (Ambrosanio & Bordignon, 2015). So numerous approaches are implemented regarding accounting theory. In the modern globalized business world to eliminate the national barriers for understanding accounting statements common rules are framed. These rules are worldwide accepted. Different approaches of accounting theory are explained below.

Ethical Aspect of Accounting tells about unbiased work, fairness, and truthfulness. This aspect of accounting highlights the following:

·         Giving equal priority to all the parties related to the enterprise.

·         Reporting of financial activity in an organization will true.i.e it will exert the correct picture regarding the business performance.

·         Ensuring the accounting information, which is shown in statements, is having no partiality.

·         Avoiding the duplicity or any error in the data.

All the stakeholders are having equal right to collect information with respect to the performance of the company. If there is an unsatisfactory level of performance, the shareholder will want to quit their investment from the company (Weinzierl, 2014). The government imposes the tax on the company earnings. Any business organization is liable to pay the certain rate of tax and must comply with the government norms. So, it can be stated that equal priority is essential. Transactions regarding financial activities which are shown in the books must be correct information which will indicate the transparency of the business. Besides the information highlighted in the statements must be impartial i.e. it no one can get a special benefit from the data. The main thing of presentation is avoiding the errors in accounting as far as possible (Gaffikin & Aitken, 2014).

Pragmatic aspect of accounting considers the real world facts and always makes an emphasis on the reality of any incidents. In terms of function, this theory is having great implications. Under this approach, interventions are adopted as per utility of methods. In order to make continuity and consistency, this theory is having a great importance. Practices of accounting are retained as useful if that provides a productive outcome. In this way pragmatic approach reveals some rules of maintaining books of accounts (Christensen, Nikoloev & Wittenberg, 2016). Accounting methods are considered as per applicability. Sometimes the theory is called ‘General Law Approach’. However, the concept is having some constraints. In the modern dynamic business world, sometimes common practices do not provide any remarkable outcome. A unique method is important to adopt to get the desired result very easily. This is the main disadvantage of pragmatic approach to accounting. Adoption of useful technique is another problem of this approach. Usefulness is interpreted by numerous parties in a different manner. So, analysis must be different in order to protect the interest of all the related parties (Dyckman & Zeff, 2014).

Inductive approach makes emphasis on the observations. According to the correct observation process ultimate decision is formed. Observations must be adopted in such a way so that outcome is positive. Here, in the process of making observation work, impartial and unbiased mindset is important (Hui & Yeung, 2012). On the basis of meaningful action theories are formulated properly. The primary benefit of this aspect of accounting is no pre-specified rule or guidelines are not needed, as per observation result, strategy is formulated. The procedure of this approach includes sales, purchase, accounting ratios etc. These are different parts of analyzing financial books. If any data is found repetitive then one decision can be taken based on this data. Numeric figures of financial performance of different business organisations are taken into the consideration. The main limitation of this concept is differences in the raw data provided by the company with actual figures (Santos, 2012).

Deductive approach of accounting is more effective than the inductive approach. It reveals the development of new intervention on the basis of prevailed ones. It follows some assumptions, made from existing theory. Here rules are formulated considering hypothesis and testing method. The approach is having some specific features which are required to make out correctly; otherwise right decision cannot be taken (Eisenhardt, Graebner & Sonenshein, 2016).

Positive accounting theory has become very important for last few years. It is mainly developed by Watts and Zimmerman. Three main hypothesis of this theory are bonus plan, debt and political cost hypothesis. In this theory different philosophies are considered to make the implication of accounting theory concrete. Before implementation of positive theory, normative theory is followed in accounting. Research work on PAT has been started from 1960. Different assumptions are considered in positive accounting theory. In this respect two approaches are very much essential i.e. “Efficient Market Hypothesis”, which is developed by ‘ Fama’ and “Capital Asset Pricing Model”, implemented by ‘Sharpe’ and ‘Linter’. Efficient market hypothesis model shows the competition of data. As per the theory there are lots of sources of collecting information regarding business enterprise. Information can be gathered from anyone or following all the alternative sources. CAPM model and the efficient market hypothesis both says that market cannot be changed with the change of accounting. This reveals changes in cash generation and no changes in cash generation. Positive theory has enhanced to understand different accounting incidents and different issues. It makes a bridge among Return on investment, numbers of accounting and financial reporting. It reveals the condition in which management of an organization can manage the revenue. CAPM model is the well accepted method by which cost of investment in equity can be identified. It is most effective technique because systematic and unsystematic both risks are considered here. In Spite of that PAT is having a major constraint regarding its methodology. Here methodology is used to make research regarding generation revenue management. Besides the PAT theory is having environmental drawbacks.

The positive accounting theory is having lots of popularity. It is a well accepted theory. The key point of wide range success of this theory is making an empirical relationship. Basically, it provides the descriptive data in respect to the nature of the professional accountants.  This theory provides a scientific level in accounting. This theory is specific and analytical. Different vital aspects of finance and economics are considered in this model (Francis, Hasan & Wu, 2013).

On the other hand, the normative theory of accounting does not focus on observation. It makes emphasis on the value derived from income. Cost is not the important part of this process. Here many experts provide their opinions in respect to inductive and deductive approach. Normative theorists believe in informal evidence. This theory requires some basis of measuring the result. The normative process is primarily a deductive approach based theory. As for example, going value theory shows the cost of the service value of an asset to the proprietor during the purchase of the asset. Potentiality of the service cannot be changed if the change does not occur in physical condition. Therefore, fixed assets are needed to exert at cost price. This is not agreed by the normative theory. In this theory, value means economic value of assets (Miller & Power, 2013). So, market price consideration is an essential part of financial statement preparation. The economic value is calculated by supply and demand position in the market. Cost is not crucial area of consideration because it represents the economic value at the time of purchasing the asset. In addition to inductive and the deductive approach, one another approach is considered here i.e. decision usefulness method. Conceptual framework of accounting is a good example of normative theory. It gives some guidelines in respect to the evaluation of assets, income, liabilities etc. This theory highlights the drastic change rather than observation process (Chatfield & Vangarmeersch, 2014). Before implementing positive theory, the normative theory was accepted accounting theory. So comparing to the first one it can be said that normative theory is an older approach.

After making a descriptive analysis of ‘Positive' and ‘Normative' theory of accounting, if the comparative study is made then fundamental differences can be identified. The two sides of accounting work from different perspectives.

·         PAT is based on observation process on the contrary observation is not an essential element of normative theory.

·         As the positive theory is a scientific model it does not influence their perception of others. On the other hand, normative model makes focus on the own view and that is implemented. In case of PAT expected applications of a specific action is considered.

·         Positive accounting concept does not make emphasis on the prescriptions. But the normative concept is having an argument regarding this. This theory supports the prescriptions.

·         A positive approach is not value free because it focuses on the action of human being. Some experts opine that the assumption is negative. In contrast, normative experts demand their theory is free from limitations which are having in positive theory. They have strongly made an argument in respect to the term ‘Value-Free'.

·         Positive accounting tools are important to evaluate past financial incidents. Normative methods are used to estimate the future economic policy. For identifying the reasons of loss positive accounting techniques are most appropriate. On the contrary, normative interventions are utilized mainly for strategy making process.

·         ‘Positive’ accounting theory is primarily objective based and ‘Normative’ accounting theory is subjective.

·         In the positive theory of accounting, a company is viewed as complete of contracts. It is because the company is dictating business. Only efficiency and effectiveness can make the company successful. On the other hand, the normative system gives advice the policy makers based on principles.

·         Normative theory is having more focus on deductive procedures. If PAT is compared to the NAT then it can be said that it is having less deductive procedures than normative theory.

As the normative theory is essential for future estimation, it is very much important to consider in formulating accounting standards. Accounting standards reveal some specific rules and regulations on the basis of which financial events are judged. Positive method is related to past event. So, it is not so important like normative approach (Dedman, Kausar & Lennox, 2014).

Conclusion:

In case making correct financial planning, both ‘Positive' and ‘Normative' theories are essential. Economic experts consider normative technique of accounting in making financial planning. But, normative accounting based statements need some realities and for this, the positive theory is very much essential. So, it can be said that both the theories are interrelated. Positive accounting tools provide a base to the business organization for normative accounting and give a transparent view of procedures of running a business in an efficient and effective manner when an enterprise is earning good revenue. Both the theories provide us information to know the view of the interpretation of accounting transactions. Two theories are really appreciable and acceptable equally all over the world.