Difference between Positive & Normative Accounting Theory
Question
Task:Compare and Differentiate between Normative and Positive theories of Accounting.
Answer
Executive Summary: Positive theory of accounting explains many concepts that assist us clarify and anticipate the various accounting methods that firms and businesses have pursued. They tend to consider the occurrences taking place in society and incorporate them into accounting practices as per their translations. Whereas, normative accounting theories, utilised a model which is completely different from the positive theories of accounting. As per normative theory of accounting, the analysts would give an accounting approach to be pursued in this scenario based on the incidents that have took place. The positive accounting theory will significantly influence the company's response at moments when a unique accounting norm is implemented on the economy. The positive accounting principle can help illuminate the company's accounting practices.
Introduction: The positive theory of accounting offers an insight of the bookkeepers' illustrative behaviour. Whereas, in positive theory of accounting, the firm's administration tends to use the strategy of adopting accounting laws and norms that improves the company's likelihood of survival. For instance: The accounting practices that mitigate their contract expenses and increase their revenues would be chosen for the businesses involved in the contract accepting sector. Simultaneously, both of the above ideas provide the firm's administrators with an integrated versatility in selecting an accounting method that suits them best and is in their best interest.
The administrators' assumptions are revolving between the three theories
Debt covenant hypothesis: Businesses that are added probability of breaching the debt agreement are supposed to choose the bookkeeping rules that enable auditors to switch to the current cycle the financial return that the organization is projected to recognize. The firm will be spared from breaching the debt covenant in this situation.
Political cost hypothesis: There is a chance that certain financial risks are going to be faced by the firm based on the income they receive in the present year. Therefore, there may be a risk in these situations that the administrators will follow an accounting principle that will transfer the present financial year's income in coming years to save the forecasted political price. High income can also result in high taxation and often high restrictions. (Watts, 1990)
Bonus plan hypothesis: The firm's executives whose compensation is related to the company's earnings are inclined to use the accounting practices that support the company's accountants transfer the company's future income to the current cycle.
However, there is a more analytical aspect of the normative accounting principle. In this case, the strategy taken is not focused on the assumption described in the context, but by how the systems of accounting truly look like. In the normative accounting model, the analysts appear to stick to a few different philosophies which they find and, depending on the same methodology, attempt to reach any conclusion that can be guided to achieve a possible solution.
The normative theory can help shape both the consumer and the firm's economic outlook. As a consequence of this situational strategy, it was adopted in accounting. (Dent, 1990)
Accounting experts have presumed that the positive accounting theory in which accounting policies have been pursued for forming may not help to build and improve accounting methods. R. L. Watts and J. L. Zimmerman were some of the earliest bookkeeping specialists to collaborate and provide proof of positive accounting theory. In their article "Towards a Positive Theory of Accounting Standards," Ross L. Watts and Jerold L. Zimmerman tried to present the management's mind-set towards accounting principles. With the assistance of their paper, they provided the means that could be useful in explaining the forces that drive the procedure of assigning accounting standards in the present date. The firm's scale often influences their point of view on the norms was also obvious from the article published by the writers. They suggested the relationship that exists in both the firm's volume as well as the accounting standards-setting process. The researchers also outlined the anomalies that occurred in the accounting methods from their review project. We explored and evaluated the ideas behind the philosophy of the company, contractual value theory, and political cost, in connection to all of the above. The researchers believed that perhaps the consequence of the research work might change up accounting theory production. They showed the clear connection amid the flow of cash and the share value.
The writer used rationalism as the model for the work on this paper. Nevertheless, most scholars rejected the use of rationalism as their model. The accountants have a firm belief that examining the notion they have to their own practices is quite crucial to understand the individual. Factors affecting the wellbeing of management and their action on the use of the key tools were like administrative, income, political concern, etc. The major explanation for this distress is that we feel that distinguishing the cultural construct from the individuals in whom it occurs is not possible. Thus, indirectly, these considerations influence the method of determining the accounting standard.
The firm's management was using the positive accounting theory to select the accounting rules that appear to submit low return and at the same time improve performance by reporting high revenue. However, while the top executives' compensation or wage payment are related to the company's performance and results, they choose to choose the accounting method that will enable them shift the future gains to the present cycle. Under scenario of positive model of accounting, the firm's administration may be able to influence the accounting standards depending upon their own requirements and demand for the circumstance. (Whittington, 1987)
The researchers prefer to base their conclusions on certain premises at times when presenting the positive accounting principle. One of them was the user's interpretation of the concept. The researchers had only thought about the implications on partial users such as specified stakeholders, government and creditors of such implementation of accounting standards. There are many other entities that have been overlooked, such as staff, consumers, rivals, consultants. Each entity has a distinct effect on the company and have an effect on the outcome to pick an accounting norm.
The generalizations made in positive theory of accounting are primarily caused by self-regard, which may make it tough as one's interest isn't quite the same for another, making the situation a little worse. Therefore, all the measures taken by positive theory would push through the urge to increase capital which turned out to be bad enough, as with many other scholars. The supposition drawn in the approach is that an entity is led by of self-interested individuals forming a corporation in the collection.
The system of accounting chosen will be described on the basis of opportunistic and productivity claims in an event the company heads in for the positive accounting model. In addition, it was claimed that there were no factual data behind the positive accounting theory which makes it hard for all the researchers to validate the key reason behind the approach to be recognized by a broad spectrum. Furthermore, several concerns were drawn into the frame, but in terms of their enhancement there doesn't seem to be any major breakthrough.
The 3 key hypotheses developed underneath the positive accounting theory by Watts and Zimmerman (1978) are: the hypothesis of the bonus plan, debt/equity, and the hypothesis of political cost. Taking a look at the fundamental analysis for this hypothesis, it is obvious that all of these hypotheses are focused on self-interest.
Therefore, the firm's management could use the positive accounting principle approach for their own benefit. In that case, creating a platform that could be used to continually improve accounting practice becomes quite challenging as in positive theory of accounting, the practices are changed centred on company criteria.
On the other hand, in the case of normative accounting theory, the method used is completely different from the positive model of accounting. In the case with normative theory of accounting, specialists could offer an accounting approach to be implemented in this scenario based on the event that took place. It was claimed that "the normative accounting model ought to be the only concept to be used as an alternative." The accounting principles in normative model include the requisite guidelines that can be used to make the accounting policy segment suitable for administration. At the same time, the normative accounting principles could be used to offer guidance on existing policies that can be included in the same manner to diverge or strengthen it. The methodology to normative accounting principles that has been pursued is distinct from the positive theory of accounting. The normative model of accounting do not take into consideration, as to what is occurring in the company today, but premised around the conceptual values, they offer decision makers with recommendations on what needs to be changed. Relative to the positive accounting theory, normative accounting theories were deemed to be more empirical system. The strategies appear to be much more detailed in the case of normative theory but not in the case of positive accounting theory. For eg: all of the financial securities retained by the banks were taken into account in the same way until the economic crisis like we do in the case of real estate as well as other corporate assets. According to the reforms, there was no need to reprice the resources and there was no system to declare the present market price. After the economic crisis which occurred the accounting policies were altered and at periods of each disclosure statement the rules allowed the resources to be priced at marked-to-market. The resources were reassessed as a consequence of this strategy and the resulting unquantifiable capital gain was allocated to the ledger for profits and losses. This was seen as a substantial change that prompted a transition in the accounting system as a consequence of the idea being pushed. (Liguori, 2011)
Both principles of accounting reinforce one another; one's deficiency is supplemented by the other. Hence it is suggested that the positive model of accounting appears to be more realistic and makes choices centred on what is currently taking place, while normative theory of accounting are abstract in definition and aren’t influenced by day-to-day activities.
It is good to be realistic in theory to pick accounting methods in the today's market situation, but in actuality, the circumstances are not always the same. It is not possible to alter the accounting strategy and activities depending on the change in daily activities. Company management given the current scenario can't think about implementing changes in the strategy since it's likely that things could be different the next day and the situations require is the same strategy they've pursued before. Therefore, it becomes necessary in that situation to accept the logical solution as the same may not vary based on the shift in daily activities. (Mora, 2015).
It is necessary for the firm's management to take both into account, the normative along with the positive accounting theory to bring out an efficient financial plan. While there is a significant vested interest in the normative accounting reforms and the accounting professionals consider the financial policies centered on the normative accounts statements. However these opinions are based on the financial aspects of good accounting practices that we have observed. The procedures practiced in positive model of accounting could be utilised as a basis in normative model of accounting records.
Although, normative principle of accounting has its upsides, in some ways the same has been condemned. The normative principle of accounting is focused on some or the other assessment of quality which makes the situation a little different. Furthermore, there is no quantitative hypothesis testing in the normative accounting theory. (Schreuder, 1983).
Conclusion
In normative principles of accounting, the specialists could provide an accounting approach to be pursued in that particular scenario depending on the event that occurred. The positive accounting philosophy, however, pertains to the concepts that help one understand and forecast the accounting practices that firms and businesses have practiced in. Positive accounting theories usually consider the events taking place in the world and transform them into accounting methods as per their interpretation. The firm's management could utilise the theory of positive accounting for their own benefit. In such situations creating a platform that could be used to maintain and enhance accounting standards becomes very challenging as, in the case of positive accounting theory, the standards get adjusted based on company criteria. The normative theory of accounting offers the needed guidelines that can be used to make the accounting policy segment suitable for management. Simultaneously, the normative accounting principles can also be used to give guidance on existing regulations that could be utilised in the same manner to strengthen it. After analysing the above points, it is clear that the normative principle of accounting continues to be used to maintain and improve accounting methods. Though this can't be simply claimed that the normative theory of accounting is the only concept that is necessary, yet simultaneously we also need some insight into the positive theory to structure the normative accounting declarations. Normative accounting theory assignments are being prepared by our accounting assignment help experts from top universities which let us to provide you a reliable best assignment help service.
References
Dent, J. F. (1990). Strategy, organization and control: some possibilities for accounting research. Accounting, organizations and society, 15(1-2), 3-25.
Liguori, M. &. (2011). Accounting change: explaining the outcomes, interpreting the process. . Accounting, Auditing & Accountability Journal, 25(1), 27-70.
Mora, A. &. (2015). The implications of research on accounting conservatism for accounting standard setting. Accounting and Business Research, 45(5), 620-650.
Schreuder, H. (1983). Positively normative (accounting) theories.
Watts, R. L. (1978). Towards a positive theory of the determination of accounting standards. Accounting review, 112-134.
Watts, R. L. (1990). Positive accounting theory: a ten year perspective. Accounting review, 131-156.
Whittington, G. (1987). Positive accounting: A review article. Accounting and business research, 17(68), 327-336.
