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Accounting Theories And Its Types

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Question:

Discuss about the Accounting Theories and its Types.
 
 

Answer:

Introduction

This study deals with discussing on accounting theories and its types. In this particular assignment, proper emphasis has been given on understanding the difference between positive accounting theory and normative accounting assumption (Watts and Zimmerman 2016). Accounting is the language of economics that gives managers as well as investors a consistent system so that they can present the assets of their corporation in a way where it should be transparent, informative and consistent at the same time. Positive and normative accounting is the theories that actually help in creating system for investors as well as managers so that they can use these theories in recent times (Balakrishnan, Watts and Zuo 2016). Accounting systems are the consequence of carefully constructed applications that consist of theories that will help in finding the best from other economically accurate method for representing the performance of a company. Economics is both science and art. For instance, an investor views at the financial data for determining the most financially stable as well as attractive stocks that they desire to purchase. Addition to that, the money invested in the company comes as a statement regarding what products or services and investor find within the stipulated time. Therefore, the dichotomy in economies explains the ideals of both positive as well as normative accounting (Scott 2016).

Positive Accounting Theory

As rightly put forward by Jones (2015), Positive accounting theory examines the real life occurrences as well as finds ways for understanding the concept and then predicts how companies address the accounting treatment for those types of transactions. Addition to that, the hypothesis looks at the genuine real world comprising of dealings and proceedings that help in examining how companies accounts for those proceedings and seek to comprehend the financial consequences of those secretarial decisions (Balakrishnan, Watts and Zuo 2016). This theory tries to predict by using the knowledge of how companies will companies will account for dealings as well as actions in the near future. Positive accounting presumption as well as accounting practices are objective and based on facts. This type of accounting focus mainly on analyzing the economic statistics as well as data as it derive at conclusions based on the given figures (Raj and Roy 2016).

Three Hypothesis of Positive Accounting Theory

There are three theory of positive accounting hypothesis where prediction is organized in definite form. The three hypotheses are as under with proper justification:

  • Bonus Plan Hypothesis- Managers of business firms with bonus plans selects secretarial events that can shift reported earnings from the prospect periods to the present time. It has been done by the managers so that they can increase their bonuses for the recent year (Hendriksen 2016).
  • Debt Covenant Hypothesis- The closer a firm is to violate the accounting-based debt covenants; manager of the firm selects accounting procedures by shifting the reported income from the prospect periods to the present period. It means increase the present earnings where the corporation will violate the debt covenants as well as management need to minimize the constraints for smooth functioning of business organization (Balakrishnan, Watts and Zuo 2016).
  • Political cost hypothesis- It depends upon the superior the political costs faced by the form where the managers selects secretarial procedures that defer reported earnings from present to prospect periods (Gaffikin 2016).

How to achieve Positive Accounting Theory

  • Positive accounting theory can be achieved by varying the accounting policies (Balakrishnan, Watts and Zuo 2016)
  • Positive accounting theory can be achieved by supervision the discretionary accruals
  • Positive accounting theory can be achieved by adopting new secretarial standards (Christensen, Nikolaev and Wittenberg?Moerman 2016)
  • Positive accounting theory can be achieved by altering the real variables such as advertising, repairs & preservation and research & development (Dutta and Patatoukas 2016)
  • Positive accounting theory can be achieved by capitalizing operating expenses in the most appropriate way.

Normative Accounting Theory

According to Deegan (2013), normative theory of accounting is a deductive process after comparing it with positive accounting theory. Addition to that, normative starts with the theory as well as deuces to exact policies when constructive start with given policies and simplify to the higher-level philosophy. Addition to that, normative accounting practices is one of the form of value judgment where it introduces subjective morality into accounting. Normative theory executes the accounting process where it derives the value based income as well as undertaking the different approaches in the most appropriate way (Balakrishnan, Watts and Zuo 2016).

 

Difference between Positive accounting theory and Normative accounting theory

Positive Accounting Theory

Normative Accounting Theory

Positive theories are descriptive, predictive or explanatory (Balakrishnan, Watts and Zuo 2016)

Normative theories are prescriptive

Positive accounting theory is an example from the positive theory of accounting that explains and predicts the accounting practice (Christensen and Demski 2012)

Normative accounting theory shows true income of a single measurement used for assets and an unique and correct profit figure (Christensen, Nikolaev and Wittenberg?Moerman 2016)

Grounded in economic theory

Normative theory help in decision-making process when the basic purpose of accounting is to aid the decision-making process of specified users that is presented through accounting reports in way to provide useful accounting data (Christensen, Nikolaev and Wittenberg?Moerman 2016)

Advantages

Focus on maintaining relationships between individuals that are involved in rendering resources for an organization and are known as agency relationship (Balakrishnan, Watts and Zuo 2016). This relationship will be between :

Owners and managers

Managers and debt providers

Advantages

Normative accounting theory is subjective as well as aims at describing what the financial prospect should be for a corporation or an shareholder (Bonin 2013)

When to use:

Positive accounting theory can be best used for explaining the past financial events and the causes of a business or individual current financial standing (Christensen, Nikolaev and Wittenberg?Moerman 2016)

This theory will help in determining the reason as to why a corporation is operating at a net loss and there is a need for implementing of positive accounting practices after comparing actual revenue to actual expenses for a given year

This type of theory can be typically used for constructing financial documents like balance sheet as well as cash flow statements.

When to use:

Normative accounting theory can be best used at the time for setting the future economic policy based on the given theory (Balakrishnan, Watts and Zuo 2016).

Mission statement or market strategies of a given company can be included in the business plans that can be further viewed in the normative statements.

It is thereby noted that the normative statements reflects the business ideals where any company wants to accomplish within the specified time (Beattie 2014)

Working together

Proper financial planning for any trade organization or in that case individual requires both positive and normative accounting theory (Christensen, Nikolaev and Wittenberg?Moerman 2016). The factual-based practices of positive accounting theory mainly explains underpinning for companies that engages in normative accounting as well as more unrealistic vision on how corporation operates and still earns profits from their operations. Addition to that, on a large scale, economists are of the opinion that financial policies can be used through normative accounting statements but in actual the normative accounting statements are based on the financial realities that is generated from positive accounting policies (Balakrishnan, Watts and Zuo 2016).

Example:

If corporate growth allows a company for increasing the shareholder dividends over the previous dividend payments, then the theory on positive accounting will conclude that corporate growth actually causes a rise in the stakeholder dividends. Therefore, most of the bookkeeping as well as data collection align with accounting and positive economic theory (Avelé 2014).

Example:

If a company increases its dividend payment, then they make use of funds for improving the corporate sustainability measures. This is where normative accounting theory is used as it indicates how much money should be invested in those measures for sustaining the corporate growth (Balakrishnan, Watts and Zuo 2016).

Therefore, Normative accounting hypothesis deals with the prospect events rather than past information and that is difference from the positive accounting practices as the theory takes into account the past data (Christensen, Nikolaev and Wittenberg?Moerman 2016).

Conclusion

At the end of the study, it is concluded that both the accounting theories are important depending upon the situation the company faces. Positive accounting hypothesis tries in making good predictions in the actual world proceedings as well as translates into specific accounting transactions. Normative theories, on the other hand, tend to recommend what should be done. The above study clearly defines both the theories, its advantages that give proper insights of information that when these theories should be used by managers and investors. Differences are mentioned in the study because that will help in understanding the fact where theories are used at the time of collecting financial information. Normative theory expresses a decision regarding circumstances that is desirable or undesirable and based upon customary that is feasible. Positive accounting theory, on the other hand, expresses estimation on a situation that actually contains no suggestion of endorsement or displeasure and not based on an average.

 

References

Avelé, D., 2014. Positive accounting theory: theoretical and critical perspectives. International Journal of Critical Accounting, 6(4), pp.396-415.

Balakrishnan, K., Watts, R. and Zuo, L., 2016. The effect of accounting conservatism on corporate investment during the global financial crisis. Journal of Business Finance & Accounting, 43(5-6), pp.513-542.

Beattie, V., 2014. Accounting narratives and the narrative turn in accounting research: Issues, theory, methodology, methods and a research framework. The British Accounting Review, 46(2), pp.111-134.

Bonin, H., 2013. Generational accounting: theory and application. Springer Science & Business Media.

Christensen, H.B., Nikolaev, V.V. and Wittenberg?Moerman, R., 2016. Accounting information in financial contracting: The incomplete contract theory perspective. Journal of Accounting Research, 54(2), pp.397-435.

Christensen, J.A. and Demski, J., 2012. Accounting theory. Irwin/McGraw-Hill.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

Dutta, S. and Patatoukas, P.N., 2016. Identifying Conditional Conservatism in Financial Accounting Data: Theory and Evidence. The Accounting Review.

Gaffikin, M.J., 2016. A Brief Historical Appreciation of Accounting Theory? But Who Cares?. In Pioneers of Critical Accounting (pp. 109-142). Palgrave Macmillan UK.

Hendriksen, E.S., 2016. Accounting theory. McGraw-Hill/Irwin.

Jones, S.., 2015. The Routledge companion to financial accounting theory. Routledge.

Raj, S.K. and Roy, S., 2016. Accounting Theory: An Ethical Perspective of Real Life Scenarios. International Journal of Business and Social Research, 6(10), pp.47-55.

Scott, W.R., 2016. Financial accounting theory (Vol. 2, No. 0, p. 0). Upper Saddle River, NJ: Prentice hall.

Watts, R.L. and Zimmerman, J.L., 2016. Positive accounting theory: a ten year perspective. Accounting review, pp.131-156.

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