Difference between positive accounting theory and normative accounting theory?
In finance, accounting is considered as its language. It provides a standardized system to the managers and investors regarding the company’s transparency, informativeness and consistency. The report presents an analysis over the difference between the positive accounting policies and normative accounting policies (Griff, 2014).
The provided report describes about the positive accounting theory and normative accounting theory. The emphasis of the report is on the difference between positive accounting theory and normative accounting theory. The positive accounting theory emphasizes on the behavior of accountants (Wolk, Dodd & Rozycki, 2012).
Positive accounting theory is more of a qualitative concept, it answers about the expected assessment and objective outcomes. In the view of economics, positive analysis deals with the logic and their empirical evidence. It can be understood as what is and what might be; it does not analyse about what is good or bad or right or wrong. Positive theory is based on logical research; the reason behind this is it makes an analysis over the accepted rules of evidence and logics which are of both quantitative as well as qualitative nature (Whittington, 2007).
While in case of normative accounting policy, it provides a value judgment that is not scientific in nature. Therefore the judgments formed by the normative accounting policy are not capable of proving the right or wrong, the reason behind this is it lacks the facts, logic and evidence. Besides this, the judgments can differ from manager to manager and situation to situation, hence it is a significant problem for the managers and accountants that the accounting policies or the judgments given by normative accounting policies cannot be universally applied (Idowu & Louche, 2011).
It has been observed that on macro level or large scale in the organization, the economists prefer use of normative accounting theory; however this normative accounting theory should be based on the positive accounting theory practices. The reason behind this is, the findings made by the positive accounting theory lays as a foundation for the normative accounting theory, as it presents a realistic aspects for how an organization can earn profits (Belal, 2012).
The positive accounting theory has been introduced by Ball and Brown in 1968. They have made an investigation over the accounting earnings and information system in the financial system and return over the stock to find out the usefulness of accounting information in the financial statements of the company. The positive accounting theory is developed from efficient market hypothesis. According to efficient market hypothesis, it has been assumed that the market is perfect, and there would be no transaction cost. Another view of efficient market hypothesis claims that the capital market would present all the information which is available to public (Mourik, 2013).
It has been analyzed by the researcher that the positive accounting policy and normative accounting policy should be applied together. The reason behind this was that it was observed by the researchers according to the study conducted in 1996 by Majone that these both accounting policies are complementing in nature; that is one weakness is overcome by the other accounting policy. Hence it said that by combining the both accounting policies the success in the organization can be ensured (Chattfeild & Vangermeersch, 2014).
In case of normative accounting theory it describes the ways that a manager or the accountant or the researcher should adopt under particular circumstances. It describes about what a financial accounting should be; that is which instrument can be considered as assets and liabilities and how it should be measured. The measures on which the normative theory is based are not real, hence the management or the accountant do not prefer such theory. However normative accounting theory is considered as goal oriented theory and a realistic approach is followed. Here realistic approach is not in the form of as what the accounting policy, rather what the accounting policy should be (Jones, 2015).
By above research analysis, it has been analyzed that the positive accounting theory describes, predict and explain about what is happening currently in the financial market. The theory is based on inductive method. This theory initiates at the level where the different accounting practices adopted by various companies. This leads to increasing the logical analysis so to make the management and accountants capable of making predictions over the different accounting standards or accounting practices that are adopted by the different firms. In case of positive accounting theory the firms are allowed to choose from the optional practices (Songini, Pistoni & Herzig, 2013).
While in case of normative accounting theory, it does not provides any predictions over the practices that can be adopted by the company. As this theory only provides the standards or practices that are acceptable by the companies. This theory uses deductive method to arrive at suggestible accounting standards and practices. However similar practices are adopted in case of inductive method, but normative accounting theory comes up with new suggestions (Edwards, 2014).
In positive accounting theory, the academics and professionals are of the view the company as the total of the contracts. It is the assumption of the positive accounting theory that to achieve the success efficiency plays a considerable role. Hence it means that to by minimizing the cost of the business, the success of the business can be ensured as reduced cost will result into creation of various opportunities.
It has been analyzed that the positive accounting theory, considers real world transactions and events. It examines that how the company will account for such events in its financial statements and would provide consequences of the accounting decisions. With the help of this framework the management of the company can account for transactions and events that can arise in future (Du, 2012).
The positive accounting theory is based on objectives, facts and figures. This theory emphasis over economic statistics and data at hand and at end making conclusion on the basis of statistics, facts and figures. It can be understood by quoting an example that is corporate growth makes the company able to pay dividend at higher rates as compare to previously paid dividend rates. In this case, the positive accounting theory, it would be said as due to increase in the corporate growth the rise in corporate dividend is seen. It has been observed that most of the accounting practices such as data collection and book keeping involves positive economic theory (CTI reviews, 2016).
While in case of Normative accounting, it follows a different approach as compare to Positive accounting theory. In case of positive accounting theory the management accounts real world transactions and events, while in case of normative accounting, the accounting policy makers tells about what should be done. Normative accounting theory is a deductive process of positive accounting theory. The reason behind deducing process is that the normative accounting theory start from the theory and arrives at the specific policies. A positive start with some specific policies leads to higher level principles in the organization. The normative accounting theory is more of prescriptive theory rather than of descriptive theory, the reason behind this is it does explain about what should be the accounting policies (Bull, 2014).
Normative accounting theory describes about what would be future of the company in economic terms. This is the reason the normative accounting theory is a descriptive theory which provides majorly judgments. It can be understood by quoting an example that is increase in dividend payments would lead to use of some of the funds to improve corporate sustainability measures. In case of normative accounting, it would be said as how much dividend should be paid so to maintain the corporate growth.
Following are the advantages and disadvantages of positive and normative accounting theory. This can be understood by quoting an example; in case of positive accounting theory the bank would do accounting of financial securities in such a way that the bank lead to hide the changes in material which were necessary for the banking operations. Because the change was considerable for the management of finance for the company, hence by hiding the material changes leads to present inaccurate representation of financial position.
The positive accounting theory is considered as relevant accounting theory, the reason behind this is it leads to explain and predict the suitable accounting practices that the management and accountants of the company should adopt by relying over the facts, figures and standards. This leads to increase in the reliability of the accounting measures and predictions which ensures success of the organization (Emerald group publishing limited, 2015).
While in case of normative accounting, it describes the method of accounting to be followed in a particular situation. In this, accounting is done as per contract signed between the principle and the agent. That is if in the contract it is signed that the revenue or expense would be recognized as immediately, lump sum in the future period of time and incrementing the sum over the time. On the basis of contract conditions, the management of the company would record the transactions. Normative accounting theory describes about the policies should be adopted hence, it is considered as goal oriented theory.
Normative accounting theory is considered as significant because the business decisions differ from industry to industry. In case of financial sector, some of the firms require adopting different accounting policies; this is the reason they have to adopt various challenges for modern business. Besides this, it has been analyzed that the normative accounting theory is the difference between the different accounting standard and practices that are adopted by the company, and at last it describes about the ways in which one method is preferred over the other method and practices. Furthermore, it has been analyzed that normative accounting theory seek to understand the current practices and methods and make the management and accountants able to make difference between the different practices. This is the reason that makes the normative theory as more of prescriptive theory (Rao, 2006).
By analyzing the above two theories it is said that they both complement each other, that is weakness of one method is offset by the use of another set. That is in case of normative accounting theory it prefers to use the current data while in case of positive accounting theory it majorly relies upon the past data of the company and the financial market. It has also been observed that the positive accounting theory is a practical approach; it considers as what is happening in the organization and financial market. While in case of normative approach, it is more of theoretical approach, as it answers the accounting method that need to be followed for day to day practices. The management follows accounting policies in such a manner that it is a mixture of practical and principle approach (Mourik, 2013).
By analyzing over the report it has been analyzed that the in case of positive accounting theory, it focuses upon explaining and predicting the current accounting practices that are adopted by the company. For example it describes about the reasons of adopting the historical accounting system rather than the policies which could be opt by the management.
While in case of normative accounting theory, the accountants and the managers has to provide their opinions on the basis of deductive logics, subjective approach and inductive method. This is the reason that normative accounting theory fails in the reality aspects because it fails to meet the reality aspects.
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Bull, R, J,. (2014) Accounting in business, Butterworth Heinemann, United Kingdom
Chattfeild, M & Vangermeersch, R,. (2014) The history of accounting (RLE accounting): an international encyclopedia, Routledge, United Kingdom
CTI reviews,. (2016) Financial accounting theory and analysis, text and cases, Cram101 textbook reviews
Du, W,. (2012) Informatics and management science I, Springer science & Business media, United Kingdom
Edwards, J,R,. (2014) Twentieth century accounting thinkers (RLE accounting), Routledge, United Kingdom
Emerald group publishing limited., (2015) New perspectives in accounting ethics, Emerald group publishing, United Kingdom
Griff, M,. (2014) Professional accounting essays and assignments, Lulu Press, United States
Idowu, S, O & Louche, C,. (2011) Theory and practice of corporate social responsibility, Springer science & Business media, Belgium
Jones, S,. (2015) The routledge companion to financial accounting theory, Routledge, United Kingdom
Mourik, C, V,. (2013) The Routledge companion to accounting, reporting and regulation, Routledge, United Kingdom
Mourik, C, V,. (2013) The routledge companion to accounting, reporting and regulation, Routledge, United Kingdom
Rao, P, M,. (2006) Accounting theory and standards, Deep and Deep publications, India
Songini, L. Pistoni, A & Herzig, C,. (2013) Accounting and control for sustainability, Emerald group publishing, United Kingdom
Whittington, G,. (2007) Profitability, accounting theory and methodology: the selected essays of Geoffrey Whittington, Routledge, United Kingdom
Wolk, H, I. Dodd, J, L & Rozycki, J, J,. (2012) Accounting theory: conceptual issues in a political and economic environment, SAGE, USA
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