Acc Theory Q1

1. What is positive accounting theory? How does it differ from normative accounting theory? What was/were the major dissatisfaction(s) with normative accounting theory which led to the development of a positive theory of accounting? Positive accounting theory is concerned with explaining and predicting current accounting practices. This means that the focus is on understanding and explaining the techniques and methods that accountants currently use and why we have ended up with the conventional historical cost accounting system. This approach can be compared with normative accounting theories, which dismiss conventional historical cost accounting as being meaningless or notdecision-useful, and which prescribe the use of more ‘useful’ systems of accounting (usually) based on inflation adjustments. One technique that can be used to show students the different approaches is to contrast the assumptions used by each theory as follows:

Objective of accounting

Normative Decision making

Positive Stewardship relationship

or

agency

Behavioural assumptions

Functional fixation or fooled by Rational economic man, able to cosmetic accounting analyse and distinguish

Economic assumptions

Little comment on historical Financial reports are an costs economic commodity. Information has a price.

Semantic assumptions

Accounting serves measurement role.

Pragmatic assumptions

Accounting is neutral/unbiased.

a Measurement role is secondary function monitoring and bonding.

a to

Accounting is a political economic or social commodity.

The dissatisfactions with normative accounting are:  To be normative, one must specify an objective function — for example, efficiency, decision usefulness, estimation of future share prices, improved quality of financial reports. However, many of the above objectives are conflicting, and it is difficult to decide which one is a superior objective. It should be noted that the definition of an objective of accounting continues to be a contentious issue. (Note that the objective is usually defined in a very broad, non-specific manner.) Popper also makes the point that no amount of empirical testing can prove or disprove the validity of normative accounting prescriptions — they are irrefutable — therefore they are weak hypotheses.  There was usually no attempt to justify — empirically — that the prescriptions from normative theories are ‘better’ than the status quo. For example, the redefinition of the objective of financial accounting from the traditional stewardship role into a decision-making role (usually to aid investors) was never justified by empirical research.

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Before condemning the usefulness of conventional accounting as a decision-making tool, it would be more scientific to analyse and compare the decision-making processes induced by conventional accounting and the proposed alternatives. Part of this research would encompass whether cosmetic manipulations fooled market participants and the role that financial accounting played in economic decision making. Normative inflation models have been widely known in the literature for over 30 years, and have not been readily accepted by the marketplace. Positive theories sought to obtain a rational explanation for the status quo. This leads positivists to attempt to model the connection between financial accounting, firms and markets in a rational economic framework, rather than to take the stance of normative theorists who dismissed current practice and took a prescriptive attitude.