Positive vs Normative Accounting Theory

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TOPIC: Discuss positive accounting theory and contrast it with normative accounting theory. Provide examples where
appropriate.
 
 

The purpose of this essay is to provide an overview of positive accounting theory (PAT) and highlight how this theory differs to normative accounting theory. Definitions and assumptions of both theories will be considered and examples of the theories will be provided. In addition specific theories related to PAT namely agency and the efficient market hypothesis will be

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the essay and then 
highlights the direction 
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EVERYTHING only 
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elaborated.

Positive accounting theory is concerned with explaining and predicting current accounting practices (Watts and Zimmerman, 1986). There is a focus on understanding and explaining the techniques and methods that accountants currently use for example why the conventional historic cost accounting system is the primary measurement system applied today. Unlike normative theory, positive theory is designed to explore current

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main topic area, new 
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mean a new 
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accounting practice not to prescribe or advise which methods should be used.

Normative

accounting

theories

dismiss

conventional

historic

cost

accounting as being meaningless or not decision useful and prescribe the use of more ‘useful’ systems of accounting mostly based on inflation adjustments.

One of the issues which became the focus of some

normative theorists is how to derive the ‘true income’ (profit).

Positive accounting theory had its origins in the late 1950’s and arose out of the dissatisfaction with normative theories. For example there are many conflicting objectives of normative theory including economic efficiency, decision usefulness, predicting future share price, improved quality of Page 1 of 3 

 

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sentence of each 
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lead into the next 
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financial reports. Deciding the importance of these objectives is problematic and in fact the definition of the objective of accounting has always been defined in very broad terms. Normative prescriptions are difficult to empirically test unlike positive theories that observe real world practice and positive hypotheses are falsifiable.

Positivists 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.

The underlying assumption of positive accounting theory is that individuals are considered to be self-interested wealth maximisers and will act opportunistically to increase their wealth.

This assumption is limited in

that the notions of loyalty or morality are not considered.

Positive

accounting theory has its roots in agency theory and theories of the efficient market hypothesis (EMH).

The primary objective of positive accounting theory is to focus on the relationships between various individuals and how accounting is used to assist in the functioning of these relationships. In particular, the fulfilment of the stewardship function and the agency relationships between owners and managers, managers and the firm’s debt providers. This contrasts with the objective of normative accounting which focuses on the notion of decision usefulness. The separation of ownership and control of firms gives rise to agency relationships.

An agency relationship is defined by Jensen and Meckling...
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