Lecture: Miss Mariati bt NorHashim
Summary Normative Accounting Theory by Md. Humayun Kadir*
This summary reviews Normative Accounting Theory by Md. Humayun Kadir* thats show five important works on normative accounting theory – MacNeal (1939), Paton and Littleton (1940), Litteton (1953), Chambers(1966), and Ijiri(1975) – with emphasis on recognition and measurement issues in accounting. It shows that there is a lack of agreement among these theorists on basic assumptions and hypothesized information needs of the users. Even where there is agreement on an assumption, different implications have been drawn therefrom by the concerned theorist. These differences lead to diffrent recognition and measurement proposals.
The concept its using is a revolutionary. His work contains a vehement attack against the present accounting practice. He thinks that the function of accounting is to report economic truth. But financial statements, he argues, do not present truth.They are misleading to the investors and creditors. In particular, he says that the historical cost principle and the conservatism convention prevent financial statements from presenting true financial position and the operating results of the firm.
MacNeal evaluates three justifications offered in favor of the cost principles. 1. The cost represents the value of a fixed asset to a going concern, called ‘the going value’ theory. 2. Second, it is impractical and expensive to revalue assets every year. 3. And even if revaluations of fixed assets were done every year that would not provide significant information to the users.
He employs a deductive model. MacNeal claims that managers, creditors and stockholders want to know the present net worth of the entity. Creditors need this information because this helps them assess the probability of being repaid. Stockholders need this information because this helps them compare the possessions of their company with those of other companies whose stock they may intend to buy. Managers, creditors and stockholders are also interested in having information regarding all of the profits/losses made by the entity. Financial statements can serve these information needs well if they report present economic values. By economic values, he means market prices established through the free play of demand and supply in a market that is free and competitive, and sufficiently broad and active.
He also says that historical cost should be used only in the case of nonmarketable and nonreproducible assets. For MacNeal, it is an irony that the resulting total asset figure in the balance sheet would not make any meaningful sense since the total asset figure would be a curious mixture of market prices, replacement costs, and historical costs. MacNeal suggests that depreciation be calculated on the present economic value of assets, rather than on their historical costs. He also defines depreciation as the loss in value of assets due to physical wear and tear. And for if the depreciation is defined as the loss in value due to physical wear and tear, it could, and should, be measured by direct reference to the market price of used asset if such price is available. It is to be noted that in that case appreciation might have to be recorded instead of depreciation. This is because the market price of used assets might exceed the original cost of the asset. It is also to be noted that MacNeal does not allocate the market price of an asset fully as depreciation expense over its life. Its changes in market prices of assets are decomposed into depreciation expense, capital profits and capital losses.And the sum of depreciation expense,capital profits and capital losses over the whole life of an asset equal its historical cost.
MacNeal says that income statement would can be include both realized and unrealized current and capital profits and losses.He suggests a form of income...