Assignment task: The two main theoretical approaches in accounting theory are the normative approach and the positive approach. The two alternative approaches would generally be appropriate to...

Positive and Normative approach in Accounting
Introduction
Positive and normative approaches are two
oad approached in accounting theory. Positive accounting theory is based on facts and defined numbers. This theory does analysis of available data, prepare reports and statistical analysis.. Such practices are generally used for analyzing past data. They are widely used for explaining the performance of a business. Financial statements are generally prepared based on positive accounting practices.
Normative accounting theory is subjective in nature. It explains what the future should be. It is based on judgment. It analysis future events and the theory is based on how an accounting process should be followed. It utilizes several approaches and decides one opinion. It is based on value and not on cost. It is considered appropriate for predicting future transactions and setting future policies and procedures. Marketing and budget plans are prepared using normative accounting approach. These reflect what business wants to achieve.
Literature and Review - Positive and Normative Theories
Research has been ca
ied out on area of accounting for around 100 years by countless researchers and is subject to many arguments. A Research that predicts and explains particular phenomenon are called positive research and related theories as positive theories. A positive theory begins with assumptions and logical deduction enabling some prediction to be made. Positive theories are developed with some form of logical reasoning. Success of a theory is determined by measuring and comparing the theory predictions and projections as against the actual facts and numbers. The closer the actuals are with projections, the more successful the theory would be considered. Positive Accounting Theory has been developed by Watts and Zimmerman, which explains why a particular accounting method has been given preference over other methods. The theory was undertaken in the field of economics and underlying factor for the development of the theory was acceptance of ‘rational economic person assumption’. It means that an accountant is motivated by self-interest and the success of method would be dependent on certain factors. Financial activities that are adhered to and for the purpose of accounting them in the books of accounts, positive accounting theory is generally used. Positive accounting is associated with contractual view of the firm. Firm is considered as a ‘nexus of contracts’ and accounting as one tool to help performance of contracts. Accounting practices mitigate contracting costs with the establishment of ex-ante agreement amount various parties. The contractual view puts it under tension and values relevance studies in accounting. It is contended that primary role of accounting is to value the firm and hence concepts like conservatism are sub-optimal. Value relevance emphasizes on usefulness of accounting information as against usefulness in contracting exercises. The major point in positive approach to accounting is to detail, explain and predict management’s standards by analysis of cost and benefits of a financial disclosure in relation to individuals and in relation to economy when allocation of resources is considered. Revenue actually earned and costs actually incu
ed are compared to understand whether a firm is making profits or incu
ing losses. If it is making losses, appropriate accounting policies and processes can be developed to improve the situation. Various parts of financial statements such as Balance Sheet, profit and loss statement, cash flows, etc. are based on positive accounting practices. The positive theory of accounting is based on proposition that managers, shareholders, regulators and politicians are rational and they intend to maximize their benefits which has a direct link to their perks, salary, and compensation and thereby to their wealth. An accounting policy is chosen after examining the benefits and cost involved in it. The choice of an accounting policy rests on comparison of costs and alternative accounting procedures and the result is taken forward in such a way so as to maximize their benefits. For example, it is hypothesized that management considers the effect of reported numbers on tax matters, management’s compensation, political costs, information product costs, etc. Similarly, hypotheses can also be related to academicians, standard – setters, auditors, etc. The crux of the discussion is that positive approach is used to develop hypotheses on factors that have an influence over the accounting practices and to test the validity of these hypotheses. Basically there are three hypotheses of positive accounting theory:
1. Bonus plan Hypotheses - This hypotheses state that managers try to take such actions which will result in showing cu
ent period’s earning to be on higher side. They choose such procedures that shift earnings from future periods to cu
ent period. This helps in increasing their part of the bonus.
2. Debt hypotheses - According to debt hypotheses, managers tend to show better profits to show a better performance picture and liquidity position to pay interest and principal of the debt accumulated in the business. Managers select accounting processes and procedures that shift earnings from future to cu
ent period. With the increase in cu
ent year’s earnings, chances of company violating debt covenants gets remote and management is able to minimize the constraints for running the business.
3. Political cost hypotheses - Political cost hypotheses assumes that firms show lower profits by adherence to different accounting policies and procedures so that they are saved from the eyes of politicians who generally keep a watch on profitable industries. This is done to escape from the sight of the government and prevent from adherence to high regulation requirements. Accounting policies that helps in defe
ing cu
ent period earnings to future period are adhered to for meeting such objectives.2
Positive theories assume that stock price is dependent on cash flows. Hence, in an efficient market, two firms with similar cash flows are value in the same way in spite of use of different accounting processes and procedures. The center of the problem is to determine how accounting procedures affect cash flows. The efficiency perspective is taken into positive accounting where researchers have explained how managers around the world have chosen accounting methods that gives a true and fair presentation of the company’s performance. With this, it is also stated that accounting policies and practices are explained for the purpose of showing true image of financial performance of the company.1
The primary objective of accounting is...