Positive or Normative Accounting Theories †Free Samples for Students

Question: Discuss about the Positive or Normative Accounting Theories. Answer: Introduction Theaccounting systems used by business organizations for preparing and disclosing their financial reports are developed through the application of theoretical concepts that have helped in developing most appropriate method for depicting an organizational performance. Theaccounting theories have been utilized in developing a standardized system that can be used for presentation of financial information to the stakeholders of a business entity (Whittington, 2007). In this context, the present essay discusses the contribution of PositiveAccounting Theory (PAT) and normativeaccounting theory (NAT) in development of accounting policies used for preparation of financial reports. The report also undertakes examination of the factors that led to the development of PAT accounting policy choice. The report also presents a discussion relating to the application of normative or positive theories in developing of accounting standards by providing the justification of the choice selected. Difference between (PAT) and normative accounting theory (NAT) and the factors that led to the development of PAT accounting policy choice The positive accounting theory (PAT) was developed by Watts and Zimmerman in 1970s to provide an explanation of the reality of accounting practices. The theory seeks to provide an explanation of the accounting choices of the firms through examining the real world situations. The theory examines the real transactions happening in the world for gaining an understanding of the accounting practices of the businesses. The theory since its establishment was believed to be based on the principle of economics and thus regarded to be appropriate for providing an explanation to the practical accounting problems. The theoretical concepts of the PAT model are utilized by the companies in preparing financial documents such as balance sheet or cash flow statements. Thus, the theory was believed to provide an adequate explanation of economic consequences of the accounting choices made by the business firms (Ghanbari et al., 2016). The theory emphasizes on examining the economic statistics for deriving a valid conclusion based on the data collected and analyzed. The theory seeks to provide an explanation to the past, current and future financial events through the application of real world practices. For example, the theory is used for gaining an understanding of the net loss occurring in a company through comparing the actual revenue to actual expenses on an annual basis. Also, the theory proves to be effective in gaining an understanding of the increase in shareholder dividend by a company at the end of a financial year due to its increased growth and profitability. The theory by proving an explanation of the past and current financial situations of a company tries to predict its accounting practices in the future context (Petitt et al., 2014). On the other hand, Normative Accounting Theory (NAT) is purely subjective and is mainly used for providing value judgment for resolving a complex accounting issue. The value judgment provided by the normative accounting theories is mainly based on the ground of morality and ethics. The theory of NAT undertakes a different approach as compared to PAT model as it intends to provide suggestions to the accountants on the basis of theoretical principle and does not integrate the application of real world accounting practices. As such, the model of NAT finds application in accounting context at the time of establishing future economic policies such as developing mission statement or marketing strategies. Thus, it can be said that the concept advocated by normative accounting practices are mainly used at the time of developing the aims and objectives that a company want to achieve in the future period of time. For example, the theory of NAT is mainly used for indicating the amount of money to be invested by a company for enhancing its business growth (Wolk et al., 2008). The main difference between NAT and PAT model is on the basis of different approaches used at the time of their development. The normative accounting theory adopt a deductive approach in providing an explanation to the accounting practices as it initiates with a theoretical principle and deduces to the development of specific policies. On the contrary, PAT model adopts inductive approach that initiates with application of specific policies and then reaching to the generalization of higher-level principles. The theory of positive accounting is very practical and hence is mainly used for achieving the practical based aims and objectives of accounting researches. However, the theory of normative accounting is purely subjective and thus not regarded to be very useful in resolving the practical based accounting issues (Whittington, 2007). The accounting field initially mainly incorporates the theoretical views and principle advocated by the normative accounting theory in providing an explanation to the accounting practices. However, the theory mainly faced criticism as it seems to be inappropriate in selection of an accounting principal to be used in resolving a complex accounting problem. For example, at the time of doing a contract, the practice of normative accounting does not help in providing a solution for the income and cost arising from the contract to be assessed immediately, over time or as a lump sum in future (Tehrani et al., 2009). Thus, the accountants are not able to achieve an appropriate answer for this accounting issue which of the above mentioned option should be used or a combination of all the above three to be applied. Thus, as the theory is purely subjective on nature it was not regarded to be appropriate in resolving scientific based accounting problems. Thus, all these factors lead to the esta blishment of Positive Accounting Theory (PAT) model to successfully resolve the practical accounting problems. The model incorporates the use of statistically based hypothesis testing for achieving a valid answer for the accounting problems. The method begins with examination of the current accounting processes of a business firm and thus making quantitative predictions on the basis of analysis. The predictions are statistical tested through the help of hypothesis development that help in achieving the most suitable answer for accounting problem (Setyorini and Ishak, 2012). Positive or Normative Accounting Theories to be used at the time of developing Accounting Standards The accounting theories were largely used for developing the accounting standards and principles used for preparation of financial statements of business entities. The theory of positive accounting was mainly established in order to fulfill the current weakness analyzed from the normative accounting theory. The theory regarded to be useful in gaining an understanding of the social context of accounting choices made by different companies was used largely by the accountants in developing financial statements. However, there is increasing debate regarding the usefulness of positive accounting theory in developing standard accounting policies to be used worldwide by business entities. The accounting theorists have stated that there has not been the development of an accounting theory till data that is able to create standard-setting process and principle in accounting. The accounting theorists have illustrated various drawbacks present in the positive accounting theory on the basis of w hich it is refereed to be unable to develop standard accounting principles. The main objective of accounting theories developed was to provide standard set of principles and conventions that helps in analyzing the accounting operations of business companies. The theory of NAT was regarded to be inappropriate in the basis of its subjective nature that leads to the development of PAT model. The PAT model was based to be developed on the principles of natural science and economics and thus was utilized largely for the development of financial statements by business firms (Ghanbari et al., 2016). However, the accounting theorists have pointed out various deficiencies in the current PAT model used by accountants for analyzing the problems pertaining in the accounting field. The main drawback of the theory as argued by the accounts is that it only helps in providing an explanation to the actual accounting practices but does not provide suggestions for improving the current accounting practices. Also, relative no development in the accounting model of PAT farer its mergence also raises questions on the reliability of this accounting model. The accountants have stated that the theory of PAT is not able to resolve successfully the contemporary accounting issues. The PAT model is mainly based on the following three hypotheses that are, debit hypothesis, the bonus-plan hypothesis and the political cost hypothesis. However, all of the above three hypothesis does not have scientific support and are falsified and thus cannot be used in the model of PAT. Thus, the theory is criticized o n the basis of all the above stated current deficiencies that make it ineffective in maintaining the objectivity of accounting researches (Bazrafshan and Talebnia, 2016). Thus, it can be said there are some deficiencies present in both the positive and normative accounting theories and therefore they are not helpful in development of a standard setting accounting rules and principles. The accountants can integrate both the theories in development of standard accounting principles as the deficiencies of one theory can be overcome by the application of other. Both the theoretical models of NAT and PAT complement each other as the weaknesses of one can be fulfilled by the other. The theory of positive accounting is very practical while normative is entirely theoretical as such the concepts of both the theories can be used in development of accounting concepts that are practical as well as principles. The accounting theorists have argued that financial policies developed through the use of normative accounting practices should be based on financial realities achieved from implementing positive accounting practices. The theory of positive accounting can he lp in understanding the reality of accounting statements while normative theory can be used in developing appropriate accounting standards. The accounting researches need to integrate the views and opinions of both the theoretical models for development of a standard-setting process that help in the establishment of accounting principles (Boland and Gordon, 2010). Therefore, it can be stated that accounting theories of positive and normative can be used in developing conceptual framework of accounting that helps in evaluation and analysis of accounting practices. The theories of normative and positive of applied in combination will help in developing qualitative and quantitative approaches for developing effective accounting and financial reporting standards. The adoption of both the theoretical and practical approaches will help in development of standard principles that will provide both qualitative and quantitative disclosure of financial information to the end-users. The quantitative approach will help in ensuring that accounting information disclosed is relevant, reliable, comparable and consistent while qualitative approach will ensure that financial statements have adhered to the generally accepted accounting principles (GAAP) (Mahmmod and Al- Kassar, 2015). The development of PAT after the establishment of NAT was regarded to be highly successful in development of accounting setting principles and standards. However, with the illustration of several current deficiencies in the PAT model, accounting theorists are now emphasizing on the development of better theoretical models that can be applied in development of both quantitative and qualitative accounting principles and standards. The current accounting practices developed through the application of concepts of positive and normative theories and thus both the theories should be used in combination for development of standard-setting accounting process (CTI Reviews, 2016). Conclusion The overall discussion held in the report inferred that both the theoretical models of positive and normative have deficiencies that limit their applicability in development of accounting standard-setting process. There exist large difference between the theoretical models of normative and positive and the deficiencies of one theory can be fulfilled by the other theory. Thus, the report has proposed that both the theoretical models should be used in combination for development of accounting-standard principles and procedures. The positive accounting theory will help in developing a practical approach for examining financial reports while normative theory will help in establishing of theoretical principles on the basis of which financial reports are developed. References Bazrafshan, M., and Talebnia, G. 2016. Challenges Positive Accounting Theory. International Journal of Basic Sciences Applied Research 5(2), 119-122. Boland, L. A., and Gordon, I. M. 2010. Criticizing positive accounting theory. Contemporary Accounting Research 9(1), pp. 142 170. CTI Reviews. 2016. Earnings Management, Emerging Insights in Theory, Practice, and Research: Business, Business. Cram101 Textbook Reviews. Ghanbari, M. et al. 2016. PAT (Positive Accounting Theory) and Natural Science. International Research Journal of Applied and Basic Sciences 10(2), pp. 177-182. Mahmmod, H. T., and Al- Kassar, T. A. 2015. 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