Normative approach and positive approach - Essay Example

? Research report on normative approach and positive approach Contents Introduction 3 Normative theory 4 Example 6 Advantages 6 Disadvantages 6 Positive Approach 7 Example 9 Conclusion 10 References 12 Introduction Since 15th century accounting is having its existence in the business world. Among various source of income, business needs to maintain everyday transactions, this are known as accounting methods. Accounting theory can be defined as the study, which helps to examine the methodologies of the assumptions, with their frame work in financial accounting principles. By the study on accounting theory helps to understand the review the historical foundations of the accounting practises and the way by which the verification on accounting practises is made and report to the relating regulatory framework which governs the financial statement and also the financial reporting (Evans, 2009, p.67). We also can say that a set of concepts which are interrelated, or descriptions or intensions which help to create a reasonable analysis on the incidents by identifying the relations among the variables that can be described as accounting theory. There is no single proper theory in financial accounting which may govern the process of accounting accurately (Belkaoui, 2004 p.125). There are differences in approaches, opinions, and values in accounting practise. In the year 2005 Deegan and Unerman stated that to understand the accounting theory a proper methodology is needed to justify the process (Most, 1977, p.56). Nowadays both economics as well as businesses are continuously evolving. Accounting theory is also changing with business and economy. New ways of doing business are discovered with the implementation of new technological standards. Various loop holes also identified during the reporting of mechanisms. Different standard organisations like International Accounting Standards Board help to implement practical implementation of accounting theories in the companies. Various individuals like corporate manager, public accountants, officer of lending institutions need to make decisions about several external accounting reports; for them accounting theories make a great help. To understand the relation between variables by large number of observations and different empirical tests they need the help of accounting theories (Kam, 1990, p.97). For the development of accounting theory several approaches have been made within the last two decades, among which are descriptive, normative, positive, decision making, empirical and welfare ones. However here we concentrate on positive approach and normative approach. Normative theory A normative theory can be defined as a theory, which does not depend on observations, but on the process by which it should be done. According to most of the researchers several different approaches are used in this theory to find a correct opinion about accounting. The formula is used in this method to find out the value what income is based on and not depend on cost. Here the opinions of the theorists are depending upon deductive logic, subjective opinion and inductive methods. On base upon this theory all the other theories are standardized. The other theories tend to give conclusion that some of the accounting rules are better or worse than the others. The normative theories generally depend upon the anecdotal evidence which may not pass the test of academic rigor (Porwal, 2001, p.245). On depending on the personal outlooks, consequent reasoning, and by using of elementary reasoning it aims to approve that there are several accounting practices which are better than others. It helps to understand what ought to be rather than what it actually is. In the part of theory construction the normative approach is likely to depend on the future related answer rather than on its present. That is like here we can find the answer of “what should be” rather than “what it is”. According to this theory, the theories will be more feasible and desirable, which does not depend upon the current scenario. A disagreement may found by the normative approach where the accounting practise is dealing with economy and social realities. Normative theories can be developed by serving the theoretical standards which may impose on quality of information and with the relevance of theoretical standard in the output of information in conventional accounting system. This theory mainly concentrates on the comparability between different financial statements which may arise by the using of different accounting rules (Whittingtom. 2007, p.342). In the year 2005, Chambers in his book “Blueprint for a theory of accounting” describe about the nature and purpose of this theory. According to him it is compulsory to make a difference between the accounting system rules and the theory of accounting. Every part needed a system of rules for the continuous practise of any kind of art. It is also mandate to sort out the rules, which are appearing. As to discover the inconsistency within the system the rules are needed to describe. However commensurate description does not help to determine which rule should be accepted, and which is need to be cast away. As a result the question must be associated to a fundamental position or a group of positions according to the theory and the subject (Glautier, and Underdown, 1976, pp. 56-78). Stating specific objectives are the main concern related to normative theories which can be defined as adjuration. That means the business income should be addressed to that how much amount is distributed among the shareholders during the accounting period, which will make ensure that the capital of the business is still within it. This type of theories mainly relies on the process of consequent reasoning, which starts with a common set of hypothesis about the matter under the study. From the making of a general statement to a particular statement deductive reasoning helps a lot. So the conclusion of the theory is depended upon the deductive reasoning. Several points for criticism can be found related to the theories. Among which the main one is whether the acceptance is widely discussed to maintain the general agreement, which may be removed as self-evident. Again if the clarifications are made in a general way, they may unable to achieve general agreement. Normative theory can be further subdivided in two theories like true income theories and decision usefulness theories. In true income theories it is asserted that, it will make provisions about different accounting role, which will provide the single best measure to acquire the profit. Whereas, decision usefulness theories will help to generate a particular type of information for a certain class of users depending on the needs of decision making assumptions. Example Continuously Contemporary accounting (CoCoA) by Raymond chambers is an example of normative approach. For many decades the historical Cost Accounting method has been accepted, which asserts that money can hold a constant purchasing power. However due inflation, change in the exchange rates, volatility in price levels and different evolution in society through the technology led to make this Continuously Contemporary model. Advantages As it provides information about the capacity an entity that can be adopted, it helps to make effective decision making. In case of valuation, there is a common problem “additives”, this theory solves this problem by applying it common basis of valuation, as it makes a scientific way to add the values of various assets together. The arbitrary cost allocation during depreciation has been eliminated. Disadvantages All type of assets do not provide its immediate market price, hence, it has to deal with its subjectivity. The assets which will create value to a certain entity only are losing their “value in use”. (like blast furnace). On basis of separate disposal method, the assets should be valued. As a result the assets which cannot be sold separately are losing its value. (like goodwill). As the business community never accepts this method widely, there will be various problems for the implementation of this method. The method is totally different from the historical methods, so the adoption of this method may create several social and economic problems. As the people are using the historical methods for decades, so to make them understand about the strength and weakness of this method may charge a huge cost. A question can arise due to the relevancy of an asset’s price, when the entity does not want to sell that asset. Positive Approach Positive approach of accounting theory is mostly concerned with the methods focused on how the world works. According to Scott PAT (Positive Accounting Theory), this is the method which helps to predict the actions of the accounting policies managed by the firm managers and their response to the new accounting standards. The hypothesis of PAT according to Scott is depending upon three factors those are the bonus plan hypothesis, the debt covenant hypothesis and the political costs hypothesis (Wolk, and Tearney, 1997, p.67). In the academic research of accounts, positive accounting is an important branch. It helps to understand and find different accounting practices. In late 60’s this accounting method has been emerged with empirical study in accounting. As it was published in the “Journal of Accounting and Economics”, several points for criticism have been expressed on it. This accounting method can be related with contractual view of a firm, as the firm is viewed as “a nexus of contracts” and the formation is made on the performances of the contracts. Depending on this view, accounting practices derive to allocate the costs of the contracts which are already established by after making discussion among various parties. The permissible views of this method create tension among the studies of value relevance in accounting. The managers allow this method in their accounting method as they able to understand the opportunity for making profit. Different perspective like cost for political causes, bonus plan, and debt hypothesis motivate the management to choose different accounting methods (Higson, 2003, pp.98-165). Million Friedman first put light on the theories of positive approach. According to him there are three main goals of positive approaches like the development of the theories as well as the hypothesis; this yields a valid meaning for the predictions and the phenomena are explored to make any observation. Watts and Zimmerman, who developed this theory, try to get prediction and explanation about the reason of the preference of one accounting theory over others. The theory is developed based upon two assumptions and the set of hypothesis. However, if the predictions are outcome as accurate as tested against the observation of reality, they will have to provide explanation for the things, as why they are happened. Depending on “rational economic person” different assumptions are made like one individual is motivated to maximize his or her wealth by self interest only. The efficiency perspective of PAT is in that different researchers try to make an explanation on different mechanisms of the contract that can be placed to minimize the agency cost of the relating firm. This will help to associate correspondingly with the costs for assigning the decision making authority to the agent. The efficiency perspective of PAT also sometime is referred as an “ex ante perspective”. It means before the fact, as it include the mechanisms, which can be put in the front place with the goal to reduce the agency cost and contracting cost (Campbell, and Houghton, 2005, pp.199-345). The negotiation of the contractual arrangements between the firms and prediction of certain opportunistic behaviours are known as opportunistic perspective of the firm. Primarily it may found that contractual agreements could have negotiation for their consideration to be the most efficient workers in constructing different interests for different individuals in the firm. Though, one cannot say that there is a complete contract for providing guidance within all accounting methods in all type of circumstances. As always there will be a space for different opportunities for the managers. This means the fact, that the opportunities which can be undertaken by different contractual agreements are considered to be put in place. Some sceptic views have been expressed over this method like it does not make any room for perception, what can be happen in the future does not considered here. It is not value free method as it gives stress what might be able to happen rather than what should happen. It also states that the management or the agent can have different views from the owners or the principal which will motivate to create their own gain only. The opposite concept is not considered here. Example “Legitimacy theory” and “Accounting theory” are the basic examples of positive approach. In legitimacy theory it has been described as the businesses are depend on the social contract, in which the companies are need to perform different social actions for the approval of different rewards and objectives which ultimately guaranteed their sustainability. Whereas stakeholder’s theory can be described as the theory for organizational management and business ethics, this will help to manage the organisation; it also includes some moral values. R. Edward Freeman in his book “Strategic Management” first mentioned it. Several researches have been made upon this theory. The theory of stakeholder’s has become popular not only for its implementation of ethics in business field but also for its main framework for corporate social responsibility. In ISO 26000 or GRI (Global Reporting Initiative) the same type of methods is used as suggested by Freeman. Challenging the usual framework analysis in different sectors like law, management, human resources the stakeholder’s theory has got its success. It was suggested that the needs of the shareholders must be put in the starting of any action. It became a surprise for all when authors like Geoffroy Murat applied the stakeholder’s theory to irregular welfare. Political philosopher Charles Blattberg makes a criticism on the stakeholder’s theory as he assumed that the interest of different shareholders may vary from each other. This controversy leads him to create the “patriotic” conception of the corporation in an alternative way of the stakeholder’s interest. Conclusion While discussing both of the approaches we get to identify some basic differences among normative approach and positive approach. The main differentiation is made due to the taxonomies. As positive accounting theory produces the accounting as science, normative approach does the same as art. Positive approach considers the fact, whereas the normative approach considers the value. Most of the time it has been found that positive approach may not be correct but must be went through a test, which make its approval. In normative approach as it depends upon opinion, it cannot be proved or disproved. However it is not easy to make distinctions between normative approach and positive approach. It is basically a variance in facts and opinions. So it will be very difficult to choose any certain method for all types of accounting theory. It depends on the situation which will be more appreciable, if one considered it as fact or considered it as value. Or one can choose a method which will combine both of them. Positive approach makes a study on the reality of the economy and operations, focusing on how the economy develops; and normative approach deals with what ought to be done. Positive facts are purely facts rather than opinion, whereas normative statements are value judgements on how the business world ought to act. However normative approach is more about an opinion, which regulates a statement. The question of acceptance or rejection does not come here. References Belkaoui, A 2004. Accounting Theory. U.S.A.: Cengage Learning. Campbell, T and Houghton, K 2005. Ethics and Auditing. U.S.A.: ANUE Press. Evans, T 2009. Accounting theory: Contemporary Accounting Issues. U.S.A.: Thomson/ south-Western. Glautier, M and Underdown, B 1976. Accounting theory and practise. U.S.A.: Pitman. Higson, A 2003. Corporate Financial Reporting: Theory and Practice. U.S.A.: Sage. Kam,V 1990. Accounting Theory. U.S.A.: Wiley. Most, K 1977. Accounting Theory. U.S.A.: Grid. Porwal, P 2001. Accounting Theory. U.S.A.: Tata McGraw-Hill Education. Whittingtom, G 2007. Profitability, Accounting Theory and Methodology: The Selected Essays of Geoffrey Whittington. India: Routledge. Wolk, H and Tearney, M 1997. Accounting Theory: A Conceptual and Institutional Approach. U.S.A.: South- Western Pub. Read More