Positive and Normative Accounting Theory

Question: Difference Between Positive And Normative AccountingTheory. Answer: The concept of Positive Accounting theory has been introduced to the world by Watts and Zimmerman. As per As Watts and Zimmerman (1986, p. 7) state, Positive Accounting Theory is concerned with explaining [accounting] practice. It is designed to explain and predict which firms will and which firms will not use a particular accounting method but it says nothing as to which method a firm should use. Through the help of the positive counting theory one can make the predictions quiet easily. This theory can help the management o ensure whether they are likely to use the method for the purpose of the accounting or not. Under the theory, the reality that has been prevailing in the industry is very well observed in this theory. For example: there is relation between certain conditions and the demand of the product. Thus, if the conditions are met the demand of the product is likely to increase and this is regarded as a positive relation. (Watt, 1990) Thus similar way the positive accounting theory has its role to play in the accounting of the firms. Being if all the conditions are satisfied then in that case the theory will be accepted in the form for the purpose of accounting. The logical thinking has a bigger role to play in the selection of the positive accounting theory. Logical thinking backed up by proper experiments and observations let to developing a notion whether the method of the accounting will be accepted or not. By applying the positive accounting theory in accounting, it will help the firm in accepting the accounting theories that are fruitful for the firm else the same will be ignored in normal means. (Fool, 2017) There is difference between positive and normative accounting theory. The positive accounting theory has been used to make correct prediction about the real world and is been used to convert them into accounting transactions. On the other hand, the normative accounting theory tends to recommend to the world what best needs to be done. The management of the company uses the positive accounting theory approach in adopting the accounting policies and standards which is important in determining the survival of the company in the industry. This can well understand with the help of an example: where a company who is engaged in the business of contract based work would prefer adopting an accounting standard that would reduce the contract cost and would increase the profit margin. The management of the company at times of selecting the accounting policy would rotate around three predictions that include bonus plus hypothesis, debt covenant hypothesis and political cost hypothesis. (Markas, 2 002) When the positive accounting theory is compared with the normative theory, it is noted that the latter one is more subjective as compared to the former. The subjective nature is very important in accounting as the same helps in defining the economic future for the investor. In case of normative theory, the researchers tend to use several different approaches to reach out to the conclusions whereas in case of positive, the researchers tend to follow just one approach. At logical front, the normative accounting theory is more deductive in nature as compared to the positive accounting theory. In the normative the work starts with the theory and then the same tends to deduce to specific policies. On the other hand, in case of positive theory, the works starts with specific policies and then the same is converted into high level principles. Both the theory because of the very nature is complimentary and compensating to the loop holes for each other. The positive accounting theory tends to be more practical whereas in case of normative the same is more theoretical. This can be well understood through the help of the below example: Before the financial crisis, the financial securities in case of banks were accounted in a similar manner as compared to real estate and other assets accounting. These other assets and the real estate value were not revalued as per the changes in the current market price of the assets. But after the financial crisis, there has been change in the method of accounting that has been followed in case of financial securities. There has been a consistent decrease in the value of the assets during the period of financial crisis but being the accounting policy that has been followed in by the company there has been no change in the book value of the financial securities as result although the securities has been shown at the purchase price in the books but the same does not carry nay value. Thus after the crisis, the accounting policy of the compan y has been changed to marked to market and the securities were revalued. This change in the accounting policies let to new unrealized gain or loss in the books that derived the balance sheet and profit and loss account to a larger scale. This can be called as a change that has been driven by principle rather than following an existing accounting treatment in the books. Thus on the current example it can be very well stated that the positive accounting theory is more practical and is based on what is actually being happening in the world whereas the normative is more theortical. (Roychowdhury, 2006) References Watts, R., Zimmerman, J., (1990), Positive accounting theory: A ten year perspective,The Accounting Review65, 131-156. Watts, R. L. and J. L. Zimmerman, (1978), towards a positive theory of the determination of accounting standards,The Accounting Review,(January): 112-134. Roychowdhury, S. (2006) Earnings Management through Real Activities Manipulation,Journal of Accounting and Economics42, 335-370. Fool M, 2017, What Are the Differences Between Positive and Normative Accounting?, Viewed on 21th April, 2017, Retrieved from Fool.com, https://www.fool.com/knowledge-center/differences-between-positive-normative-accounting.aspx Milne Markus, 2002, Positive Accounting Theory, Political Costs And Social Disclosure Analyses: A Critical Look, Viewed on 21th April, 2017, Retrieved from _ https://www.researchgate.net/publication/222665782_Positive_accounting_theory_political_costs_And_social_disclosure_analyses_a_critical_look