Positive accounting theory is the explanation of accounting concepts to show scientifically the truth of accounting statement. Positive accounting theory seeks to explain and predict actual accounting practices. This theory contrasts normative accounting that seeks to prescribe and derive optimal accounting standards. The scientific concepts of positive accounting theory is the focus on relationships between various individuals involved in providing resources and accounting concepts used to coordinate functioning of the two relationships .
Bloom Robert, 1990 looked in to the various accounting concepts in his works. There is a strong relationship between suppliers of equity capital and suppliers of managerial labor. Another major relationship is between managers and firm’s creditors. A number of relationships involve delegation of decision making from one party to another creating principal and agent relationship. Creation of agency relationship is a major development in accounting that leads to identification of agency costs. The theory is based on economic assumptions that all actions by individuals are driven by self-interest.
Opportunist is another consideration put forth by positive accounting theory since it leads to accumulation of wealth. Positive accounting theory predicts that organizations will seek to put in place mechanisms that consolidate interests of firm mangers with interests of firm owners. Positive accounting theory gives answers to accounting problems measured on the basis of conformity with theory and facts. On the other hand, normative accounting theory prescribes how a process of accounting should be done.
This theory is not based on observation and in certain instances it suggests radical changes related to current practices in accounting (Kinney William, 2003). Normative accounting theory is an explanation to justify feasibility of appropriate accounting treatment with intended purpose. Using appropriate normative accounting theory gives logical reasoning. Normative accounting theory is known as the Generally Accepted Accounting Principles (GAAP). Normative accounting theory approach provides the best alternative for predicting various accounting phenomena.
It is a theory that describes how accounting variables interact in real world functions. Normative accounting theory expresses normative statement a judgment about whether a situation is desirable or undesirable. In economics it is important to distinguish positive and normative accounting theory that is a means of communicating accounting concepts. Normative judgments by economists are desirable because it is a way of policy analysis whereby on normative issues economists is not supposed to speak with special expertise.
According to Mayper Alan, 1993, normative theorists rely heavily upon evidence that fails to meet academic rigor. The theory advocates for use of accounting opinions based upon inductive, subjective and deductive methods. Challenges in obtaining measurement method best for financial reports Financial reporting measures inherently debatable and abstract concepts in accounting such as income, liabilities, net assets and capital. Financial reporting measurement is a matter of evolving conventions that assumes that there is always a theoretical right answer.
There are various methods used in financial reporting measurement. The main concern however, is selection of the best method of measurement in financial reports. According to (Hopwood Anthony, 2004), Financial reporting measurement entails measuring the performance of business entity and the financial position of organizations This affects all people working within the organization as a way of evaluating the efforts by each stakeholder in the entity. Measurement of financial reports helps to determine allocation of resources such as capital across countries, organizations, business entities and the entire economy.
This is a wide area of coverage that posses challenge to economists, accountants and financial analysts. Financial reporting measurement helps to determine whether a business is successful or will fail at some time, tax paid by business, dividends allocated to shareholders and bonus paid to employees. A major challenge in financial reporting measurement is the perceived movement away from traditional basis of measurement that is historical cost towards a new basis of fair value.
The basis upon which an appropriate method of financial reporting measurement can be agreed has led to mixed reactions among financial reporting standard-setters. Both people in accountancy profession and the entire business world are adversely affected by change in accounting standards. A major concern is financial reporting measurement framework, reliability, base work and their relevance. The current financial reporting measurement practices are very diverse, technical and inconsistent.
This makes it hard for accountants, financial analysts, economists and users of financial statements fail to agree on the relevant method necessary for measurement. This was examined by Collins Marilynn, 1994, in his publication. Accounting practices should be done in a more uniform way than any other organizational concepts. This is because the purpose of measuring financial reports is to reflect true and fair value of the organization. Financial reports such as balance sheet and income statement reflects the financial position of the entity and this call for use of uniform measurement policy.
However, this may differ in certain circumstances because all organizations are not run in the same way and perhaps each business entity has its own reason for existence. Another reason for failing to agree on the appropriate measurement method is that different jurisdictions in organizations have their own financial reporting requirements influenced by available reporting information and regulatory environment. In addition, different business entities or organizations have different types of assets or liabilities.
References Bloom Robert, 1990, Opportunity Cost in Finance and Accounting, Quorum Books. Kinney William, 2003, New Accounting Scholars-Does It Matter What We Teach Them, Issues in Accounting Education. Mayper Alan, 1993, Accounting History and Empirical Research, The Accounting Historians Journal. Hopwood Anthony, 2004, The Economics and Politics of Accounting: International Perspective On Research Trends, Oxford University Press. Collins Marilynn, 1994, The Schism in accounting, Quorum Books.