Accounting Theory - Comparison between Positive and Normative Approach Essay

Accounting Theory - Comparison between Positive and Normative Approach - Essay Example The study of accounting theory enables to understand our past and provide us with a positive reception of how our recent practices and problems came into being. A historical investigation also tells that certain problems are continuing and may not be capable of an everlasting solution, for example, accounting for intangible and changing price levels. The accounting theory’s development came up because of needs and changes in accounting concepts and techniques. The main purpose of accounting is to plan periodic matching of revenues and cost. The accounting theory is classified into positive and normative accounting theory. This paper will take into consideration the positive and negative approach of accounting theories; their advantages and disadvantages, comparison and relationships between the two and evidence supporting that where each of the approaches might be appropriate in the current economic and business environment. Positive Approach The positive approach in accountin g starts with observations of financial information of business firms and on the basis of recurring relationships proceeds to draw overview and principles of accounting. Financial and accounting information, hence, represents recurring relationships leads to the formulation of principles. Different steps involved in positive accounting theory are: doing the observations and then recording of all the observations, analysis and then doing classification of these observations in order to detect recurring relationships, inductive derivation of principles of accounting and generalizations from those observations which signify recurring relationships and last step is the testing of generalizations (Rao, 2006, p.57). This approach is appropriate in the business environment in order to explain and forecast management’s choice of standards through analysing the benefits and costs of particular financial exposures in relation to allocation of resources and to various individuals within the economy. This theory is based on the propositions that shareholders, managers, and politicians or regulators are rational and that they try to make the best use of their utility, which is related to their reward and therefore to their wealth. The preference of an accounting policy by any of these groups depends on a comparison of the relative benefits and costs of different accounting procedures in such a way so as to maximize their utility. For example, it will be appropriate in such a business environment where it is assumed that management takes into consideration the effects of the reported accounting of numbers on political cost, information production cost, tax regulation, management compensation, and constraints found in bond-indenture provisions. The fundamental idea of the positive theory is to develop hypotheses about factors that persuade the accounting practices and to test the legality of these hypotheses empirically.