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1. What is positive accounting theory?

How does it differ from normative accounting

theory? What was/were the major dissatisfaction(s) with normative accounting theory
which led to the development of a positive theory of accounting?
Positive accounting theory is concerned with explaining and predicting current accounting
practices. This means that the focus is on understanding and explaining the techniques and
methods that accountants currently use and why we have ended up with the conventional
historical cost accounting system. This approach can be compared with normative accounting
theories, which dismiss conventional historical cost accounting as being meaningless or notdecision-useful, and which prescribe the use of more useful systems of accounting (usually)
based on inflation adjustments. One technique that can be used to show students the different
approaches is to contrast the assumptions used by each theory as follows:

Objective of accounting

Decision making




Behavioural assumptions

Functional fixation or fooled by Rational economic man, able to

cosmetic accounting
analyse and distinguish

Economic assumptions

Little comment on historical Financial reports are an

Information has a price.

Semantic assumptions

measurement role.

Pragmatic assumptions

Accounting is neutral/unbiased.

a Measurement
monitoring and bonding.


Accounting is a political
economic or social commodity.

The dissatisfactions with normative accounting are:

To be normative, one must specify an objective function for example, efficiency, decision
usefulness, estimation of future share prices, improved quality of financial reports. However,
many of the above objectives are conflicting, and it is difficult to decide which one is a
superior objective. It should be noted that the definition of an objective of accounting
continues to be a contentious issue. (Note that the objective is usually defined in a very
broad, non-specific manner.)
Popper also makes the point that no amount of empirical testing can prove or disprove the
validity of normative accounting prescriptions they are irrefutable therefore they are
weak hypotheses.
There was usually no attempt to justify empirically that the prescriptions from
normative theories are better than the status quo. For example, the redefinition of the
objective of financial accounting from the traditional stewardship role into a decision-making
role (usually to aid investors) was never justified by empirical research.

Before condemning the usefulness of conventional accounting as a decision-making tool, it

would be more scientific to analyse and compare the decision-making processes induced by
conventional accounting and the proposed alternatives. Part of this research would
encompass whether cosmetic manipulations fooled market participants and the role that
financial accounting played in economic decision making.
Normative inflation models have been widely known in the literature for over 30 years, and
have not been readily accepted by the marketplace. Positive theories sought to obtain a
rational explanation for the status quo.
This leads positivists to attempt to model the connection between financial accounting, firms
and markets in a rational economic framework, rather than to take the stance of normative
theorists who dismissed current practice and took a prescriptive attitude.