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There are different schools of thought on what represents accounting theory. The first school
focuses on the development of accounting principles and describes accounting theory as follows:
Thus, accounting theory may be defined as a logical reasoning in the form of a set of broad
principles that (1) provide a general frame of reference by which accounting practice can be
evaluated and (2) guide the development of new practices and procedures (Hendriksen 1982:1).
Accounting theory is the basic assumptions, definitions, principles and concepts that underlie
accounting rule making (Wolk et al. 2008:2). The other school of thought explains accounting
theory as an activity to explain and predict: the primary objective of accounting theory is to
provide a basis for the prediction and explanation of accounting behavior and events (RiahiBelkaoui 2004:108). The objective of accounting theory is to explain and predict accounting
practice (Watts & Zimmerman 1986:2). Theory attempts to explain relationships and predict
phenomena (Wolk et al. 2008:28). While the first school focuses on the principles of accounting,
the second endeavours to evaluate practice itself. Hendriksen (1982:1) expresses his preference
for the first school as follows:
Accounting theory may also be used to explain existing practices to obtain a better understanding
of them. But the most important goal of accounting theory should be to provide a coherent set of
principles that form the general frame of reference for the evaluation and development of sound
accounting practices. These two schools of accounting theory are grounded in the two main
methodologies for the development of theory in general that is, normative and descriptive
methodologies. Normative methodology questions existing theory to describe what the theory
should be, while descriptive methodology investigates the underlying phenomena to describe
what they are (Hendriksen 1982; Riahi-Belkaoui 2004). Normative metho-dology is more
concerned with what the outcome should be and is more prescriptive (Deegan & Unerman
2006:10). By contrast, descriptive methodology describes, explains and predicts the underlying
phenomena (Deegan & Unerman 2006:8). Normative and descriptive methodologies are also
distinguished by the process followed to develop theory. Normative methodology is a deductive
process in which objectives are formulated, from which principles are developed. Descriptive
methodology is an inductive process that focuses on observations of the real world. The aim of
the inductive process is to record the underlying phenomena. However, a third process, the
predictive process, is sometimes identified. This process goes further than the inductive process
in that it not only records the observations, but also explains and predicts them hence the fact
that it is often referred to as a positive research methodology (Deegan & Unerman 2006:8). he
second school of accounting theory, the explain-and-predict school, although descriptive in
observing the underlying phenomena, focuses more on explaining and predicting the phenomena,
and is therefore more positivistic. The result is that many accounting theorists do not distinguish
between normative and descriptive research, but between normative and positive research
(Schroeder et al. 2005; Deegan & Unerman 2006). Inanga and Schneider (2005) compare the
normative and positive theories as follows: A normative theory is a goal-oriented theory that


represents real world situations, not as they are, but as they should be. It is prescriptive rather
than descriptive theory that explains, and sets out, principles of what ought to be. Normative
theories are characterised by goal assumptions and deduction (Inanga & Schneider 2005:231).
Positive theories attempt to describe real world situations as they are. Research based on positive
theories involves empirical observations of the relevant phenomena from which a problem is
defined. Data relevant to the problem are then collected and hypotheses formulated and tested by
independent process. If the theory that results is an accurate representation (description) of the
empirical phenomena, such a theory can be used for predictive purposes. Induction follows
empirical observation and takes the form: if event Y takes place, the outcome will be Z. The
greater the number of empirical observations, the better supported the related induction will be
(Inanga & Schneider 2005:230). To understand the role that these methodologies of development
of theory play in the development of accounting theory it is important to note the developments
in accounting research over the last few decades

The positive accounting theory

4.1 Background
Henning, Van Rensburg and Smit (2004:17), experts on research methodologies in the social
sciences, describe a positivist framework as follows: In its broadest sense, positivism is a
rejection of metaphysics. It is about finding truth and providing it through empirical means. It is
a philosophical position that holds that the goal of knowledge is simply to describe and, in some
designs, to explain and also to predict the phenomena that we experience (whether quantitatively
or qualitatively). The purpose of science is thus what we can observe and measure. The focus of
a positivist framework is to find truth by describing the reality. The empirical tool gives the
research process validity. The starting point is a descriptive approach, but by incorporating the
empirical testing tools to explain and predict the phenomenon, positivism is created. Under the
positivist approach, accounting theory is developed by formulating hypotheses or designing
models and testing them. Science is deemed to be a process of trial and error. A hypothesis or
model is never absolute truth, but as long as it is not refuted through research, it is regarded as
the truth.
he generalizability of PAT hypotheses is limited by accounting environments and time. For
example, the three widely tested hypotheses of earnings management (i.e., the bonus plan
hypothesis, debt-equity hypothesis, and the political cost hypothesis) have particular institutional
environmental backgrounds and may not be equally valid in all cultures (Sunder, 1999; Sawabe
& Yamaji, 1999). Ali and Hwang (2000) found that value relevance of earnings and book value
of equity depended on country-specific factors. More recent research has found that earnings
quality depends on institutional factors such as ownership structure, tax-book conformity,
importance of the stock market in the countrys economy, rule of law, etc. (Ball, Robin, & Wu,


2003; Soderstrom & Sun, 2007). Begley and Freedman (2004) found that the role of accounting
numbers in public debt contracts changed during the 1975-2000 period. The frequency of
accounting-based restrictions on dividends and borrowings declined significantly from the 19751979 sample to 1999-2000.
Large number of academicians and theorists consider positive approach to be much more
practical and sensible than the normative approach because the positive approach is based more
on theory and real time data as opposed to the normative approach but one thing that again raises
question towards the credibility of the approach is the possibility of the capitalization of personal
conveniences and benefits by the management, shareholders and controllers of a firm. There is
no determination of why an organization chooses one alternative over another and hence it is
obvious that the decision makers of the firm would include their own conveniences while making
a selection. (Boland, et. al 1992) Positive theory helps in evaluating the pros and cons of the
alternatives adopted by any firm or institution but while doing so, it fails in establishing the
efficiency of any option or methodology adopted. The approach only helps in analyzing and
assessing the nature of the methodologies adopted but does not really provide any evidence if the
approach is efficient or not. There is hardly any evidence that proves and establishes if the
adopted practices are fruitful or not. And hence it still leads to the generation of suspicion and
speculation in terms of the efficacy of the approaches being used. The positive approach to the
development of accounting theory relies on one basic assumption and that is that all he policy
makers and decision makers of an organization are completely rational in nature. It assumes that
all the decisions that are being made would be a result of rationality where the accountants can
follow the best of options. But that is not what actually happens. The decision makers always
have some factors that act as biases in the development of the required theories and approaches.
(Sinha, 2008) The positive approach does not even provide alternatives to the existing
approaches or principles in case they are considered as irrelevant. Where the normative approach
presents an explanation of the things that the companies should do, the positive accounting
approach only examines and analyzes the existing principles and makes no recommendation for
the principles that need to be used.

The Flaws of Positive Accounting Theory The premises.

The Flaws of Perfect Markets.
The first flaw that can be found with a premise of PAT is that of economics and its reliance on
the theoretical perfect market. A perfect market relies on (amongst other things) perfect
information and no transaction costs. This point of view finds problems because accounting
exists because of transaction costs (Boland & Gordon 1992). It is also difficult to imagine
equilibrium for information when accounting information contributes to this equilibrium. Watts
and Zimmerman also say that regulation and political costs interfere with the operation of perfect
markets. In saying this they are effectively conceding that perfect markets do not exist as they


call for the removal of regulation to assist in the more efficient allocation of resources (Boland &
Gordon 1992

The Lack of Development of PAT.

When Positive Accounting Theory was first developed in the 1970s it relied upon three
hypotheses, the debt hypothesis, the bonus plan hypothesis and the political cost hypothesis.
Since this period however there have been no additions to these three, nor has there been any
development or expansion of them. Although much research has been performed throughout the
1980-90s PAT has remained stagnant in its development and this has perhaps led to the present
decline in interest in PAT (Deegan 2000). Sterling (1990) has argued that PAT doesnt have any
potential for future development and that it will continue indefinitely in its present form without
any new ideas. This lack of development and PATs recent decline in research are firm arguments
that PAT will be deemed a failure in the light of hindsight.
Critical theory and the popularity of PAT.
Positive Accounting Theory has been the predominant research paradigm of the 1980s and
1990s however upon reading PAT this becomes something of a curious phenomenon (Mouck
1992). Watts and Zimmerman would claim this success is due to its scientific or empirical basis
however the evidence of this is threadbare at best and rhetoric is the main instrument used in
getting PATs message across.
This leads us to examine other reasons for PATs popularity. The positive/empirical paradigm
became popular around the same time that new age conservative governments were elected in the
USA and the UK. A connection can therefore be made between the rise of governments ruled by
ideologies based around deregulation and small government and an accounting theory that
argues the same point. It is also plausible that universities in the USA that benefit from corporate
funding were conducting accounting research as a tool to promote the deregulation argument that
forms the foundation of Positive Accounting Theory. This means that the apparent success of
PAT in the research market has little to do with the merits or applicability of PAT, and much
more to do with its ideological arguments that preserve the power of those who presently hold
capital (Deegan 2000). Those who stand to reap the benefits of a deregulated government have in
effect captured the accounting research movement so as to glorify and justify their position.

Normative Approach
The normative approach to accounting theories is a special approach, which is based on defining
the things that should be instead of defining what actually is. Different approaches to accounting
theories include the analysis of different elements and carrying out studies in different ways,


which the help in the formulation and development of different accounting theories that define
the basis and construct of accounting practices. In the normative approach, the policymakers
discuss their opinions and judgment on different accounting practices and explains what a theory
should include. The theorists make use of their past experiences and analyses and thus depending
on that they explain and define the things that the accounting theories should include. Some of
the main things included in the normative approach are the personal outlooks, deductive
reasoning and use of inductive techniques. (Mattessich, 1992) The normative approach has been
there since long time and has been adopted for the formulation of different accounting theories.
Theorists make use of the approach because of one main reason and that is to match up to the
changing world environment and the accounting procedures. The world, operations of businesses
and everything else related to an organization are highly dynamic in nature and nothing remains
stagnant after a point of time. And hence normative approach is expected to help the accountants
keep up with the current changes and make changes in the established accounting theories
according to current observations and analysis. But at the same time, there is also a possibility
that there may occur some major changes in the existing theory without any sound basis. The
accountants may analyze the changing environment in different ways, thus causing major impact
on the existing practices and theories. (Demski, 1976) Despite of using logics and logical
reasoning for the development of different theories, one question that always arises while using
the approach is if it actually reflects the actual accounting practices. Most of the normative
theories are completely based on observations and hence it is not always possible to determine if
they actually make sense in the accounting world. For example, a simple methodology of the
valuation of assets would be interpreted and seen in different ways. Some accountants would
focus more on the social and environmental impacts whereas some would focus more on the
historical costs. Some theorists believe that the normative approach is the most logical way
because it is not based on what is happening but provides a clear picture of what and how the
accounting practices should be. But then again the assumptions behind each accounting theory
and the development of practices would depend on the policymakers opinions. One wrong
assumption or one loophole in the reasoning and logical analysis can cause serious problems and
hence this demonstrates the possibility of manipulating accounting theories. (Hakansson, 1969)
Thus, it is clear that though the normative approach presents an extremely practical way and
methodology for the development and formulation of the accounting theories, it still has some
severe drawbacks and hence whether to be used or not is still a question that needs to be
A normative accounting theory seeks to prescribe some basis of accounting measurement,
particular accounting procedures, and the contents of financial reports (Ijiri 1975; W & Z 1986).4
Ijiri views normative theories as a special case of deductive theories. Deductive theories that start
with some goal assumptions and deduce accounting procedures therefrom are labeled normative
theories.5 Thus, there are two important elements of a normative theory: (a) goal assumption,
and (b) deduction. A theorist may set his own goals that are not inherent to current accounting
practice. Chambers (1966) falls in this group. Again, a theorist may inductively derive goals


from accounting practice and use those goals to suggest improvements in current practice. Ijiri
falls into this group. Such theories are also categorized as normative in this paper. It is to be
noted that not every theorist is explicit on goal statement. Some state the basic assumptions and
deduce accounting measurement from these. Paton and Littleton (1940) fall in this group. So far
three approaches have been employed in normative accounting research. These are (a) inductive
model, (b) deductive model, and (c) the decision usefulness approach.

Accounting is a system, which incorporates numerous special activities and information
management techniques to make the available information more presentable to the readers and
users of the information. There are several accounting theories that have been developed and
keep developing for enhancing the current accounting system or for introducing something new
in the system. And hence in order to efficiently develop these accounting theories, theorists and
academicians usually adopt different approaches to reach to their conclusions. Two approaches
that are commonly used for the formulation of accounting theories are normative and positive
approaches. Where normative approach believes in elaborating on the things that should be done,
positive approach is focused more on the existing techniques and principles. Both the approaches
have different pros and cons and hence can be used under different circumstances. However, the
final selection of one of the two approaches depends on the given scenario and even on the
people involved in making the decisio