Accounting theory is a set of basic premises, definitions, rules, and constructs environing the accounting regulation. It includes the coverage of accounting and fiscal information to relevant or interested parties. There are several attacks that are used in the development of accounting theory. The two chief 1s are normative theory attack and the positive theory attack.
Normative theory attack is a theory that is non based on observation. It is based on how things in the accounting procedure should be done. This attack comprises of different attacks to hold a individual but effectual accounting attack ( Khandelwal, & A ; Jain, 2008 ) . This sort of attack uses a expression to come up with an income based on value, non costs.
On the other manus, positive or descriptive theoretical attack to accounting theory is a set of theories that is concerned with what comptrollers really do ( Rosenfield, 2006 ) . These theories rely on a procedure of inductive thought, which involves doing observations and pulling illations from them. The chief intent of doing observations is to place certain similarities, place the figure of cases that the similarities are really observed to infer a certain grade of confidence necessary to put up a theory about all the similar cases ( Ackert, & A ; Deaves, 2009 ) .
Each of these accounting theoretical attacks are applicable in any concern today. However, it would be hard to use them together at the same clip, since each of them has different aims ( Ackert, & A ; Deaves, 2009 ) . It is hence up to an comptroller to make up one’s mind what attack is most accurate or best suited for what state of affairs. This calls for the right judgement of comptrollers to be able to do the right determination in every state of affairs or dispute that a concern entity is faced with.
Normative Theory Approach
There are several attacks covered in this attack. Each of these theories is best suited for a different state of affairs ( Belkaoui, 2004 ) . Below are these different theories and assorted state of affairss where each theory is best to be applied.
Historical Cost Accounting
This theory is applied in times when the costs or monetary values for things are on the rise ( Murphy, 2008 ) . The Historical cost accounting theory is based on the premise that money holds a changeless buying power. The chief challenge with this theory is that it assumes that the pecuniary unit is fixed and changeless over clip.
This theory is nevertheless based on three constituents. One is that there are specific degrees in monetary value degrees, which may be characterized by technological factors and alterations of consumer demands. Another constituent is that there is normally a general alteration in monetary value degrees, which is what is known as rising prices ( Murphy, 2008 ) . The 3rd constituent is fluctuation in the exchange rates for different currencies. Due to these three constituents, the book value of a concern should demo the current value of assets when fixing fiscal studies ( Murphy, 2008 ) .
As stated earlier, historical cost accounting is used when a company is sing lifting monetary values. Monetary values are expected to raise every now and so, and this may render the attack useless in most of these state of affairss. Companies that make usage of this attack are safe from exaggerating net incomes particularly in times when monetary values are on the rise ( Whittington, 2007 ) . Distribution of net incomes in such state of affairss can impact the buying power of a company.
This sort of attack may non be feasible to utilize since it affects the operating consequences of the current twelvemonth as it includes additions asserted in old periods of the companyaa‚¬a„?s being. More to that, capital care depends on keeping an integral fiscal capital and buying power ( Murphy, 2008 ) . Using existent current values as they are soon in the market may give a certain step of net incomes which should be good distributed to keep a physical operating capital.
Current Buying Power Accounting
This theoretical attack is best suited in state of affairss where comptrollers need to keep capital and the buying power of a company. The Current buying power accounting theory was developed on the footing that if a company distributes its net incomes as is required by historical accounting, so the existent value of a company has to be reduced ( Murphy, 2008 ) . This means that the company would hold to administer a certain sum of its capital.
This attack applies indices and is hence easy and cheaper to use when in such a state of affairs ( Rosenfield, 2006 ) . This is because any accommodation that needs to be done is done at the terminal of a period, and on records made from historical cost accounting.
Under this attack, non-monetary assets are termed as assets that pecuniary value may alter overtime due to rising prices. Such assets include the machinery in a mill. On the other manus, net-monetary assets are defined as pecuniary assets minus the pecuniary liabilities.
With this theoretical attack, alterations in the buying power of a company are non attributed to the non-monetary assets. The loss of buying power comes approximately as a consequence of keeping net-monetary assets ( Murphy, 2008 ) . In general fortunes of monetary value degree accounting, non-monetary assets are listed to the current buying power and as therefore, no net incomes or losingss are recognized. This theoretical attack is non dependable when doing determinations for the company.
Current Cost Accounting
This attack is best suited when seeking to keep the buying power of a company during times if rising prices, or fluctuation of exchange rates of currencies, because it is based on existent ratings. This theoretical attack cuts a clear line between net incomes that are made after gross revenues, and the additions that come with keeping an plus, be it a net-monetary plus or a non-monetary plus ( Murphy, 2008 ) .
Scholars have argued that a physical or existent attack to keeping capital outputs the best consequences in any concern entity, particularly in footings of income. This attack values as plus on the footing of replacing costs ( Murphy, 2008 ) . Operating income of the plus is valued as accomplished gross, minus the replacing costs of that peculiar plus.
This attack of ciphering replacing costs is best for ciphering operating net income. This makes it possible to keep the operation capacity of the concern at a changeless degree. The current cost runing net incomes before absorbing additions and losingss, and the accomplished additions of keeping an plus are both counted as grosss, and therefore the amount of the two equates to historical cost net income ( Rosenfield, 2006 ) .
Additions of keeping an plus are different from additions after doing gross revenues ( Porwal, 2001 ) . This is because are the two are dependent on differing factors in the market, most of which are beyond the control of the direction in a concern. There is an uncertainness environing the prevalence of replacing costs though.
Current cost accounting is founded on two concern constructs ; current operating net income and realizable cost nest eggs. Current operating net income is defined as the surplus of the present value of the end product sold, over the cost of related inputs. Realizable cost nest eggs, besides termed as the keeping additions or losingss, are the addition of the present cost of assets that the company is keeping in a given period. Keeping additions or losingss of an plus can be realized or unrealized. For illustration, the keeping addition of an extra in reappraisal in unfulfilled, but is still considered as portion of the concern net income in the income statement ( Whittington, 2007 ) .
In the event that there are two companies that were started at different times, the company that was started before will hold a larger operating net income. This is because it has less depreciation costs. Any one would believe that this company has a more efficient system of running its operations in the current old ages than other companies that were started subsequently. The existent instance is that the direction made a wise determination when get downing the company. The fact that they bought their assets back in clip is a conducive factor. This is a good illustration of the construct of realizable cost nest eggs.
Exit Price Accounting
This attack argues that assets should be valued as per their issue or market monetary values, non-marketable consistent assets at replacing costs, and seasonal no marketable, non-reproducible assets be valued at the original cost ( Rosenfield, 2006 ) . The theory besides argues that fiscal statements should be structured in a manner to demo how much a company is able to accommodate to different state of affairss and environments, and that income should be inclusive of all net incomes and losingss, those that have been realized and those that have non been unrealized.
This attack is suited particularly when the direction has to do determinations about the hereafter of a company. The fact that it gives a heterosexual on focal point on the adaptability of a company, makes it stand out of other theories ( Whittington, 2007 ) . The adaptability of a concern entity is based on how liquid or marketable its assets are. This sort of attack would come in ready to hand at a clip when a company is sing to sell some of its assets to antagonize rising pricess in the market.
Positive Theories Approach
As defined earlier, positive theories are used to explicate and foretell a phenomenon after doing observations ( Deegan, & A ; Samkin, 2011 ) . Positive theories are based on the premise that if one makes a series of observations on a behaviour, they are able to develop a certain spiel which they use to do decisions and anticipations. Examples of positive theories include the stakeholder theory and the legitimacy theory ( Deegan, & A ; Samkin, 2011 ) .
PAT is chiefly involved with relationships between people or entities that provide resources to a concern organisation ( Deegan, & A ; Samkin, 2011 ) . For case, the relationship between the direction of an organisation and its proprietors. The chief elements of most of the relationships harmonizing to this theory affect the deputation of determination devising from one party ( perchance the proprietors or direction who act as the rule ) and the agent ( 2nd party ) . If the rule makes incorrect determinations, so the two parties are likely to endure losingss, and increased costs due to inefficiency. Such disbursals are known as bureau costs.
The Positive Accounting theory seeks to happen a manner to cut down bureau costs by usage of contractual agreements. It is therefore based on the premise that stakeholders will move in favour of their ain involvements, and will therefore grab any chance available to increase their wealth ( Deegan, & A ; Samkin, 2011 ) . With this premise, morality and trueness are decidedly non features of this theory ( Ketz, 2006 ) .
The positive accounting theory states an organisation is normally a aggregation of people who have single opportunisms, but are willing to collaborate to accomplish corporate ends, while at the same clip, working on their personal ends ( Alexander, Brittan, & A ; Joseen, 2007 ) . One anticipation of the PAT is that organisations will put to death steps that align the involvements of the whole organisation to opportunisms. Most of these steps are based on the end product of the accounting system, where the stakeholders get to portion the surpluss of the organisation. Such mechanisms need to be backed up by fiscal statements.
Harmonizing to PAT, directors should perpetrate themselves to fixing the fiscal statements ( Freedman, & A ; Jaggi, 2010 ) . This is an expensive activity and the costs incurred are known as bonding costs. Adhering costs can hence be defines as costs incurred to relevant governments or agents when set uping agencies to pass on to the principals, so that they may move in a manner that will non impact ends of the organisation or the persons involved.
Bing portion of the stakeholders, the direction functionaries excessively, have their ain opportunisms. Based on this premise, PAT states that the fiscal statements that are prepared by the direction should be audited ( Alexander, Brittan, & A ; Joseen, 2007 ) . This would assist avoid possibilities of the agents to move or pull strings figures in the fiscal statements to accommodate their involvements. On this note, PAT assumes that non all timeserving actions can be controlled by contractual agreements such as the auditing exercising, hence, there will ever be residuary costs. Costss incurred during the auditing exercising are known as monitoring costs.
Decisions or probes that are based on the Positive accounting theory follow an efficiency position or an timeserving position. The efficiency position seeks to happen mechanisms that can be executed so as to cut down bureau costs ( Freedman, & A ; Jaggi, 2010 ) . A good illustration of this is that when companies produce fiscal statements that have been audited, they cut down existent costs since there are no concealed figures that are non good accounted for. The audited fiscal statement hence serves as an efficient position, and therefore the organisation can be termed as efficient ( Deegan, & A ; Samkin, 2011 ) .
Still from the efficiency position, accounting patterns of an organisation should reflect the implicit in fiscal public presentation of the organisation. Organizations adopt different accounting methods, which can be explained by assorted organisational features. A good illustration of this is goodwill. If a company is able to supply dependable information about its public presentation, possible investors will non necessitate to travel out looking for more information from other beginnings. This saves clip and reduces costs ( Schroeder, Clark, & A ; Cathey, 2011 ) .
A company will pick an accounting method that will outdo show its implicit in public presentation. This means that puting certain restrictions or ordinances on how companies prepare their fiscal statements can take to a company incurring more costs than necessary, and likely non accomplish their end. Based on this, this theory recommends that companies should be allowed to fix their fiscal statements in a manner that best suits their operations, and that will demo their implicit in public presentations good ( Deegan, & A ; Samkin, 2011 ) .
As for the timeserving position, PAT seeks to explicate and foretell timeserving behaviour probably to go on after acquiring into a contractual understanding. For illustration, when seeking to minimise bureau costs, the direction of a given organisation can negociate a contractual agreement to increase their fillips on net incomes made. This would aline the involvements of the directors with those of the proprietors of the concern entity. With the understanding in topographic point, the direction can so happen other mechanisms to guarantee that more net incomes are generated ( Freedman, & A ; Jaggi, 2010 ) . The more net incomes are made, the better the fillip that both the direction and the proprietors will bask. These mechanisms that the direction adopts may non be reflected on the set up of the organisation or its assets.
The timeserving position assumes that proprietors of an organisation predict that directors will at some point act timeserving ( Deegan, & A ; Samkin, 2011 ) . The rules are hence likely to put what accounting methods should be used. For case, a fillip program understanding may hold a judicial admission that a depreciation method be used to cipher income inform of fillips. The direction may happen it a bit dearly-won to lodge to the stipulated program, and may seek an alternate method. Following such a possibility, PAT states that agents will ever hold an upper manus in make up one’s minding what accounting method to utilize.
The above theories are applicable in different state of affairss. Harmonizing to the analysis put above, the two theories address different issues, and therefore, it would give beliing consequences to unite them. For case, normative theories are best applied when a company is faced with assorted outwardnesss like fluctuations of currencies and rising prices of monetary values. These affect the buying power of a company and therefore, the theories come in ready to hand to assist the direction to do determinations on how to last such challenges.
As for the positive theories to accounting theory, these come in ready to hand when covering with issues that affect the relationship between the major stakeholders of any concern ; the proprietors and the direction. The two parties may hold beliing involvements, and the positive theories come in ready to hand best in such state of affairss.