Chapter 1: Introduction to financial accounting theory
Solutions
1.1 Broadly speaking, a positive theory seeks to explain and/or predict particular
phenomena whereas a normative theory seeks to prescribe what should be done in
particular circumstances based on particular assumptions made by the researcher.
In relation to accounting, the assumptions adopted within a normative theory
might relate to assumptions made by the researchers about what information
people need to make informed decisions, or what is the central objective, or role,
of accounting.
Positive theories are typically evaluated by considering how well the explanations
or predictions relate to actual observations. That is, how well the explanations or
predictions are supported by available empirical evidence. The predictions are
usually based upon assumptions about what motivates human behaviour. For
example, there might be a maintained assumption within a positive theory of
accounting that all people are motivated by self-interest linked to maximisation of
personal wealth.
Normative theories, by contrast, are not (or should not be) evaluated on the basis
of their correspondence with observations of real-world phenomena. For example,
a researcher may develop a theory that prescribes a particular approach to asset
measurement. The theory should not be considered as invalid if people currently
do not adopt the prescribed approach to asset measurement. Normative theories
provide prescriptions, not predictions.
1.2 If we developed a theory to explain how a financial statement preparer’s cultural
background influences how they prepare financial statements then, as we are
attempting to ‘explain’ particular practice (and not evaluate it relative to some
normative criteria), we have developed a positive theory. Such a theory would
then be evaluated in terms of how well its predictions (perhaps based on particular
cultural attributes of a given population) correlate with the predicted accounting
practices (for example, we might have predicted that people from a ‘conservative’
society or culture are more likely to adopt historical cost accounting rather than
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utilising valuations based on fair values). In developing such a theory, we are not
attempting to prescribe what accounting methods should be used – which contrasts
our research with normative research.
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