Normative Theories in Accounting - Report

Running Head: Normative Theories in Accounting
Conceptual framework of
Accounting

Normative Theories in Accounting 1
Answer 1: Important Qualitative Characteristics of Accounting Information
Conceptual framework is an accounting theory prepared by the regulatory body of accounting
standard setters which can be used to solve the practical issues of financial reporting. The
general purpose financial statements are aimed at imparting the financial information to the
intended users, especially, the current and potential investors as they are the external parties
and hence are not involved in the preparation and presentation of reports. These parties play
important role for an entity as they invest huge amount of funds in it. To take critical
decisions about their investments they require entity’s financial reports. Financial information
is the organised form of raw accounting related data that is presented in the financial terms
for the purpose of financial reporting requirements. While making the presentation of such
significant information in the financial reports an entity’s professional accountant has the
statutory duty to fulfil the requirements of conceptual framework of accounting (IASB, 2010).
The framework on financial reporting prescribes certain qualitative characteristics which the
information contained in the financial reports must possess. As significant decisions are made
using such information it is necessary that it is reliable, relevant, understandable and
comparable. These features increases the overall quality of the financial reports of the entity.
If the information is not carrying the prescribed qualities it may not reflect the true picture of
company’s financial situation which misleads the intended users. An information is
called relevant when it has the capability of the influencing the decisions of intended users.
The relevant quality of the information must provide it the predictive value and confirmative
value (Birt, Muthusamy & Bir, 2017) (Jones & Smith, 2011). Also, the information
must be reliable so as to be used by the users in understanding the financial performance as
well as the situation of the reporting entity. Reliability of the information is generated when it
is faithfully represented in the financial statements (Collier, 2015). Both the relevance and
faithful representation are fundamental qualitative characteristics of financial information.

Normative Theories in Accounting 2
However, the requirement of information’s faithfulness can be considered as more important
as in comparison to the relevance feature. Even if the relevant information is disclosed in the
statement and reports but if is not free from material errors or is no complete in the holistic
manner than it would not be useful to the readers. The term faithful representation has
replaced the term reliability as was used previously. It requires the financial statements to
depict accurate information of the company’s business. This feature of information must be
applied to all the significant parts of financial statements like results of operating segments,
company’s financial position and the entire cash flows of the company (Kadous, Koonce, &
Thayer, 2012).The information that possess faithfulness as its characteristics will have
mainly three aspects. First, the information must be free from any kind of bias treatment and
hence it must be neutral. The neutrality concept requires the preparers of financial reports to
present the financial statements in such a way that it reflects the true position of reporting
entity without inflating its profitability merely to make it attractive or to gain some undue
advantages. Unbiased accounting treatment is necessary to promote and maintain the greater
level of transparency of the company’s operations. Second, the information is considered as
faithful when it is free from material that means the reports must not contain any errors either
in terms of presentation or in calculation (Lusardi Mitchell & Curto, 2010). Only if the
information is accurate then it will reflect the true and fair view of company’s financial
situation. The relevant information if not correctly prepared or presented may impair its
ability to influence the thought process of its investors (Kargin, 2013). Third, the
information must be complete in each sense as an incomplete information can lead the
investors or potential investors to take inappropriate decisions about the company. An
information is reliable only when it faithfully represents all the necessary events and
transactions of entity’s operations. If the information holds influencing power by nature but is

Normative Theories in Accounting 3
not represented or disclosed in the reliable manner than it would not be able to serve its
purpose (Nobes & Stadler, 2015).
Given the nature of accounting standard setting it is not possible for the preparers of financial
reports to achieve the quality of faithful representation because of the inherent uncertainties,
assumptions and estimates made in accounting. These factors might not always allow the
financial information to be free from material errors. Hence, it would be difficult for the
preparers to achieve this feature. However, if any omission or error does not affect the
explanation of economic phenomena of financial information and the processes that have
been used in producing the reported information are selected and applied with no errors the
faithfulness can be still be achieved.
Answer 2: Alternative Normative Theories to Historical Cost Accounting
Normative theories of accounting are those theories that are not based on the observations
rather they based formed on the basis of the ways that tells how accounting operations are
undertaken. These theories are believed to use various differing methodologies to ultimately
find the best and suitable accounting opinion. They use few formulas to determine business
income based on the values and not on the costs. Historical cost is the aggregate of prices
paid by the company to acquire and install the asset to make it available in the working
condition. The approach that Historical cost accounting follows is based on the actual cost
incurred in acquiring the ownership of asset and under this accounting the same cost is
disclosed in the balance sheet of the firm (Greenberg, et.al, 2013).
There are certain strengths and weaknesses of this concept. Its strengths includes the
objectivity provided it as the financial statements are not affected by the increase and
decrease in the values of its elements. So it avoids the chances of data manipulation. Further,