Positive Accounting Theory: Explaining and Predicting Accounting Practices

This article provides an overview of Positive Accounting Theory, its application in explaining and predicting accounting practices, and the differences between Positive Accounting Theory and normative accounting theory.

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Positive Accounting Theory
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Introduction
Accounting is a finance language that gives investors and managers an entrenched
structure to present the accounts of a business in a manner that is direct, predictable, and
educational. Most of the assorted accounting guidelines are not naturally or arbitrary occurring,
yet, the existing accounting structure is the result of painstakingly developed exploitations of
theories that strive to trace the finest and the most financially precise techniques for representing
business's performance (Nana, 2018). The two theories are normative accounting and positive
accounting. We should jump into a couple of key differences.
Positive Accounting Theory (PAT) deals with expounding and foreseeing recent
accounting rehearses. This infers the stress is on clarifying and understanding the measures and
the strategies that auditors are using and the reason why they are done with the customary
authentic cost accounting system. Some of the instances for PAT include:
1) Clarifying why companies select explicit accounting tactics
2) Foreseeing which company will oppose revised or new book-keeping rules
3) Clarifying share price responses related with accounting data released.
This methodology can be contrasted normative accounting theory which expel customary
recorded cost accounting as being useless or not helping in making decisions and recommend the
utilization of progressively 'valuable' system of accounting, generally in understanding of
inflation modifications (Penno, 2017). Some of these instances of normative theory are:
1) Specification of the favored measurement system.
2) Theories with regards to the goal of broadly purpose financial reporting.

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3) Defining components of financial statements. Positive bookkeeping
For the Positive Accounting theory, scholars view businesses as collections of pacts sign
into.
The theory arrays that, since establishments are in a general sense about the pacts that
succeed its business, a core driver of organization success is productivity. That implies
restricting the expenses of its pacts to open the most encouragement from them. As of that
premise, Positive Accounting looks at sincere events and tries to understand and after that
anticipate how actual establishments address the accounting actions of those exchanges.
According to this, Positive Accounting Theory takes a glance at genuine world transactions and
events, looks at how businesses are representing those events, and tries to understand the
economic results of those accounting adoptions (Hohik, 2017). With that knowledge, this theory
at that point tries to anticipate how businesses will account for the events and transactions later
on.
On the other hand, the normative accounting theory contends to abide by significant
strategies. Observing what is as of now occurring at organizations, normative accounting theory
states to the accounting strategy makers what must to be done dependent on a speculative
principle. Rationally, normative is all about deductive procedure which contrasts with the
Positive Accounting Theory. Normative commences with the theory and concludes to explicit
policies, while the Positive Accounting Theory begins with explicit strategies and amounts up to
some higher-leveled values (Polulekh, M, 2018).
For instance, most unclear financial safeties possessed by banks earlier, the money linked
emergency were exemplified in a manner like property and other basic assets. The assets were

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not obligatory to be accounted and revalued at their existing market esteems. In any case, that
changed after the crisis when the market for these assets seemed to have evaporated, and
accounting methods were changed to necessitate the assets to be revalued or set apart to be
shown on each financial statement. That made new unaware losses and advantages for the banks
and proved to be a notable driver of loss and profit.
This was a notable alteration in accounting strategy determined by a principle, but not with
the predominant accounting handling set up at the banks keeping the assets. This is one of the
major disadvantages of positive accounting theory. The banks were representing financial
sanctuaries in a manner that buried material variations in their regard that was relevant to the
activity of the banks. That change in esteem was apropos to the financials of the businesses, and
the everyday activities were never again showing an exact portrayal of the business’s financial
position.
On the other hand, the dare for the normative accounting is establishing what accounting
basics should be connected to every situation. When a pact is signed, should the cost and income
from that pact be perceived immediately, increasingly after a while, or as a particular amount
later on? Dependent upon the contract, the business, and the merchandise or services provided.
The appropriate response might be slightly of the three, or a combined figure of each
(Mattessich, 2010).
Thusly, the two concepts supplement one another, each merging in for the faults of the other.
Positive accounting is somehow logical, and dependent on what is really occurring. Normative is
somehow more imaginary, promising that, as everyday does advance, they do not separate from
proper economic concepts. The result is the accounting context that exists today, both principled
and practical.

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2. Reasons that Led to the Improvement of PAT of Accounting Strategy Choice
During the 1970s, Positive Accounting hypothesis picked up strength in accounting research,
for the most part through the supply of capital statistical surveying, as it twisted out to be
obvious that analysts couldn't sanction how to get ready financial summaries till they recognized
whether and additionally how entrepreneurs exploited budget reports in their uncomplicated
leadership. All the same, the initial positive accounting study hinged on perfect market
presumptions where, such as, data is available openly; there are no interchange costs, and
dominant control. These assumptions suggest that investment economic specialists could not
clarify why segment costs did not respond quickly to replicate accounting statistics as expected.
At that point wound up clear to the scientists that they needed a hypothesis to explain why
accounting information were prepared, before they may possibly reveal capital market responses
to accounting facts (Mansbach, 2011). In exploring the market responses to companies,
accounting practices and acquiring exonerations, analysts viewed some factors that encouraged
the advancement of the positive accounting speculations of accounting preparation decision, for
instance,
1) There must to be paybacks in planning money related information since many
organizations willingly took the expenditures of getting ready financial information even
before any guideline supposing them to do as such.
2) Companies look for support in connection to suggested accounting benchmarks, which is
an expensive measure that would be possibly focused by rational supervisors if the
returns exceeded the costs.
3) Firms made consistent patterns of accounting arrangement conclusion that were
recognized with the governance and economic abilities of the businesses (Dobie, 2016).

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4) Firms would in general choose accounting methods that offered conservative procedures
of assets, equity and profit.
Neither capital market nor normative theories could clarify these perceptions. This is the reason
why Positive accounting theory was created as methods to deal with these issues.
Accounting Theories that can be applied when Accounting Standards are being set
In setting accounting standards, Positive Accounting Theory is the kind which needs to be
applied. The positive accounting theory of accounting strategy decision choices makes various
presumptions with respect to manager’s behavior. This theory clarifies the economic results of
existing elective accounting estimation method (Seok-Woong Kim, 2013). There are several
determinants which influence accounting policy decision by looking into past studies. Some of
these are:
1. Firm size is recognized as an intermediary for the radical expenses of the firm. Bigger
corporations in the open eye are probably going to pick accounting strategies which
diminish total compensation to relieve political costs . Interestingly, Rogowska, (2018)
argued that huge corporations are liable to extraordinary basic open examination and
henceforth select income-increase accounting choices. The observational consequences
of this theory are diversified which is steady with (Desmarais-Tremblay, 2014), who
insists that political cost theory would deliver various outcomes in countries which are
still developing. While Rogowska, (2018), Martimort, and Pouyet, (2008) locate that
bigger firms use income-diminishing accounting techniques, bigger firms select income-
expanding accounting choices. In this way, managers of little firms select income-
expanding accounting strategies which may not get wide public consideration. In South

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Asian nations, bigger firms are probably going to be presented to politically visible and,
in this way, hope to utilize income-diminishing accounting methodologies. In light of the
above contentions, the accompanying non-directional theory is planned. Due to these,
Administrators of giant firms pick income-decrease/increase techniques.
2. Assets set up (capital force). (Martimort, and Pouyet, 2008) contend that a capital-
concentrated firm does not charge the opportunity cost of capital in deciding net gain and
in this way will report higher benefits than a labor escalated firm. However, capital-
escalated firms are liable to political expenses and are probably going to lessen detailed
benefit by choosing income-reducing methods. Nana, (2018) additionally contend that
organizations which are exceptionally capital-concentrated are probably going to produce
higher accounting benefits than high-growth alternative firms. More so, Rogowska,
(2018) and Tinker, Merino, administrators of firms with more resources set up are bound
to utilize income-increase accounting methodology. According to this research, directors
pick income-decrease/increase strategies when firms' capital power is higher.
3. Investment chance set. (Desmarais-Tremblay, 2014) invented the word IOS which
portrays firms' an incentive as relying upon optional consumptions. As per Nana, (2018),
it likewise shows organizations' development prospects and development openings. The
contracting cost theory expresses that the IOS impacts contracts set up, thus an
administrator's accounting strategies are somewhat determined by the association's IOS.
IOS is characterized as the "degree to which firm esteem relies upon future optional
consumptions by the firm". Rogowska, (2018) speculates that organizations with higher
IOS give real or future productivity and administrators utilize their carefulness to expand
accounting income. To begin with, Martimort, and Pouyet, (2008) and, later, Tinker,

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Merino, and Neimark, (1982) look at the relationship between an association's IOS and
its accounting decisions and give mixed outcomes. (Desmarais-Tremblay, 2014) reports
that IOS is emphatically connected with an association's income expanding accounting
strategies, while (Martimort, and Pouyet, 2008) find that bookkeeping decisions are
adversely connected with IOS. Earlier research, for example, Polulekh, 2018 and
Rogowska, (2018) use IOS intermediaries in accounting policy decision studies.
Following earlier research, we build up the following non-directional theory that
Supervisors use income-decrease/increase accounting strategies when the IOS is higher.
4. Financial influence/obligation agreements. The Debt Covenant Theory expresses that as
firms with a larger amount of obligation are compelled by debt covenant, owners of these
organizations select income-increase accounting techniques to lessen the likelihood of
covenant infringement and stay away from the potential expenses of renegotiation of
obligation contracts (Nana, 2018). On the off chance that they disregard obligation
pledges, firms may cause huge expenses including lawful charges and renegotiation
expenses and may have issues in getting external credits (Desmarais-Tremblay, 2014).
The vast majority of the earlier research utilizes influence proportion as an intermediary
for the infringement by a firm of its obligation covenant. Debt holders are probably going
to screen firms' presentation and see whether firms are disregarding obligation covenants.
Past researches (Nana, 2018; Martimort, and Pouyet, 2008; Polulekh; Rogowska, (2018)
demonstrate that utilized firms have more noteworthy motivations for income-increase
accounting systems to keep away from requirements on manager’s conduct forced by
debt contracts that limit their opportunistic conduct. In South Asian nations, business
banks and concentrated financial organizations as a rule give fund to firms. Firms are

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required to present their yearly reports preceding the endorsement of an advance just as
all the time amid the term of that credit. Following the obligation pledge contention, we
can say that as banks assume a significant job in financing, they force imperatives that
organizations ought to set out on gainful task; therefore, firms taking advances are slanted
to expand profitably. The above dialog prompts the accompanying theory that
organizations select income-increase techniques when organization’s debt-equity
proportion is higher (Nguyen & Gong, 2014).
5. Profitability. Another contributing factor of accounting strategy decision is whether a
firm has an impetus pay plan (Alesina, and Tabellini, 1992; Deegan, n.d; Martimort, and
Pouyet, 2008; Rogowska, 2018). Nana, (2018) argues that short-term contracts are
generally attached to detailed income. On the off chance that organizations’
compensation is attached to accounting earnings, at that point it is normal that they will
pick accounting strategies that will somehow increase revealed income if a part of their
salary is acquired from motivator plans (Desmarais-Tremblay, 2014). As indicated by the
bonus-plan theory, business owners whose extra installments are found out based on
detailed pay are probably going to utilize an income-expanding accounting strategy
(Polulekh, 2018 and (Rogowska, 2018). Nana, (2018) discovers that the decision of an
income-expanding accounting technique is emphatically connected with a company's
productivity. An organization based in South Asian for the most part don't unveil bonus
ideas in their yearly information, they use productivity as an intermediary for these
bonus. According to this report, one can agree that organization use income-expanding
accounting arrangement decisions when their reward is tied with detailed benefit.

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6. There have been several other researches which ruminates taxes as one of the variables
impacting accounting arrangement decision literally, and they are viewed as one of the
proportions of political costs. Tax rules, are seen as contracts between the government
and these organizations, and are probably going to affect the accounting approach
decision (Nana, 2018). (Desmarais-Tremblay, 2014) analyze whether organizations
choice of accounting techniques to limit the current estimation of taxes. They contend
that organizations might pick accounting approaches limiting or conceding taxes. The use
of tax rates as the revenue tax isolated by overall revenue before the tax following earlier
research is used. (Deegan, n.d.). This prompts our last theory that administrators use
income-decrease strategies when these tax rates are higher.
Conclusion
Accounting standards are subjective in a way that powerful accounting theories are applicable in
preparation of financial records. Thus the most significant part of accounting theories is its
usefulness. This, in the corporate-finance world, implies that every fiscal report ought to give
significant data that can be used to settle on informed trade choices. This likewise suggests that
the accounting theories are knowingly adaptable so they can create compelling financial related
data, notwithstanding when the authorized condition changes. Adding to its worth, accounting
theories articulates that every accounting data ought to be important, dependable, practically
identical and reliable. This implies that each financial summary must be exact and stick with the
Generally Accepted Accounting Principles (GAAP). Devotion to the GAAP enables the planning
of financial reports to be predictable and similar to an organization's former financials, just as of
other organizations. Last but not least, accounting theory necessitates that each financial and
accounting specialists work by the four assumptions. The primary assumption states that a

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corporate is isolated from its owners. Secondly, it certifies the principle that businesses will
continue to occur and not go bankrupt. Thirdly, it adopts that every fiscal summary is set up with
dollar quantities and not with different quantities like unit fabrication. At last, all financial
reports need to be set up once a year or once a month.

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