Theories of Accounting

Introduction

Both positive accounting and critical theoretical perspectives are sets of suppositions, outlines and methodologies applied in the study and utilization of financial reporting codes. The two theories form the historical foundations of accounting practices and the way in which accounting practices are embraced and incorporated in the regulatory framework that regulates financial statements and financial reporting. The following discussion critically evaluates the value and purpose of accounting standards from the perspectives of the two theories.

Positive Accounting Theory

Positive accounting theory tries to give some description of accounting principles founded in the purposes of executives. The pioneers of the theory, Watts & Zimmerman try to create positive theories that help in accounting standards determination. In this case, accounting standards mean the accounting measures that encompass the regulations used in the integration of transactional events into finances reporting. According to the positive theorizers, for an accounting action to be described using a positive theory, it needs to specifically comprise the measures employed by analysts to compute such things like total liabilities, total assets, net income, owners’ equity, etc.  The positive accounting theoretical perspective highlights the significance of explaining an event and relating it to its causes. In accounting standards, the theory argues that people act to capitalize on their own utility (Williams 1989). The typical application of this hypothesis is that executive advocate for accounting standards depending on their own self-interest.  In regard to this, the first theoretical proposition of the positive accounting theory is considering the financial self-interests of executives as a determiner of their likings for accounting measures. Moreover, the positive theorists consider the likings of executives for accounting measures to have an impact on the apparent set of current accounting measures.

Based on the view of positive theorists regarding management, their view is that the management is manipulative. This implies that the preferences for accounting procedures for the managers are for those that enable them to report narratives that are beneficial to them economically. According to Watts & Zimmerman, the positive accounting theory offers investors and financial analysts a significant predictive model of the accounting procedures essential to financial statements. In the modern world, this is applicable because utilizing the theory, analysts or investors don’t consider balance sheet and earnings figures as impartial approximates of the value of firm and alterations in the value of the firm. Instead, they take into consideration the impact of political processes and contracting on the computation of incomes and balance sheet figures. For instance, the incentive of the executive to select incomes decreasing or increasing accounting methods is dependent on the current payment and debt contracts. Supposing the analyst is aware of the contracts, he or she can adjust the reported numbers (Gendron 2018). What positive theorists assert is that for the aims of financial analysis, accounting standards are influenced by the unscrupulous behavior of the administration and that this behavior is determined by their values.

The perspectives of the positive accounting theory are concerned with forecasting actions such as the choices of accounting policies by firms and the responses of firms to the existing accounting standards. Positive theorists assist in the reconciliation of efficient securities market theory with economic impacts through asserting the contracts that firms enter into are responsible for the management’s concern regarding accounting standards.  In regard to positive accounting theory, the positive theorists have formulated the hypothesis that is regarded to be influential in determining the decisions that stakeholders take considering accounting standards. First, the bonus plan hypothesis is related to the maximization of compensation. According to the positive theorists, when all things are equal, the management of companies with bonus plans is more possibly going to choose the accounting standards that will favor the shifting of the reported earnings from future periods to the present period.  Second, there is the debt covenant hypothesis that is related to the minimization of the problems with the creditors. The hypothesis shapes positive theorists in that it influences their decisions concerning the accounting standards related to creditors (Nobes 2014). According to the hypothesis, when all other things are held equal, the more a company is close to violating debt contracts that are account-based, the more possibly the company’s management is to choose accounting standards and policies that will shift the reported earnings from future periods to the present period. Lastly, there is the political cost hypothesis that is related to the minimization of the political heat. It supposes that when all other things are held equal, the higher the political cots a firm faces,  the more possible that the management will opt for the accounting standards and policies that will assist in deferring reported earnings from present to future periods.

The positive accounting theory perspectives forecast that managers will select account standards with the aim of furthering the above-mentioned objectives.  This implies that although the accounting standards and policies that managers select are usually within the scopes of GAAP, the possibility of reporting different accounting variables in the wrong section occurs (Godfrey et al 2010).

 

 

Critical Accounting Theory

According to critical theorists, critical accounting theory entails a strategy of accounting research that goes beyond questioning if specific strategies of accounting need to be used and instead concentrates on the role of accounting standards in maintaining the powerful stakeholders that are responsible for the regulation of specific resources like capital while minimizing or limiting those without capital. The goal of accounting standards in the society is to ensure financial information provided during reporting will be correct to assist stakeholders to make short and long term economic decisions. according to critical theorists, justification of a company’s operations are mainly done through accounting practices and also it is through the accounting standards that companies provide pieces of evidence like liabilities, assets, expenses, income, and equity (Deegan and Unerman 2011). Critical theorists consider accounting standards as a framework that legitimize the ongoing existence of the firm and fulfilling the ‘social contract’ between society and organization. Moreover, they argue that the motive of legitimation is possibly harmful, specifically if it legalizes activities that are not in the best interests of specific classes in society and benefits those strong stakeholders. For critical theorists, they consider accounting standards to regulate the disclosures of both financial and non-financial information are applied intentionally to support specific social structures and stakeholders that ends up benefitting a group of people on the expense of others.

Critical accounting theory claims that firms deliberately reveal non-financial information to legitimize their behavior. In regard to this, the theory claims that firms only react to specific concerns that have emerged in relation to their operations in regard to the survival as opposed to a liability owed to society at large. Besides, critical theorist claims corporate survival is linked to legitimizing disclosures. This implies that management only follows the accounting standards when they are needed to do.  Accounting standards result in the existence of limited disclosures because of limited concerns. Critical theory perspectives consider accounting standards being helpful in assisting establish reality and are considered as a way of establishing or making a specific social structure legitimate. This means that financial reports can be created and assessed without effective market intrusion (Edwards 2013). Critical theorists claim that accounting standards do not produce an objective representation of economic reality and the agenda behind it is to transfer wealth to another specific group of people.  This is connected to the positive accounting theory that claims that all people’s action is motivated by self-interest and people will behave in an opportunistic manner to the extent that the actions will result to an increase of their wealth. For instance, the management of a company with bonus plans is more possibly going to apply accounting policies that will increase the present period reported income. This will entail increasing the present values of bonuses paid to management and assist them to attain their bonus and incentives.

According to critical theorists, the major objective of accounting standards results to the creation of unequal distributions of wealth and power across society, taking into consideration that accounting practices are in the hands of reporting entities and regulation of accounting is in the hand of government and associated regulatory agencies. Accounting standards are perceived to empower only those who use them like organizations were mostly is applied to legitimize myths. Thus, accounting standards are considered being conceptual frameworks that are utilized to legitimize and self-regulate the accounting profession and are normally used to assist powerful stakeholders to legitimize their financial reports or attain their incentives (May 2013). Critical theorists consider accounting standards as tools used in manipulating figures, as strategies of distributing wealth, and as ways of legitimizing financial reports. In most cases, accounting standards favor the powerful and wealthy in society.

Conclusion

The evaluation of both critical accounting and positive accounting theories reveals that they interpret and apply accounting standards in different ways. The positive accounting theoretical perspective highlights the significance of explaining an event and relating it to its causes. In accounting standards, the theory argues that people act to capitalize on their own utility. The typical application of this hypothesis is that executive lobbies on accounting standards depending on its own self-interest. For instance, the incentive of the manager to select incomes decreasing or increasing accounting methods is dependent on the current compensation and debt contracts. On the other hand, Critical theorists consider accounting standards as a framework that legitimize the ongoing existence of the firm and fulfilling the ‘social contract’ between society and organization. Moreover, they argue that the motive of legitimation is possibly harmful, specifically if it legalizes activities that are not in the best interests of specific classes in society and benefits those strong stakeholders. Thus, accounting standards are considered being conceptual frameworks that are utilized to legitimize and self-regulate the accounting profession depending on the principles of the theory adhered to.

 

 

 

 

 

 

References

Deegan, C. and Unerman, J., 2011. Financial accounting theory: European edition. McGraw-Hill.

Edwards, J.R., 2013. A History of Financial Accounting (RLE Accounting). Routledge.

Gendron, Y., 2018. On the elusive nature of critical (accounting) research. Critical Perspectives on Accounting, 50, pp.1-12.

Godfrey, J., Hodgson, A., Tarca, A., Hamilton, J., and Holmes, S., 2010. Accounting theory.

May, G.O., 2013. Financial accounting. Read Books Ltd.

Nobes, C., 2014. International classification of financial reporting. Routledge.

Williams, P.F., 1989. The logic of positive accounting research. Accounting, Organizations and Society, 14(5-6), pp.455-468.

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