Accounting

Accounting 1.1

Theory

Chapter 1: Introduction to financial accounting theory

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, these assumptions might relate to such things as what motivates people, or what is the central objective of accounting.) Positive theories are typically evaluated by considering how well the explanations or predictions relate to actual observations. Normative theories are not 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 valuation. The theory should not be considered as invalid if people currently do not adopt the prescribed approach to asset valuation.

1.2

A conceptual framework, such as the International Accounting Standards Board (IASB) Framework, provides some fundamental assumptions about the role of general purpose financial reporting and the attributes that financial information should possess for it to be useful in assisting the resource allocation decisions of financial statement readers. As indicated in this chapter, the United States’ Financial Accounting Standards Board (FASB) defined a conceptual framework as ‘a coherent system of interrelated objectives and fundamentals that can lead to consistent standards’. Because conceptual frameworks provide perspectives about such issues as: the qualitative characteristics that financial information should posses; the identification of the types of entities that should produce general purpose financial reports; the way in which the elements of financial accounting should be defined and recognised, and so forth (note the emphasis on ‘should’), the conceptual frameworks—in providing prescription—are considered to be normative...