- Importance of Accounting Principles
- An Introduction to Managerial Accounting & Cost Concepts
- Agency Theory vs. Accounting Theory
- The Difference Between FASB, GASB & Statement of Cash Flows
- A Comparison of Financial Ratio to Industry Average
- Difference Between Income Statement vs. Balance Sheet vs. Cash Flow
In some ways, economics is both a science and an art. An investor can look at financial data to determine the most financially stable or attractive stocks to purchase. At the same time, the money invested in a company is a statement of what products or services an investor finds worthwhile. This dichotomy in economics is expressed through the ideals of positive and normative accounting.
Positive economic theory and accounting practices are objective and based on fact. Positive accounting focuses on analyzing the economic statistics and data at hand, and deriving conclusions based on those figures. For example, if corporate growth allows a company to increase shareholder dividends over previous dividend payments, positive accounting theory would conclude that corporate growth causes a rise in stockholder dividends. Most bookkeeping and data collection involved with accounting relates to positive economic theory.
Normative economic theory is subjective and aims to describe what the economic future should be for a company or investor. As a result, normative accounting practice is a form of value judgment that can introduce subjective morality into accounting. For example, if a company that increased dividend payments could use some of those funds to improve corporate sustainability measures, a normative accounting statement would indicate how much money should be invested in those measures to sustain corporate growth. Normative accounting also deals with future events rather than past data, which is the domain of positive accounting practices.
When to Use
Positive accounting practices are best used to explain past financial events, as well as the causes of a business's or individual's current financial standing. Determining why a company is operating at a net loss requires the positive accounting practices of comparing actual revenue to actual expenses over the course of a year. These accounting practices are typically used to construct financial documents, such as balance sheets or cash flow statements. Normative accounting practices are best used when trying to set future economic policy based on theory. A company's mission statement or the market strategies included in business plans can be viewed as normative statements -- they reflect the business ideals that a company wants to accomplish.
Proper financial planning for any business or individual requires the use of both positive and normative accounting practices. On a large scale, economists indicate financial policies through normative accounting statements, but these normative statements must be based on the financial realities found through positive accounting practices. The factual-based practices of positive accounting provide a foundation for companies to engage in normative accounting, and a more idealistic view of how the company can operate while still earning a profit.