L012

Summary Loi The philosophy of positive accounting theory The philosophical objective of positive
accounting theory is to explain and predict the application of accounting practice. It also seeks to explain
how and why capital markets react to accounting reports. In contrast, normative or inflation theorists often
argue for a change in accounting method without putting forward any supporting empirical evidence and
without trying to understand the rationale for current and past use of accounting principles and rules.
Positive theory has an empirical economic focus- It assumes investors and financial accounting users and
preparers are rational utility maximisers. Positive theorists reject arguments based on anecdotal evidence,
and call for the testing of normative assumptions.

loi 2 The strengths of positive theory The strengths of positive theory lie in the fact that hypotheses are
framed in such a way that they are capable of falsification by empirical research. Researchers aim to provide
an understanding of how the world works rather than prescribing how the world should work. In capital
market research that means understanding the association of accounting numbers and stock prices.
Researchers attempt to understand the connection between accounting information, managers, firms and
markets and to analyse those relationships.

loi 3 The scope of positive accounting theory Positive theory developed in two stages. lhe first stage
involved research into the impact of accounting and the activity of capital markets. The second-stage
literature sought to explain and predict the application of accounting practices across firms.

loi 4 C.apital market research and the efficient markets hypothesis Two types of capital market research are
particularly important to positive accounting theory: ( I ) those studies that attempt to determine the impact
of accounting information on share returns, and (2) those studies that consider the effects of changes in
accounting policy on share prices. Most research in these areas has been conducted by testing the semistrong
form of the efficient markets hypothesis (EMH). Event studies, association studies and the mechanistic
behavioural approaches are examples of research, which tests relationships in capital markets.

loi 5 The influence of accounting information on investor behaviour and share prices 'Ihe major results
suggest the following:
• Historical cost profit releases have information content for the marketplace in terms of CARS and the
effect on volatility and trading volume.
• Information (which is by size) price changes, the of price changes, and of
•is a continuous by and, accounting reports not the only sources of studies show that a of
including,uncertainty, size, industry, interest financial potential and and temporary profits a role In value,
Adding profit (as well as changes in profit),components, adding cash flows, accruals and balance well
taking into account broader macroeconomic factors further power of accounting variables.