Free Essay

Positive Accounting Theory

In: Business and Management

Submitted By ayurishi
Words 3323
Pages 14
Qualitative characteristics in accounting disclosures: a desirability trade-off

Malcolm Smith Associate Professor of Accounting, School of Economics and Commerce, Murdoch University, Perth, Australia

A number of studies in the USA, UK, Australia and Canada have addressed the evaluation of the usefulness of accounting information and sought to identify criteria for assessing the quality and utility of financial reports (e.g. Institute of Chartered Accountants in England and Wales (1975), Financial Accounting Standards Board (1980), Institute of Chartered Accountants in Scotland (1988), Accounting Standards Board (1991)). The qualitative characteristics viewed as desirable for the fulfilment of the fundamental objective of communicating decision-useful measurement recognize that all of these characteristics are not simultaneously achievable and that some trade-off is necessary. Examines the nature of this conflict of objectives and attempts to quantify the extent of the conflict for different user groups.

Introduction
Since the late 1960s research efforts regarding a conceptual framework have been commissioned in response to mounting public and professional pressure with regard to the nature of corporate reporting and deficiencies in the accounting standard setting process. Peasnell[1, p. 254] with respect to the Financial Accounting Standards Board (FASB) conceptual framework observes: “it perceives a need to show that its heart and mind are in the right place: to demonstrate that it is trying by logical means to develop accounting standards based on principles of general appeal”. If accounting standards and the resulting disclosures are to meet the varying and potentially conflicting needs of all user groups, then such standards should be adaptive to the changing requirements of interested parties. The presence of a conceptual framework should guide the standard setting process by deriving relevant usergoals consistent with the definitions and qualitative characteristics of its elements. The Corporate Report of the Accounting Standards Steering Committee, Institute of Chartered Accountants in England and Wales (ICAEW) (1975)[2] identifies seven qualitative characteristics viewed as desirable for the fulfilment of their fundamental objective of communicating decision-useful measurements: 1 relevance; 2 understandability; 3 reliability; 4 completeness; 5 objectivity; 6 comparability; 7 timeliness. That these characteristics are desirable is not in doubt, rather the problem is that they are not simultaneously achievable (and may, in any case, be ambiguous in meaning). Their very nature makes a conflict of objectives inevitable and this paper seeks to examine and quantify this conflict. The Corporate Report[2] provides no indication of perceived importance of the desirable attributes. It is apparent that all may not be capable of simultaneous achievement, and it

Managerial Auditing Journal 11/3 [1996] 11–16 © MCB University Press [ISSN 0268-6902]

is evident that some compromise position is necessary in order to satisfy an inevitable conflict in objectives. The desirable compromise position, and the permitted trade-off between properties, will likely depend on both the user-group and the decision-making context. Thus, the sevenfold classification of The Corporate Report[2] might, a priori, be aggregated as shown in Figure 1. Such divisions are consistent with the approaches of the accounting standard setting bodies. Thus FASB[3] makes a clear distinction between those qualities viewed as user-specific and those inherent in the information. Relevance, reliability and comparability are apparently viewed as the key attributes, with other characteristics viewed as sub-attributes contributing to the fulfilment of the key properties. A “materiality threshold” is suggested such that the benefits provided by the disclosure of information should exceed its cost. FASB[3] admits that there may be a tradeoff between relevance and reliability, indicating that although ideally the choice of an accounting alternative should produce information that is both more reliable and more relevant, it may be necessary to sacrifice some of one quality for a gain in another. Understandability is viewed as a user-specific property in the FASB model, desirable, but one whose importance is played down, since the understandability of the information is related to both the characteristics of the information and of the information-user making it difficult to evaluate without reference to a particular set of decision makers. Given that information can only be useful if it can be understood, even though it may be reliable and relevant to the decision-making context, this lack of emphasis may not be wholly appropriate. Stamp[4], operating within a Canadian context, emphasizes that not only is “understandability” user-specific, but so is “relevance”, since any judgement of relevance must be made relative to user needs and the decision-making context. Solomons[5, p. 30] emphasizes this point: “Relevance must come first, for if information is irrelevant, it does not matter what other qualities it has”.

[ 11 ]

Malcolm Smith Qualitative characteristics in accounting disclosures Managerial Auditing Journal 11/3 [1996] 11–16

Figure 1 Aggregated classification of The Corporate Report Usefulness Accuracy Validity

Reliability Timeliness Completeness Objectivity

Understandability

Readability

Stamp identifies several pairs of criteria that might be perceived to be in conflict, so much so that a trade-off is necessitated in their fulfilment. However, he makes no attempt to quantify the nature and extent of such tradeoffs, preferring to develop absolute weighting scores for each of the criteria. However, as Stamp emphasizes, there are no generally accepted definitions of the criteria employed and semantic differences may influence user preferences; the criteria employed are neither mutually exclusive nor collectively exhaustive. Their meanings clearly overlap and it is possible that all desirable aspects have not been completely covered. In any case it may be unrealistic to expect a consistent assignment of absolute numerical weightings to qualitative criteria, since such a ranking system is likely to be decision specific. In such circumstances it may be more appropriate to evaluate relative weightings by examining the trade-off between conflicting characteristics for particular user-groups. A number of studies (notably Stanga[6] and Duncan and Moores[7]) have already addressed the issue of a trade-off between relevance and reliability, concluding that a positive association exists between the two, with minimum levels of reliability necessary to achieve relevance. This study tackles the other trade-offs too. The corporate governance debate generated by the Cadbury Committee Report[8] in the UK and the COSO Report[9] in the USA have clear implications for qualitative characteristics. The COSO Report emphasizes the importance of both “information and communication” while the Cadbury Report emphasizes, in its code of best practice, the duty of the board to present an assessment of a company’s position which is both balanced and understandable. Recognition of the importance of understandability highlights the need for both words and figures in explaining a company’s position. In

[ 12 ]

{

Relevance Comparability

Quality of content

Quality of presentation

Australia, qualitative characteristics are implicit in a number of financial reporting reforms recommended by the ASCPA/ICAA [10, para. 3026] as a consequence of this debate, which would improve relevance and comparability and highlight the need for timely information, future oriented information, consistency of accounting policies and a preference for substance over form. FASB[3] identifies three criteria for the assessment of qualitative criteria: 1 Convergent validity of operational characteristics. The same decision context should result in coincident ratings of particular characteristics. 2 Predictive validity. A comprehensive set with all important factors represented. 3 Discriminant validity. A parsimonious set of characteristics with minimum overlap. Joyce et al.[11], in an empirical study with a group of US policy makers, embracing alternative policy decisions, find such a model almost completely non-operational and highlight that: • scarcely any common meaning is attributed to the same qualitative characteristic by different policy makers; • scarcely any common meaning exists for the same qualitative characteristics across different accounting issues; • little agreement exists on the importance of characteristics ranked for different issues; • virtually no agreement exists among policy makers on which accounting alternative provided more of a particular characteristic. However, individual participants had little difficulty in expressing global policy preferences consistently through the qualitative characteristics, and characteristic rankings were a good predictor of individual participants’ policy choice. Joyce et al.[11] find that the accounting standard setters, though consistent as individuals, vary greatly between themselves with regard to the relativities accorded different qualitative characteristics. Such a finding makes group preference weightings largely inappropriate for this set of respondents, but needs testing with other, arguably more diverse, user groups. Further, the Joyce et al.[11] findings make it difficult to justify a complex experimental design with multiple policy scenarios used to provide decision contexts; individual differences are more significant than those attributable to the scenarios. In this study, therefore, global policy preferences are explored, without regard to a specific decision context. As with the earlier Stamp[4] study, Joyce et al.[11] confine their attention to accounting policy standard setters. There is no attention

        

Malcolm Smith Qualitative characteristics in accounting disclosures Managerial Auditing Journal 11/3 [1996] 11–16

to the needs of other users of accounting information. This present study corrects this deficiency by seeking the participation of two other sub-groups among those with high levels of accounting sophistication: the first being accounting practitioners from a Big 6 enterprise; and the second being graduate students of an MBA Finance programme. Differences in the performance of members of these two sub-groups might be anticipated where the task domain requires measurement of their perceptions of the relative importance of different qualitative criteria. However, Ashton and Kramer[12] and Zimmer[13] suggest that students make excellent surrogates for practitioners in behavioural accounting research involving simple decision tasks. This application is concerned with 21 similarity judgements (i.e., 7C2 being all combinations of two qualitative properties from the seven (stimuli) deemed desirable by The Corporate Report[2]). Schiffman et al.[14] recommend the use of an undifferentiated 5in. scale to record respondents’ similarity judgements. They suggest that a 4in. line will compress results, while a 6in. line will encourage the non-use of the right-hand scale. The line used is not differentiated in any way (i.e. no boxes, numbers, synonyms or verbal descriptors) to avoid the potential for bias. These suggestions are incorporated into the test instrument.

To explore the potential of the research approach two groups of respondents were identified: 1 A group of “users”. Forty MBA Finance students at a UK university business school skilled in financial statement analysis and already familiar with those properties deemed desirable in accounting communications. 2 A group of “auditors”. Eighteen practicising accountants from the London office of a “Big 6” accounting firm, comprising three partners, five managers, three assistant managers, four supervisors and three seniors. Each group was supplied with an abstract from The Corporate Report in which the properties are designated and a brief reinforcement of each of the seven properties, and their meaning. Respondents were required to quantify their ranking of characteristics by indicating their preference between pairs of properties. This preference was stated in a measurable way by showing the trade-off that each respondent thought permissible; that compromise position whereby a degree of one property might be sacrificed for part of the other. The 21 pairs of properties (all combinations of 2 from 7) are distributed randomly, for order and for position on the left-hand or right-hand of the test instrument scale of Figure 2, to ensure, as far as possible, that 21 separate decisions were made.

Figure 2 Experimental task: property trade-offs

[ 13 ]

Malcolm Smith Qualitative characteristics in accounting disclosures Managerial Auditing Journal 11/3 [1996] 11–16

Respondents were asked to mark each line with an “X” to indicate their preferred position. Thus, for the first trade-off “reliability v. relevance” an “X” at the extreme left-hand end of the line indicates an absolute preference for “reliability” which sacrifices all “relevance”. Realistically, we would expect the “X” to be positioned part way along the line to indicate a trade-off which expressed a preference for reliability . A 40-point measurement scale was used. A score of 20 represented indifference between the two properties. The results and responses represent the satisfaction of inter-property conflict on an individual basis.

Results
Table I details each of the 21 trade-offs together with the mean preference scores corresponding to the two-user groups. In each case the lower the score, the greater the preference for the left-hand characteristic in the trade-off. Low scores are particularly apparent, in both user groups, for preferences associated with the “reliability” characteristic.

Despite some apparently large differences between groups in scores between user groups, such are the sizes of standard deviations that none of the mean differences is significant at the 5 per cent level. Aggregation of the trade–offs by characteristic (i.e. six for each) reveals a strong preference for reliability, objectivity and relevance among both sets of respondents in their perceived importance of the different properties. Table II displays the mean scores recorded. None of the differences in preference percentages or ranks is significantly different at the 0.025 level between the groups despite the likely individual differences attributable to education and experience. The preference for reliability is marked in both groups, a result significantly at variance with that of Stamp[4], who reported a clear preference for “relevance” among accounting professionals. The overriding common feature is that the scores recorded for both groups reflect a positive preference for the same three qualitative characteristics (reliability, relevance and objectivity). The distribution of properties for each respondent group is so close as to suggest that

Table I Mean trade-off scores for two user groups Trade-off 1 Relevance – understandability 2 Relevance – reliability 3 Relevance – completeness 4 Relevance – objectivity 5 Relevance – timeliness 6 Relevance – comparability 7 Understandability – reliability 8 Understandability – completeness 9 Understandability – objectivity 10 Understandability – timeliness 11 Understandability – comparability 12 Reliability – completeness 13 Reliability – objectivity 14 Reliability – timeliness 15 Reliability – comparability 16 Completeness – objectivity 17 Completeness – timeliness 18 Completeness – comparability 19 Objectivity – timeliness 20 Objectivity – comparability 21 Timeliness – comparability Note: Standard deviations in parentheses [ 14 ] Mean scores MBA group (n = 40) Accountants (n = 18) 15.65 22.30 13.78 17.75 19.35 17.90 26.45 18.35 24.10 20.53 21.88 11.65 15.53 16.05 13.00 23.45 22.40 23.18 19.73 19.32 18.87 (10.38) (8.91) (8.20) (8.99) (8.29) (9.23) (7.90) (9.52) (9.82) (9.23) (8.82) (6.52) (7.21) (8.14) (9.09) (9.52) (8.91) (8.12) (9.46) (9.57) (8.53) 19.22 21.50 18.44 20.33 17.61 19.33 24.11 18.50 21.78 18.17 20.00 13.39 18.11 16.22 15.00 23.39 18.17 18.67 15.67 18.39 22.56 (9.61) (11.80) (9.87) (10.24) (9.38) (9.39) (9.43) (11.71) (8.43) (10.73) (7.57) (7.45) (7.96) (11.32) (9.55) (8.76) (11.19) (10.85) (6.02) (7.32) (8.93)

Malcolm Smith Qualitative characteristics in accounting disclosures Managerial Auditing Journal 11/3 [1996] 11–16

Table II Relative desirability of qualitative characteristics MBA students (n = 40) Preference (%) Mean SD 18.2 15.9 14.4 14.2 13.6 12.4 11.3 100 3.5 4.0 4.2 4.7 4.5 5.1 3.9 Rank Mean 2.3 3.4 3.9 4.1 4.3 4.7 5.2 SD 1.3 1.8 1.8 2.1 1.9 2.1 1.5 Accountants (n = 18) Preference (%) Mean SD 17.0 14.7 15.4 12.3 13.6 13.9 13.1 100 4.1 4.5 2.8 4.8 3.8 3.4 5.0 Rank Mean 2.9 3.7 3.4 4.8 4.2 4.2 4.7 SD 1.7 2.2 1.6 2.3 1.9 1.4 1.9

Property Reliability Relevance Objectivity Timeliness Comparability Understandability Completeness

they provide user groups of similar needs, forming sub-groups within a “sophisticated” accounting audience. In fact, a linear discriminant analysis, treating accounting practitioners and MBA students as separate groups, classifies only 69 per cent of subjects correctly based on their preference profiles for qualitative characteristics.

differences between these two sets of users certainly appears insufficient to justify a difference in financial reporting approach.

References
1 Peasnell, K., “The function of the conceptual framework for corporate financial reporting”, Accounting and Business Research, Vol. 12 No. 48, Autumn 1982, pp. 243-56. 2 Institute of Chartered Accountants in England and Wales (ICAEW), The Corporate Report, Accounting Standards Steering Committee, London, 1975. 3 Financial Accounting Standards Board (FASB), Statement of Financial Accounting Concepts No 2. Qualitative Characteristics of Accounting Information, 1980. 4 Stamp, E., “First steps towards a British conceptual framework”, Accountancy, Vol. 93, March 1982, pp. 123-30. 5 Institute of Chartered Accountants in England and Wales (ICAEW), Guidelines for Financial Reporting: The Solomons Report, ICAEW, London, 1989. 6 Stanga, K.G., “The relationship between relevance and reliability: some empirical results”, Accounting and Business Research, Winter 1980, pp. 29-39. 7 Duncan, K. and Moores, K., “Usefulness of CCA information for investor decision making: a laboratory experiment”, Accounting and Business Research, Vol. 18 No. 70, Spring 1988, pp. 121-32. 8 Cadbury Committee, Report of the Committee on the Financial Aspects of Corporate Governance, Cadbury Committee, London, 1992. 9 Committee of Sponsoring Organisations (COSO) of the Treadway Commission, Internal Control – Integrated Framework, Washington DC, 1992. 10 Australian Society of Certified Accountants/ Institute of Charted Accountants Australia, Bridging the Expectations Gap: a Research

Conclusions
The empirical findings for both MBA Finance students and accounting practitioners demonstrate preferences which suggest that these users are prepared to sacrifice completeness, comparability, timeliness and understandability in disclosures in return for reliability, objectivity and relevance. This preference for reliability and relevance is consistent with the proposals of accounting standard–setters worldwide, and may be attributable to a correspondence of the user groups concerned with the sophisticated target user designated by the accounting standard-setters. Respondents perception of the relative importance of understandability is apparently also consistent with the subservience attached to it by the accounting standard setters though at odds with the Cadbury Committee’s “Code of Best Practice”[8]. This study demonstrates considerable homogeneity within sophisticated user groups, greater than that evident in studies of accounting standard setters. By highlighting the conflict inevitable in seeking to satisfy simultaneously mutually incompatible characteristics, this paper demonstrates common preferences in user groups sufficient to provide encouragement to standard setters in their desire to target a single sophisticated target user group. The

[ 15 ]

Malcolm Smith Qualitative characteristics in accounting disclosures Managerial Auditing Journal 11/3 [1996] 11–16

Study on Financial Reporting and Auditing, Melbourne/Sydney, 1994. 11 Joyce, E.J., Libby, R. and Sunder, S., “Using the FASB’s qualitative characteristics in accounting policy choices”, Journal of Accounting Research, Vol. 20 No. 2, Part 2, Autumn 1982, pp. 654-75. 12 Ashton, R.H. and Kramer, S.S., “Students as surrogates in behavioural accounting research: some evidence”, Journal of Accounting Research, Vol. 18, Spring 1980, pp. 1-15. 13 Zimmer, I., “A lens study of the prediction of corporate failure by bank loan officers”, Journal of Accounting Research, Vol. 18, Autumn 1980, pp. 629-36.

14 Schiffman, S.S., Reynolds, M.L. and Young, F.W., Introduction to Multidimensional Scaling: Theory, Methods and Applications, Academic Press, New York, 1981.

Further reading
Accounting Standards Board (ASB), Qualitative Characteristics of Financial Information, ASB, London, July 1991. Institute of Chartered Accountants in Scotland (ICAS), Making Corporate Reports Valuable, ICAS, Edinburgh, 1988. Jensen, R.E., Phantasmagoric Accounting, American Accounting Association, Sarasota, FL, 1976.

[ 16 ]…...

Similar Documents

Premium Essay

Positive Accounting Theory, Political Costs

...POSITIVE ACCOUNTING THEORY, POLITICAL COSTS AND SOCIAL DISCLOSURE ANALYSES: A CRITICAL LOOK Markus J. Milne Accountancy and Business Law University of Otago Dunedin New Zealand Ph: 64-3-479-8120 Fax: 64-3-479-8450 Email: mmilne@commerce.otago.ac.nz POSITIVE ACCOUNTING THEORY, POLITICAL COSTS AND SOCIAL DISCLOSURE ANALYSES: A CRITICAL LOOK* ABSTRACT This paper critically reviews the literature seeking to establish evidence for a positive accounting theory of corporate social disclosures. It carefully traces through the original work of Watts and Zimmerman (1978) showing their concern with the lobbying behaviour of large US oil companies during the 1970s. Such companies were argued to be abusing monopolists and likely targets of selfinterested politicians pursuing wealth transfers in the form of taxes, regulations and other ‘political costs’. Watts and Zimmerman’s reference to “social responsibility” is shown to be a passing remark, and most likely refers to “advocacy advertising”, a widespread practice amongst large US oil companies at that time. Subsequent literature that relies on Watts and Zimmerman to present a case for social disclosures is shown to extend their original arguments. In the process, concern over the “high profits” of companies is shown to diminish, and the notion of political costs is so broadened that it blurs with other social theories of disclosure. Consequently, the positive accounting based social disclosures literature fails to provide......

Words: 11604 - Pages: 47

Premium Essay

The Methodology of Positive Accounting

...The Methodology of Positive Accounting Charles Christenson The Accounting Review, Vol. 58, No. 1. (Jan., 1983), pp. 1-22. Stable URL: http://links.jstor.org/sici?sici=0001-4826%28198301%2958%3A1%3C1%3ATMOPA%3E2.0.CO%3B2-Z The Accounting Review is currently published by American Accounting Association. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/journals/aaasoc.html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. The JSTOR Archive is a trusted digital repository providing for long-term preservation and access to leading academic journals and scholarly literature from around the world. The Archive is supported by libraries, scholarly societies, publishers, and foundations. It is an initiative of JSTOR, a not-for-profit organization with a mission to help the scholarly community take advantage of advances in technology. For more information regarding JSTOR, please...

Words: 12864 - Pages: 52

Premium Essay

Positive Theory of Accounting

...Synopsis Positive accounting theory is perceived as a hypothetical study in accounting which helps in clarifying and foreseeing tangible accounting procedures. These theories have a tendency to rationalize why a number of accounting practices are accepted than others. Positive accounting theory was introduced to better apprehend exactly how practices in accounting must be effectively managed. Introduction Modern positive accounting research began flourishing in the 1960’s and other introduce empirical finance method to financial accounting. The subsequent literature adopted the assumption that accounting number supply information for security market investment decision and used the information perspective to investigate the relation between accounting number and stack prices. The information perspective has taught us much about the market’s use of accounting numbers. It was structured as an educational thought of discipline by the efforts of Ross Watts and Jerold Zimmerman which when made known were received with extensive criticism. Summary of the Article Positive accounting can be related with the predetermined opinion of a firm. A firm is regarded as a conception initiative put forth by a number of economists and legal commentators which stresses that corporations are nothing more than a compilation of agreements concerning different parties – mostly shareholders, directors, employees, suppliers, customers and accounting – one tool to expedite the......

Words: 1357 - Pages: 6

Premium Essay

Positive Accounting Theory

...7.14 What are some of the criticisms of PAT? Do you agree with them? Why or why not? Positive Accounting Theory (PAT) ▪ The branch of academic research in accounting that seeks to explain and predict actual accounting practices. ▪ Watts and Zimmerman: o PAT is concerned with explaining accounting practice. It is designed to explain and predict which firms will and which firms will not use a particular method…but it says nothing as to which method a firm should use. ▪ Explain why firms still use historic cost accounting, why certain firm switch between a numbers of accounting techniques. Criticisms of PAT ▪ Does NOT provide prescription o Not providing a means of improving accounting practice. o No guidance as to what people should do ▪ Not value free o Selecting a theory to adopt for research is based on a value judgement; what to research is a value judgement; ▪ Fundamental assumption that all action is driven by self interest argued to be too negative and simplistic a perspective humankind o All action is driven by a desire to maximise one’s wealth. o Rational behaviour of human ▪ Addressed issues have not shown great development o Continue to be tested in different environments and in relation to different accounting policies o The debt hypothesis o The bonus hypothesis o The political cost hypothesis ▪ Measurements or proxies being used within the literature......

Words: 290 - Pages: 2

Premium Essay

Positive Accounting Theory

...the accounting literature of the past decade" (1989, p. 327). They are also the joint founder-editors of The Journal of Accounting and Economics, a journal devoted to positive accounting research, which has achieved an international reputation. So their story, while admittedly controversial, has achieved credibility among a significant number of accounting researchers. But what accounts for that credibility? According to Watts and Zimmerman's (1986) view of science, a theory's credibility will ultimately be a function of explanatory power and predictive capability: "Ultimately the users, who assess alternative explanations' intuitive appeal and bear the costs and benefits of theories' predictions, will determine the success of the theory outlined in this book" (p. 355). And a theory, in their conception, consists of: the assumptions, including the definitions of variables and the logic that relates them, and the set of substantive hypotheses" (1986, p. 9). And since the hypotheses of a theory bear the brunt of empirical testing, the primary concern of the empirical testing of PAT is whether or not the hypotheses can predict accounting practice. Prediction of accounting practice means that the theory predicts unobserved accounting phenomena" (1986, p. 2). More concretely, they mean that PAT can be used to predict which accounting procedures will be chosen by management when management faces a "portfolio" of accepted accounting procedures from which to choose. In Positive......

Words: 1189 - Pages: 5

Premium Essay

Positive Accounting Theory

...Financial Accounting Theory Chapter 8 – Summary The Positive Theory of Accounting 1. Outline In the text, Scott defines Positive accounting theory (PAT) as: “concerned with predicting such actions as the choices of accounting policies by firms and how firms will respond to proposed new accounting standards.” (263) PAT uses theory to predict the choices that management will make regarding their choice of accounting policies. This theory is introduced as a way to merge efficient securities markets with economic consequences. PAT takes the view that firms will conduct themselves in the way that maximizes their own best interests. Managers do not always do what is best for shareholders, but what will be the most beneficial to their organization. The choices that an organization makes are dependant on what industry they are in, and the factors within that industry. An organization can be portrayed by the contracts it enters into. A firm’s contracts with employees, suppliers, lenders, and shareholders are central to its operations. The organization is inclined to keep these contract costs as low as possible. PAT emphasizes that an organization’s choice of accounting policies is motivated by keeping contract costs down. PAT does not propose that organizations completely identify what accounting policies they will use. Such specification is costly to commit to, and does not give management the opportunity to respond to unforeseen circumstances. ...

Words: 2061 - Pages: 9

Free Essay

Positive Accounting Theory

...Positive Accounting Theory: A Ten Year Perspective Ross L. Watts and Jerold L. Zimmerman University of Rochester ABSTRACT: This paper reviews and critiques the positive accounting literature following publication of Watts and Zimmerman (1978, 1979). The 1978 paper helped generate the positive accounting literature which offers an explanation of accounting practice, suggests the importance of contracting costs, and has led to the discovery of some previously unknown empirical regularities. The 1979 paper produced a methodological debate that has not been very productive. This paper attempts to remove some common misconceptions about methodology that surfaced in the debate. It also suggests ways to improve positive research in accounting choice. The most important of these improvements is tighter links between the theory and the empirical tests. A second suggested improvement is the development of models that recognize the endogeneity among the variables in the regressions. A third improvement is reduction in measurement errors in both the dependent and independent variables in the regressions. I T is more than a decade since our two papers, "Towards a Positive Theory of the Determination of Accounting Standards" and "The Demand for and Supply of Accounting Theories: The Market for Excuses" were published in The Accounting Review. The intervening time allows us to look back on these papers and the ensuing literature with some perspective. The two papers......

Words: 273 - Pages: 2

Premium Essay

Positive Accounting Theory

...136 Positive Accounting Theory and Science JCC Journal of CENTRUM Cathedra ™ Positive Accounting Theory and Science by M. Humayun Kabir Senior Lecturer, Faculty of Business Auckland University of Technology, Auckland, New Zealand Abstract This paper examines the development of positive accounting theory (PAT) and compares it with three standard accounts of science: Popper (1959), Kuhn (1996), and Lakatos (1970). PAT has been one of the most influential accounting research programs during the last four decades. One important reason which Watts & Zimmerman (1986) have used to popularize and legitimize their approach is that their view of accounting theory is the same as that used in science. Thus, it is important to examine how far accounting has been successful in imitating natural science and how the development of PAT compares with the three standard accounts of science. This paper shows that accounting could not emulate the success of natural science. Further, the methodological positions of PAT conform to none of the standard accounts of science. Rather, PAT contains elements of all three. Finally, this paper identifies some methodological gaps in PAT. Keywords: Positive Accounting Theory, Philosophy of Science, Methodological Controversies Acknowledgements I would like to thank two anonymous reviewers of the journal for their helpful comments. Earlier versions of this paper benefited from comments from Lee Parker of the University of South Australia,......

Words: 9637 - Pages: 39

Premium Essay

Positive Accounting Theory

...The Positive Theory of Accounting Outline In the text, Scott defines Positive accounting theory (PAT) as: “concerned with predicting such actions as the choices of accounting policies by firms and how firms will respond to proposed new accounting standards.” (263) PAT uses theory to predict the choices that management will make regarding their choice of accounting policies. This theory is introduced as a way to merge efficient securities markets with economic consequences. PAT takes the view that firms will conduct themselves in the way that maximizes their own best interests. Managers do not always do what is best for shareholders, but what will be the most beneficial to their organization. The choices that an organization makes are dependent on what industry they are in, and the factors within that industry An organization can be portrayed by the contracts it enters into. A firm’s contracts with employees, suppliers, lenders, and shareholders are central to its operations. The organization is inclined to keep these contract costs as low as possible. PAT emphasizes that an organization’s choice of accounting policies is motivated by keeping contract costs down. PAT does not propose that organizations completely identify what accounting policies they will use. Such specification is costly to commit to, and does not give management the opportunity to respond to unforeseen circumstances. Managers have flexibility to choose from a set of accounting policies,......

Words: 1003 - Pages: 5

Free Essay

Determinants of Different Accounting Methods Choice in Tanzania : a Positive Accounting Theory Approach

... DETERMINANTS OF DIFFERENT ACCOUNTING METHODS CHOICE IN TANZANIA : A POSITIVE ACCOUNTING THEORY APPROACH Objectives: • The purpose of this study is to investigate the factors that influence the choice of accounting policies by managers of companies in Tanzania. • These studies also examine the number of factors that influence the managers’ incentives for accounting choice. Population/ sample size: The study investigates managers’ decisions to choose accounting methods in a positive accounting theory perspective using panel data covering 60 years from 15 companies listed on the Dar es Salaam Stock Exchange. Research Methods: • Sample and data source: used quantitative methods to examine the relationship between independent variables and dependent variables. The data are drawn from annual reports of 15 companies listed on DSE for four years which resulted in 60 firm years. • Income strategy measurement: consider a company’s set of accounting choices that are disclosed in the company’s annual report as a single comprehensive decision. • Model specification: INCOME STRATEGY = α0 + α1 LEVER + α2 SIZE + α3 LABFORCE – α4 ODILUTION + α5 INTERFIN + α6 PROPNED + ε Findings: The results show that the significant factors are company size, internal financing, proportion of non-executive directors and labor force. Different with the outcome of prior studies, the authors found that the company size and internal financing are positively related with income strategy. So the......

Words: 298 - Pages: 2

Premium Essay

Positive Accounting Theory

...The role of positive accounting theory. PAT has been the most significant accounting research agendas during the past four decades (Kabir). Before the arrival of PAT, normative accounting research had been the leading research tradition in accounting. Normative accounting theorists concentrated in developing accounting principles for recognition and measurement issues. In contrast with normative accounting theory which deals with “should” kind questions, PAT deals with “is” kind questions. According to Watts and Zimmerman “the objective of positive accounting theory is to explain and predict accounting practice. It explains why financial reports are prepared. Positive accounting theorists have explained the accounting practices by including the measures accountants employ to calculate total assets, total liabilities, owners' equity and net income. Moreover, they also claim that positive accounting theory provides a scientific explanations of accounting practice that is that their findings are empirically test. PAT also examines the effects of accounting standards on management’s self-interest hence PAT recognizes management biased attitude on accounting standards which are likely to affect corporates lobbying on accounting standards. Pat also identifies certain factors that are expected to affect a firms cash flows and share price .These factors are taxes, political costs and information production and management compensation. PAT theoretically played its role in......

Words: 1910 - Pages: 8

Premium Essay

Positive Accounting

...Positive Accounting Theory (PAT) is universally acknowledged as one of the most important theories in the accounting theory research. It is worth noting that Chambers had raised an idea that “PAT is responsible for turning back the clock of research 1000 years.” From my perspective, I agree with the criticism of Chambers about the negative effects of PAT. In the first place, Positive Accounting Theory is not value-free as it was based on the assumptions that all action is driven by self-interest. According to the Agency Theory, which PAT is originated from, it shows the great impact of self-interest. With the development of growing markets and economics, the Agency Theory states that there exists a “price protection”. In other word, when the agents perform services and delegate decision-making authority of principal, they might accept a contract detrimental to them or having limits on them. With a consideration of not undertaking the opportunistic loss of company, the limits might protect their actual income or benefits. In a word, the incentive of self-interest is considered as a prerequisite of the theory and could not be eliminated or mitigated by effective methods. Secondly, Positive Accounting Theory is considered to be too negative and simplistic a perspective of human kind. It assumes that individuals will always act in an opportunity manner to the extent that these actions will increase their wealth. Political Cost Hypothesis illustrates that large......

Words: 522 - Pages: 3

Premium Essay

Positive Accounting Theory

...Critical Perspectives on Accounting (1996) 7 , 409 – 435 RECONSIDERING THE ‘‘SOCIAL’’ IN POSITIVE ACCOUNTING THEORY: THE CASE OF SITE RESTORATION COSTS DEAN NEU AND CYNTHIA SIMMONS University of Calgary This paper seeks to challenge the hegemony of positive accounting theory explanations of managerial behaviour. We argue that the decontextualized perspective of positive accounting theory is limiting and that changing the perspective offers a more complete explanation of behaviour. Starting from the notion of social relations developed by Marx, we reinterpret positive theory variables as proxies for a subset of the social relations in which managers are embedded. From this perspective, a more inclusive explanation of behaviour can be obtained by considering the entire web of social relations that influence behaviour. To demonstrate the ‘‘cash value’’ of a social relations perspective, accounting for site restoration costs is used as an illustration. The results are consistent with a broad social relations perspective. ÷ 1996 Academic Press Limited Introduction ‘‘[I]t is clear there is a relation between firm’s accounting choice and other firm variables, such as leverage and size and the signs of the relations are mostly consistent across studies. Positive accounting research guided the search for empirical regularities and provided explanations for them. To date, there are no systematic alternative sets of explanations for those regularities articulated and tested...

Words: 13164 - Pages: 53

Premium Essay

Positive Accounting Theory

...Chapter 7 - Positive Theory Positive Accounting Theory Philosophy of PAT Million Friedman championed positive theories in economics. He stated that: (part 3 Empirical Research in Accounts of Accounting theory from Jayne Godfrey) The ultimate goal of positive science (i.e. INDUCTIVE) is • The development of a ‘theory ‘ or ‘hypothesis’; • that yields valid and meaningful “Predictions’ • about phenomena not yet “observed”. Consistent with Friedman’s view, Watts and Zimmerman asserts that: The objective of “positive accounting theory” is to “explain” and “predict” accounting practice. • “Explanation” means providing reasons for observed practice. For example, positive accounting theory seeks to explain why firms continue to use historical cost accounting and why certain firms switch between a numbers of accounting techniques. • “Prediction” of accounting practice means that the theory predicts “unobserved phenomena”. Watts and Zimmerman start their book with a fundamental statement of The Role of Theory (Chapter 1).They asserts that the objective of positive accounting theory is to explain and predict accounting practice,(p.2) “Unobserved phenomena” are not necessarily future phenomena; they include phenomena that have occurred, but on which systematic evidence has not been collected. For example – Predicting the reaction of firms to a proposed accounting standard and an explanation of why firms would lobby for and against...

Words: 2421 - Pages: 10

Premium Essay

Positive Accounting Theory

...It is implied by the positive accounting theory that managers base decisions based on personal or organizational objectives such as higher compensation or increased implementation of corporate governance procedures (Mattessich 2007). The two standard setting bodies try to implement policies in order to ensure better reliability and transparency of financial statements relevant to specific managers applying these standards. The two bodies set standards to improve accounting practice in their respective regions so they act on improving areas of corporate governance. Decision usefulness deals with the process of decision making based on accounting theories, concepts and principles. This theory involves the development of procedures that can be applied to make decisions in a useful manner (Cyert and DeGroot 1987). The standards proposed by both standard setting bodies entail a thorough process and involve significant research to make standards more useful to accountants, investors, shareholders and other users of financial statements in the decision making process. The moral hazards in accounting are concerned with risks between two parties when one party is not willing to work honestly or in a trustworthy manner (Wessels 2006). If any of the standard setting bodies does not want to apply same techniques and strategies in issuing standards then the other board is subject to moral hazards or risks. Measurement approaches deal with measurement of several items based on......

Words: 257 - Pages: 2