Discuss about the Positive Accounting Theory for Accounting Review.
According to Watts and Zimmerman, Positive Accounting Theory ‘is concerned with explaining the [accounting] practice. It is designed to explain and predict which firms will and which firms will not use a particular accounting method, but it says nothing as to which method a firm should use’. The concept of positive accounting theory has been launched in by Watts and Zimmerman in the mid of nineties. They were among those people who have worked upon these concepts and provide the concept of positive accounting theory to the entire world. This theory keeps a watch on the changing attitude of the management towards the accounting practices based on their need and requirements. Through the help of this theory the analysts and convert the events that are being taken place in the world into the form of accounting transactions. In this scenario, the Positive Accounting Theory will explain and make predictions of the accounting policy that the firm will choose and try to explain its reaction to this new change of adoption. The basic concept that exists in case of Positive Accounting Theory is the question of survival of the firms. The firms are likely to choose the accounting standards that tends to benefit them the most and accordingly the decisions are taken for their adoptions. These situations generally arise in case when the individual’s personal interest is linked to the interest of the firm. This can be very well understood through the help of an example: Every company in the industry is striving for success and that can be achieved by maximizing the profit levels. In the case of a construction company, the management of the company will prefer choosing an accounting standards that tends to reduce the cost and maximize the profit. This will be done through the help of Positive Accounting Theory. (Watts and Zimmerman, 1990)
In the Positive Accounting Theory it has been concluded that the operations and the environment conditions which are prevailing in the industry should be kept in mind at times of taking the decisions related to choosing the accounting standards for the company. However, neither the researchers nor the theory or the article provides and guidelines that needs to be followed in by the management of the company at times of choosing the accounting standards for the company or firm. In case of Positive Accounting Theory, the adoption of the counting methods is a bit difficult being the theory does not provide and specific list of the methods from which the management of the company has to choose from. There are majorly three accounting hypothesis that are being used in the framing out the positive accounting theory. Major of the predictions that are being made in the positive accounting theory revolves around the following three hypotheses:
Bonus plan hypothesis: As per this hypothesis, the accounting managers of the firm are likely to choose the accounting methods and procedures that help the managers to pre pone the future profit of the company in the current period. Being the bonus that the mangers are expected to receive in the current period is dependent on the profit that is being earned by the company in the current period.
Debt covenant hypothesis: If the managers of the company are under the notion that company in the coming period is going to violate the Debt covenants, there is likely a possibility that the management of the company will adopt accounting procedures that will again pre pone the future earnings of the company in the current period. By doing this, the management of the company will stand green on the debt covenants
political Cost hypothesis: In the above hypothesis, we have discussed, the areas where the management of the company were planning to pre pone their future profit to the current period as it was in the interest of the company as well in their individual interests but in case where the company has some political cost attached, in these scenario’s the management of the company will adopt accounting procedures that will help the company to defer some of its current year earnings to future periods.
The concept of positive accounting theory is different form that to the normative accounting practices. This theory helps us to make the predictions related to the accounting practices that have been followed in by the company whereas the normative accounting theory tends to prescribe the optional accounting practices to the firms. The positive accounting theory in some or the other way helps in understanding the descriptive behavior of the accountants. This theory has its roots from the theory that has been framed in by Fama and later by Ball & Brown in the 1960’s. Watts and Zimmerman in their theory has used this research work and based out their PAT theory. In case of normative accounting theories, the situation is other way round. In this case, the accounting solution that has been provided in by the experts is purely based on the event that has taken place. While the situation is not the same in case of positive accounting theory, which will help the management of the companies, to predict the reaction that would have taken place at times when a new accounting standard has been adopted in the market. ( Branchmann)
There are certain assumptions that need to be taken in place by the management of the company at times of considering the positive accounting theory for itself. Some of them are as follows:
In case of positive accounting theory, the logical thing has an important role to play. The accounting methods that needs to be discussed and should be backed up by proper logical thinking and then accordingly the same should be adopted after considering the entire positive as well as the negative aspects of the decisions. Thus, the logical thinking provides the roadmap for adoption of accounting practices in the form. Through the help of this theory the analysts and convert the events that are being taken place in the world into the form of accounting transactions. In this scenario, the Positive Accounting Theory will explain and make predictions of the accounting policy that the firm will choose and try to explain its reaction to this new change of adoption. The basic concept that exists in case of Positive Accounting Theory is the question of survival of the firms. The firms are likely to choose the accounting standards that tends to benefit them the most and accordingly the decisions are taken for their adoptions. Based on the assumption that we have encountered above arose attention of the many authors about the success percentage of the theory. There has been many times where this policy has been criticized as well as appreciated by many authors. Majorly the positive accounting theory has been criticized is because of the assumptions that frame out the positive accounting theory.
There are certain assumptions that are being taken into consideration by the authors at times of framing the positive accounting theory. The major assumption that they have taken during the course of the theory is the choice of the users that are going to get affected by the adoption process of the accounting standards. They suggest that the any new accounting standard is going to affect limited users like listed shareholders, government and creditors. The others users like employees, customers, competitors, advisors are not affected and thus they are ignored. On the other hand, each of the users that are being defined above influence the company in some or the other way. They thru should be considered in the process of choosing the accounting standard.
The article that has been farmed in by the author Watts and Zimmerman has positive as well as negative points associated to it.
There are certain plus points of the positive accounting policy as well. The probability of company’s survival increases over the period of time with the accounting policies that has been adopted by the company through the help of positive accounting theory. For example: A construction company will tend to adopt an accounting policy that will maximize the profit levels by minimizing the cost associated with the construction. The flexibility level among the managers of the organization increases at times of choosing the accounting standards and practices so that they will best suit them and is in their own interest. The positive accounting theory will help to predict the reaction which the companies would have at times when a new accounting standard has been introduced in the market. The positive accounting theory will help to understand the accounting policies that will be adopted by the companies. The descriptive behavior of the accountants is very well understood through the help of the positive accounting theory. (Milne, 2002)
Conclusion
The primary objective in the given article is to provide an overview upon the theories given by various authors. This theory keeps a watch on the changing attitude of the management towards the accounting practices based on their need and requirements. Through the help of this theory the analysts and convert the events that are being taken place in the world into the form of accounting transactions. In this scenario, the Positive Accounting Theory will explain and make predictions of the accounting policy that the firm will choose and try to explain its reaction to this new change of adoption. Thus, overall, the positive accounting theory has helped in developing a better accounting world.
References
Watts, R., Zimmerman, J., (1990), Positive accounting theory: A ten year perspective, The Accounting Review 65, 131-156.
Watts, R. L. and J. L. Zimmerman, (1978), towards a positive theory of the determination of accounting standards, The Accounting Review, (January): 112-134.
Roychowdhury, S. (2006) Earnings Management through Real Activities Manipulation, Journal of Accounting and Economics 42, 335-370.
Branchmann S, studio D, Differences between Positive & Normative Accounting, Retrieved from Finacebase, https://thefinancebase.com/differences-between-positive-normative-accounting-1663.html , viewed on 12th Dec, 2016
Fool M, What Are the Differences Between Positive and Normative Accounting? , Retrieved from Fool.com, https://www.fool.com/knowledge-center/differences-between-positive-normative-accounting.aspx , Viewed on 12th Dec, 2016
Milne Markus, 2002, ‘Positive Accounting Theory, Political Costs and Social Disclosure Analyses: A Critical Look’, viewed on 12th Dec, 2016_
https://www.researchgate.net/publication/222665782_Positive_accounting_theory_political_costs_And_social_disclosure_analyses_a_critical_look
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