Chapter 3 – Problem 18
a) Let the probability of state 1 (the high performance state) be P(H) = 0.5

Let the probability of state 2 (the low performance state) be
P(L) = 0.5

We assume that the amount of utility or satisfaction Ajay derives from a payoff is equal to the square root of the amount of the payoff.

So, we get
Ui(a) = √x, x≥0
Where x is the amount of the payoff

The decision theory tells us that the act with the highest expected utility should be chosen.

We denote the expected utility of act a1 (AB Ltd.) by EU(a1) and the expected utility of act a2 (XY Ltd.) by EU(a2).

Thus, we get
EU(a1) = 0.5 x √1089 + 0.5 x √0 = 16.5
EU(a2) = 0.5 x √324 + 0.5 x √196 = 16

∴ Ajay should choose act a1 and invest in AB Ltd. since it has the higher utility

b) To calculate prior state probabilities, we use Bayes’ Theorem. So the posterior probability of the high performance state is
P(H│GN) = P(H)P(GN│H) / P(H)P(GN│H) + P(L)P(GN│L)
where
P(H│GN) is posterior probability of high state given good news F/S P(H) is prior probability of high state
P(GN│H) is probability F/S shows good news in high state
P(L) is prior probability of low state
P(GN│L) is probability F/S shows good news in low state
Thus, from Bayes’ Theorem, we get
P(H│GN) = (0.5 x 0.6) / [(0.5 x 0.6) + (0.5 x 0.5)] = 0.55
Then Ajay’s posterior probability of the low performance state is
P(L│GN) = 1 - 0.55 = 0.45
So the expected utility of each act based on Ajay’s prior probabilities is
EU(a1) = 0.5 x √1089 + 0.5 x √0 = 16.5
EU(a2) = 0.55 x √324 + 0.45 x √196 = 16.2

∴ Ajay should still choose a1 and invest in AB Ltd. since it has the higher expected utility.

c) Given this new information system, the posterior probability performance of high state is P(H│GN) = (0.5 x 0.8) / [(0.5 x 0.8) + (0.5 x 0.2)] = 0.8
So, the posterior probability performance of low state is
P(L│GN) = 1 – 0.8 = 0.2
Then the expected utility of each act is...

...positive accounting approaches:
Definition of PAT:
Watts and Zimmerman (1986) defined Pat as a theory that seeks to explain and predicts particular phenomenon. It is concerned with explaining accounting practice. The three basic hypotheses as outlined by Watts and Zimmerman (1978) underlying PAT are:
1. Bonus plan hypothesis:
The bonus plan hypothesis is that managers of firms with bonus plans are more likely to use accounting methods that increase current period reported income. Such selection presumably increase the present value of bonuses if the compensation committee of the board of directors does not adjust to the method chosen
2. Debt/equity hypothesis:
The debt/equity hypothesis predicts that the higher the firm’s debt/equity ratio, the more likely that the managers use accounting methods that increase income.
3. political cost hypothesis:
The political cost hypothesis predicts that large firms rather than small firms are more
likely to use accounting choices that reduce reported profits. Size is a proxy variable for political attention.
THE NATURE OF POSITIVE ACCOUNTINGTHEORY VS. NORMATIVEACCOUNTING THEORY:
1. POSITIVE ACCOUNTINGTHEORY
The basic idea of positive accountingtheory (PAT) is adopted from the Pop Suwaldiman 48 SINERGI Vol. 6 No. 1, 2003 per idea...

...Reading 1.2 - Accountingtheory and development
AccountingTheory Construction with Inductive and deductive approach
Deductive approach vs. Inductive approach in accountingtheory construction
Deductive reasoning entails a valid argument in which it is impossible to assert the premises and to deny the conclusion without contradicting oneself.
Deductive approach to accountingtheory construction begins with establishing the objective of accounting. Once identified, definitions and assumption must be stated.
The researcher must then develop a logical structure for accomplishing the objectives, based on the definitions and assumptions.
The methodology is often be “going from the general to the specific” as the research must develop a logical structure for accomplishing the objective then, which based on the definition and assumptions.
The validity of any theory developed through this process is highly dependent upon the ability of the researcher to correctly identify and relate the various components of the accounting process in a logical manner.
Induction is a method of reasoning by which a general law or principle is inferred from observed particular instances.
Inductive approach emphasis making observations and drawing conclusions from it and is often be “ going from specific to general, because...

...BUS310 ACCOUNTINGTHEORY AND ACCOUNTABILITY
WORKSHOP 1
SOLUTIONS
1) GHHT: Chapter 1: Theory in Action 1.1
The article describes how a particular theoretical approach has been replaced by another. Explain why one theory replaces another, and who, or what, determines whether an existing theory survives.
A theory is primarily meant to explain or predict an event, behaviour or outcome. Proponents of atheory look for evidence to support the theory. This evidence should be independently observed and consistent after repeated observations. Some theories are speculative or ideas or guesses floated to encourage researchers to undertake the observations required to prove or disprove the theory. The question often debated is what comes first — the theory or the observation? For example, did Darwin start thinking about different species and the idea of natural selection or did evolution enter his thoughts? Did he detail these thoughts as a testable proposition and then set out to observe? Or did he observe aspects of nature which led him to formulate a theory of evolution? The latter is much more likely and for most theoretical development, observations result in development of propositions which are tested over time.
2) Where the body of evidence in support of the underlying theory...

...effect of the agency theory and accounting choice usually been made by managers of Nigeria listed companies. It (agency theory and accounting choice) can be demonstrated in the modern day companies where management is usually separated from the ownership of business. The professional managers are supposed to make decisions and take actions that are consistent with the objective of maximising shareholders wealth. But this may not be happen in practice because the managers may have goals that are inconsistent with those of the shareholders (Isenmila, Erabhe, & Ogiedu (2010). Prior researchers like Hagerman & Zmijewski (1979) and Zmijewski & Hagerman (1981) have attempted to model what motivates managers in choosing accounting methods, This study extends their scope of work by examining the depreciation method choices relationship with agency theory for a set of listed firms in Nigeria.
There are several theories that help us to develop hypotheses on the effect of Agency theory and accounting choice as noted by Gopalakrishnan (1994): the positive accountingtheory (Leftwich, Watts and Zimmerman (1981) and Watts and Zimmerman (1978)), the signalling theory (Ross (1977)), and legitimacy and institutional theory. These theories are the background of several...

...Chapter 1 – Financial AccountingTheory
1.1 What is Financial AccountingTheory?
Henderiksen (1970) – Theory is defined as:
A coherent set of hypothetical, conceptual and pragmatic principles forming the general framework of reference for a field of inquiry.
FASB – a coherent system of interrelated objectives and fundamentals that can lead to consistent standards.
Introduction – theories of financial accountingAccounting is a human activity and will consider such thing as people’s behavior and/or people’s needs as regards financial information, or the reason why people within organizations might select to supply particular information to particular stakeholder group.
Theories will include consideration of:
• Prescribe how, asset should be valued for external reporting purpose (normative theories – Current cost accounting), based on a particular perspective of the role of accounting.
• Predict that managers paid bonus on the basis of measures such as profits will seek to adopt those accounting method that lead to an increase in reported profit (i.e. Positive Accountingtheory)
• Predict that the relative power of a particular stakeholder group.
• Seek to explain how an individual’s cultural background will impact on the types of...

...assist with planning)
TOPIC: Discuss positive accountingtheory and contrast it with
normative accountingtheory. Provide examples where
appropriate.
The purpose of this essay is to provide an overview of positive accountingtheory (PAT) and highlight how this theory differs to normative accountingtheory. Definitions and assumptions of boththeories will be considered
and examples of the theories will be provided. In addition specific theories
related to PAT namely agency and the efficient market hypothesis will be
Notice how the essay
introduction starts
with the purpose of
the essay and then
highlights the direction
of the essay.
Remember in your
essay you don’t need
to include
EVERYTHING only
enough to get your
message across and
answer the question –
stick to the word limit
elaborated.
Positive accountingtheory is concerned with explaining and predicting
current accounting practices (Watts and Zimmerman, 1986). There is a
focus on understanding and explaining the techniques and methods that
accountants currently use for example why the conventional historic cost
accounting system is the primary measurement system applied today.
Unlike normative theory, positive...

...AccountingTheory Construction
The function to study accountingtheories is to classify them according to the assumptions they rely on, how they were formulated, and their approaches to explaining and predicting actual events. There are some classification which are pragmatic, syntactic, semantic, normative, positive, and naturalistic approaches.
Pragmatic approaches are based on observing the behavior of accountants or those who use the information generated by accountant. Syntactic approaches rely on logical argument, based on a set of premises. Semantic approaches concern how theories correspond to real-world events. Normative theories rely on both semantic and syntactic approaches. Positive approaches test hypotheses against actual event . Positive approaches test hypotheses against actual and the last is Naturalistic approaches consider individual cases and do not try to generalise.
PRAGMATIC THEORIES
Descriptive Pragmatic Approach
Descriptive pragmatic approach based on continual observation of the behavior of accountants, a theory can be developed from observations of how accountants act in certain situations. The theory can be tested by observing whether accountant do act in the way the theory suggest. This approach is probably the oldest and most universally used method of accounting...

...Expectancy Violation Theory
Have you ever felt like someone was violating your personal space? What makes you decide what is too close for comfort? The Expectancy Violation Theory explains how we react to our person space being invaded and how we perceive the violator. We have different opinions of people invading our personal space depending on who the violator is. Would you feel the same way about your boss hugging you as if your friend hugged you? That is what the expectancy violation theory is trying to explain.
We judge if someone is too close to us or invading our personal space by certain criteria such as: age, gender, and ethnicity. The amount of space we put between one another can have an influence of the message and meaning that you or someone else is trying to portray. There are four zones that we consciously use to define the boundaries of which we want people in. There’s the intimate space which is from 0-18 in. This space is reserved for people you feel extremely comfortable around. Next is the personal space which is from 18 in. - 4ft. This space is mostly where you keep friends and family. The further of this space is usually for acquaintances or people such as cashiers. Then there’s your social space which ranges from 4 – 12ft. People that may occupy your social space are fellow employees or people you see in a more formal manner. The last zone is your public space which is from 12ft. and...