Positive Accounting Theory

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Compare and contrast normative and 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 basic idea of positive accounting theory (PAT) is adopted from the Pop Suwaldiman 48 SINERGI Vol. 6 No. 1, 2003 per idea about what is theory in science (Boland & Gordon, 1982, p. 145). The function of theory is to explain and predict about a field or phenomena that is being observed. Therefore a theory is descriptive and explanative but not normative. The theory is not to conduct nor drive the phenomena to be in such a way. A theory is long life true since there is not a new theory that proves or refutes that the old theory is fail, so that, a theory cannot be proved as a truth but it is possible to be proved as a false (refutable). Furthermore, the function of a theory is to answer what is and why not what should be nor how to do. Positive accounting theory was revealed to the debate by Watts and Zimmerman book “Positive Accounting Theory”. Referring to the Popper idea, it is claimed that the objective of accounting theory is to explain and predict accounting practice (Watts and Zimmerman, 1986, p. 2). Furthermore, it is argued that their definition of accounting practice is broad based on the reason that the development and nature of accounting is closely tied to auditing, auditing practice is included as part of accounting practice (Watts and Zimmerman, 1986, p.2). They define explanation as providing reasons for observed practice (i.e. why a firm use the LIFO method of inventory rather than FIFO method), and prediction is defined that the theory predicts unobserved accounting phenomena that is not always necessarily future phenomena, but it can be phenomena that have occurred but on which systematic evidence has not been collected (Watts and Zimmerman, 1986, p. 2). In addition, the objective of PAT is to provide explanation and prediction that is useful for interesting parties in accounting information to maximize their wealth (i.e. accounting practice rooted in the purpose of managers) (Williams, 1989, p. 455). Therefore,to achieve this objective, accounting research must be conducted empirically todevelop PAT. Furthermore, because PAT is to be explanatory in the sense envisioned by positive theorists, it must contain at least one premise or proposition that permits causal attribution. Finally, PAT is based on assumption that individuals have interest in accounting information act to maximize their own utility (Williams, 1989, p. 458).

Since accounting failed in explaining about the great depression in 1930’s, it was started that there should be a theory that influences the accounting practice so that the practice is running in to achieve a certain objective. Then, the research to develop accounting theory became normative and tried to answer the question what should be done by...
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