Topic 4:

POSITIVE THEORY OF
ACCOUNTING POLICY AND
DISCLOSURE
QUESTION 6
Prepared by: Amizat, Ferra, Izzah, Nasihah, & Sumaiyah
QUESTION 6:
Contracting theory, which forms part of the
second wave in the positive theory of
accounting, focuses among other things on
agency theory. What is agency theory?
Elaborate the components of agency costs as
described by Jensen & Meckling (1976).

(6 marks)
Answer:
Agency theory is based upon the more general
contracting theory that the most cost effective form
of organizing economic activity is through a firm
based structure.
Jensen & Meckling describe agency theory is a
contract under one party (the principal) engages
another party(agent) to perform some service on the
principals behalf.
3 components of agency costs
Monitoring cost
Cost of monitoring
agents behavior
Eg: Engage the external
auditor to audit FS
Bonding cost
Cost to establishing and
complying with
mechanism to
guarantee that agent
will behave in the
interest of the principal
Eg: Manager(agent)
may voluntarily provide
shareholders(principle)
with quarterly FS
Residual loss
When agent act not
entirrely in the
principals interest
Eg: Manager put less
work effort that the
shareholder prefer.