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Group 82
Group 82
403
Chapter 8 Summary
Feb. 27, 02
8.1 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 firms
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 organizations 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, and
these options let them choose the policies that are the most beneficial to them.
The most favourable accounting policies are a balance of minimal costs, and
flexibility to give management the option of changing policies in response to
9.403
Chapter 8 Summary
Feb. 27, 02
9.403
Chapter 8 Summary
Feb. 27, 02
9.403
Chapter 8 Summary
Feb. 27, 02
can also be chosen on an efficiency criterion. Quite often, these two theories
make similar forecasts. It is difficult to determine whether opportunism or
efficiency is driving the policy changes.
Research has addressed this problem. Christie and Zimmerman
investigated the frequency of firms that faced takeover, to use income-increasing
accounting policies to maximize reported net income and financial position. They
found that these policy changes were not used to avoid possible takeover, and
that were not as opportunistic as originally thought.
Sweeney discovered that managers would change accounting policies in
response to debt covenant problems, only when it was cost-effective. In another
study, Sweeney found that firms that would benefit opportunistically through
substantial tax costs from switching accounting policies, chose not to do so in
favour of a more efficient alternative. Her results show support for both the
opportunistic and efficient views of hypotheses, and firm specific analysis is
required to distinguish between the two. Dechow did research that found net
income to be more highly associated with net returns than cash flow.
Subramanyam that managers choices of discretionary accruals served to
improve the predictive value of current earnings to predict future earnings.
These findings support the efficient contracting version of PAT, as opposed to the
opportunistic.
8.5 Conclusion
Positive accounting theory is used to predict and comprehend the
accounting policy choices that firms make. It is introduced as a way to merge
market theory with economic consequences.
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Chapter 8 Summary
Feb. 27, 02
Quiz
True/False Questions
9.403
Chapter 8 Summary
Feb. 27, 02
1. The Political Cost Hypothesis states that the closer a firm is to violating
debt covenants, the more likely they are to:
a)
b)
c)
d)
efficiency, different
efficiency, similar
positive, different
positive, similar
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Chapter 8 Summary
Feb. 27, 02
6. Delaying payment of current liabilities, writing off large amounts of slowmoving inventory , and lowering receivables are all examples of ______.
a)
b)
c)
d)
total accruals
negative accruals
discretionary accruals
positive accruals
9.403
Chapter 8 Summary
Feb. 27, 02
Quiz Answers
True/False
1. True
2. True
3. True
4. True
5. True
6. False
7. True
8. False
9. False
10. False
Multiple Choice
1.
2.
3.
4.
5.
6.
C
D
B
B
D
B
Short Answer
1.
The debt covenant hypothesis deals with debt, and it states that all
other things being equal, the closer a firm is to violation of accountingbased debt covenants, the more likely the firm manager is to select
accounting procedures that shift reported earnings from future periods to
the current period.
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Chapter 8 Summary
Feb. 27, 02
2.
Opportunistic behaviour- Given the available set, managers may
choose accounting policies from their set for their own interests.
Ex: Managers who are actively exploring oil companies whose
remuneration contracts are based on reported net income may choose
full-cost accounting over successful-efforts with the intention to smooth out
income and increase the present value of their bonus streams.
3.
Christie and Zimmerman found that although firms who have
become takeover targets were expected to have behaved
opportunistically, showed that income-increasing accounting policies were
relatively small.
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Chapter 8 Summary
Feb. 27, 02