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Positive Accounting Theory

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PAT Concept
Agency Theory Efficient Market
Hypothesis (EMH)

Normative Positive Accounting


Theory Theory (PAT)

Bonus Debt Political


Plan Covenant Cost
Hypothesis Hypothesis Hypothesis

Accounting Standards and Practices


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Positive Accounting Theory

Watts and Zimmerman in 1978 and 1986
Apply to Positive Theory of Economic

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Normative Theory
(Prescribe)


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Positive Accounting Theory
(Explain and Predict)

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Agency Theory
The agent (like the principal) will be
driven by self-interest, and therefore
the principals will anticipate that the
manager, unless restricted from doing
otherwise, will undertake self-serving
activities that could be detrimental to
economic welfare of the principals.

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Efficient Market Hypothesis
(EMH)

The capital markets react in an efficient


and unbiased manner to publicly
available information.

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Positive Accounting Theory
Assumptions:
The accountants (and, in fact, all individuals)
are primarily motivated by self-interest (tied
to wealth maximisation), and that the
particular accounting method selected
(where alternative are available).

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The Three Hypotheses
1. The Bonus Plan Hypothesis
2. The Debt Covenant Hypothesis
3. The Political Cost Hypothesis

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The Bonus Plan Hypothesis
Bonus based on net income
To get more bonus, choosing accounting
methods that increase current reported
earnings

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The Bonus Plan Hypothesis
All other things being equal, managers
of firms with bonus plans are more
likely to choose accounting procedures
that shift reported earnings from future
periods to the current period

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The Bonus Plan Hypothesis
Because of the nature of of the accrual
process, this will tend to lower future
reported earnings and bonuses, other things
equal.
PV of managers utility from future bonus
stream will be increased by shifting earnings
toward the present

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The Bonus Plan Hypothesis

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The Debt Covenant Hypothesis
All other things being equal, the closer
a firm is to violation of accounting-
based 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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The Debt Covenant Hypothesis
Violation of debt covenant is costly
Restriction on dividends
Limit additional borrowing
Issuance of stock,
Increase current earnings
Assets increase
To avoid violation

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The Debt Covenant Hypothesis





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The Political Cost Hypothesis
All other things equal, the greater the
political costs (taxes, regulations) faced
by a firm, the more likely the manager
is to choose accounting procedures that
defer reported earnings from current to
future periods

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The Political Cost Hypothesis
Large firm with high profit attracts
media, consumers, and politicians
attention
Large firm trend to reduce profit reports

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The Political Cost Hypothesis



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Theory Perspectives
Opportunistic Perspectives


Efficiency Perspectives

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Criticisms
Not improving accounting pratices
Not value free
Not positive thinking for humankind

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PAT Concept
Agency Theory Efficient Market
Hypothesis (EMH)

Normative Positive Accounting


Theory Theory (PAT)

Bonus Debt Political


Plan Covenant Cost
Hypothesis Hypothesis Hypothesis

Accounting Standards and Practices


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() Positive
Accounting Theory
Bonus Plan Hypothesis
Deb Covenant Hypothesis
Political Cost Hypothesis

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