Positive Accounting Theory: Explaining and Predicting Accounting Practices

Emergence and Founding Figures

Positive accounting theory emerged in the late 1960s, gaining momentum with the proliferation of empirical studies in accounting. Ross Watts and Jerold Zimmerman played a pivotal role in organizing positive accounting as an academic school of thought. Their contributions, along with the establishment of the Journal of Accounting and Economics in 1979, solidified positive accounting theory as a distinct field of study.

Purpose and Contrast with Normative Accounting

Positive accounting theory aims to explain and predict accounting practices, contrasting with normative accounting, which prescribes “optimal” accounting standards. Positive accounting theory seeks to understand why accounting practices are employed by accountants in different circumstances and by different firms. It does not attempt to dictate how accounting should be done, but rather focuses on understanding the factors that influence accounting choices.

Contractual View and Efficiency Perspective

Positive accounting theory is often associated with the contractual view of the firm, which sees accounting as a tool to facilitate the formation and performance of contracts. Under this perspective, accounting practices evolve to mitigate contracting costs by establishing ex ante agreements among varying parties.

The efficiency perspective within positive accounting theory suggests that accounting practices adopted by firms aim to show a true representation of the firm’s performance. This perspective emphasizes that accounting practices are chosen to provide relevant and reliable information to users of financial statements, such as investors and creditors.

Opportunistic Perspective and Hypotheses

The opportunistic perspective holds that managers, as agents to the principal, act in their self-interests and choose accounting policies that allow them to gain personally. This perspective has led to the development of several hypotheses, including:

• Management Compensation Hypothesis

  This hypothesis states that managers with accounting incentives, such as bonuses tied to accounting performance, may manipulate accounting methods and figures to show better accounting performance.

• Debt-Equity Hypothesis

  The debt-equity hypothesis suggests that managers may use accounting methods to show better profits to improve the liquidity position for paying off accumulated debt.

• Political Cost Hypothesis

  The political cost hypothesis assumes that firms may use different accounting methods to show lower profits to avoid attracting attention from politicians and higher regulation.

Criticisms and Limitations

Positive accounting theory has faced criticism for several reasons:

• Lack of Prescriptions

  Positive accounting theory does not provide any prescriptions or guidance on how accounting should be done. It only explains and predicts what people might do, which some argue is insufficient.

• Value Judgments

  Critics argue that positive accounting theory is not value-free because it assumes that every manager’s (agent) and owner’s (principal) actions have a self-interest motive, with the primary goal of maximizing their own wealth without considering any adverse effects.

• Difficulty in Avoiding Value Judgments

  Researchers acknowledge the challenge of avoiding value judgments in the choice of research topics and the design of research studies.

References

• Wiratama, R., & Asri, M. (2020). A Literature Review: Positive Accounting Theory (PAT). SSRN. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3523571
• “Positive accounting.” Wikipedia. https://en.wikipedia.org/wiki/Positive_accounting
• “Positive Accounting Theory (PAT).” BINUS University. https://accounting.binus.ac.id/2021/11/15/positive-accounting-theory/

FAQs

What is positive accounting theory?

Positive accounting theory is a branch of accounting research that seeks to explain and predict accounting practices, contrasting with normative accounting, which prescribes “optimal” accounting standards.

What is the purpose of positive accounting theory?

Positive accounting theory aims to understand why accounting practices are employed by accountants in different circumstances and by different firms. It seeks to explain and predict accounting choices, rather than dictate how accounting should be done.

What is the contractual view of the firm in relation to positive accounting theory?

The contractual view of the firm sees accounting as a tool to facilitate the formation and performance of contracts. Under this perspective, accounting practices evolve to mitigate contracting costs by establishing ex ante agreements among varying parties.

What is the efficiency perspective in positive accounting theory?

The efficiency perspective suggests that accounting practices adopted by firms aim to show a true representation of the firm’s performance. This perspective emphasizes that accounting practices are chosen to provide relevant and reliable information to users of financial statements, such as investors and creditors.

What is the opportunistic perspective in positive accounting theory?

The opportunistic perspective holds that managers, as agents to the principal, act in their self-interests and choose accounting policies that allow them to gain personally. This perspective has led to the development of several hypotheses, such as the management compensation hypothesis, debt-equity hypothesis, and political cost hypothesis.

What are some criticisms of positive accounting theory?

Positive accounting theory has been criticized for not providing any prescriptions or guidance on how accounting should be done, for not being value-free, and for assuming that every manager’s and owner’s actions have a self-interest motive. Additionally, researchers acknowledge the challenge of avoiding value judgments in the choice of research topics and the design of research studies.

What are some examples of positive accounting theory research?

Positive accounting theory research has examined a wide range of topics, including the impact of accounting choices on firm value, the determinants of accounting conservatism, the role of accounting information in contracting, and the effects of regulation on accounting practices.

How is positive accounting theory used in practice?

Positive accounting theory is used by accounting standard-setters, regulators, and practitioners to understand the economic consequences of accounting standards and to design accounting standards that are efficient and effective. Additionally, positive accounting theory is used by researchers to develop new insights into the role of accounting in organizations and capital markets.