Positive Accounting Theory

2425 Words Apr 23rd, 2012 10 Pages
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
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92). The main objective of normative accounting theories is to provide guidance to individuals to enable them to select the most appropriate accounting policies for given circumstances (Deegan, 2003, p. 90).
Therefore, the result of normative accounting research should provide prescription to inform others about the optimal accounting approach to adopt and why this particular approach is considered optimal.
Normative accounting research has resulted accounting theories that are relevant for the setting of financial reporting standards (Mozes, 1992, p. 93). In this case, the FASB’s (U.S Financial Accounting Standard Board) call for normative research can be interpreted as a request for accounting researchers to investigate whether the user specific and decision-specific qualities that standard-setters require are present in the accounting data (Mozes, 1992, p. 93). A successful example of normative accounting theories is conceptual framework for financial reporting published by FASB. It was started in 1978 by SFAC (Statement of Financial Accounting Concept) No. 1: Objectives of Financial Reporting by Business Enterprises.
Conceptual framework is defined by FASB as follow (FASB, 1980, p. i): Conceptual framework is a coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and reporting.
It is expected to serve the public interest by
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