Criticisms of Positive Accounting Theory

Criticisms of Positive Accounting Theory

Introduction 

The main goal of the Positive Accounting Theory (PAT) is to describe and forecast accounting practices (Sinha 2008). The theory is anchored in the fundamental economic assumption that people’s actions are naturally motivated self-interest and, therefore, their actions tend to be opportunistic to an extent of being fixated on increasing their wealth (Watts & Zimmerman 1990). Basing on supposition that “self-interest” motivates people’s actions the theory hypothesises that firms would often attempt to put in place measures that align the interests of the managers (agents) with that of the owners (principals). In spite of its strengths in forecasting the motives of agents and principals and translating them into accounting transaction, the theory face deep criticism for having limited contribution to the accounting practice. Therefore, this paper discusses criticisms of the theory.

The Positive Accounting Theory seeks to forecast real world events or actions that it then translates into accounting transactions (Watts & Zimmerman 1990). I agree with this view. For instance, examples of these actions may include the policies that accounting firms would select or how companies would respond to new accounting standards. Overall, the Positive Accounting Theory potentially enhances an understanding of varied accounting problems and phenomena. For instance, it has a capacity to yield significant insights into the relationship between stock returns, accounting numbers, as well as the financial reporting incentives of the management. Despite this, the theory does not necessarily offer any recommendation or prescription, or even suggest what should occur. Instead, it only describes and predicts what may occur. In most circumstances, this is often insufficient. At any rate, it can still be argued that the theory only assumes that all actions of the managers and owners are motivated by self-interest, and that they are intent on maximization of their individual wealth yet it fails to consider any adverse effects (Dunmore 2009).

The Positive Accounting Theory can be commended for its capacity to mitigate contracting costs. At the same time, it enables firms to be perceived as accumulation of the contracts they have been bound to. I agree with the view. Indeed, According to Dunmore (2009), positive accounting can be linked to the contractual perspective of the firm, which is considered to be “a nexus of contracts” as it assists in the creating and accomplishing of contracts. Within this perspective, accounting practices has evolved to moderate contracting costs as it establishes agreements based on predictions among parties to a contract. An example is where the theory hypothesises that conservatism in accounting has its origin in contract markets, such as managerial compensation contracts. A case in point is absent conservatism, where managerial compensation agreements can be used to provide rewards to managers rooted in the current reports that subsequent evidence shows were not warranted.

The Positive Accounting Theory enables firms to select accounting policies perceived to be optimally acknowledging a need to minimize the costs of contracts. The theory acknowledges that changing situations demand that managers have to be flexible while selecting accounting policies. However, this advantage also has some setbacks as it necessitates the complexity of “opportunistic behaviour,” which happens whenever the managers’ actions are viewed to be superior to their personal or individual interests. To this end, accounting policies considered to be optimal might be as a result of a compromise between putting up accounting policies, minimizing contract costs, as well as promoting flexibility in the event of changing economic situations (Dunmore 2009).

Additionally, the Positive Accounting Theory can be subjected to criticisms on ground that it restricts itself to positively studying accounting practice or practitioners. This hampers progresses in accounting, as they neglect a need to assess accounting practice. Citron (1995) also criticises the Positive Accounting Theory for being methodological intolerant and instead preferred the normative accounting theory suggesting that it was more legitimate in accounting practice. The theory has also been criticised for narrowing the focus of the researchers. Indeed, as Boland and Gordon (1992) claim, the Positive Accounting Theory potentially narrows the focus of researchers, despite igniting emotions among researchers.

Conclusion

As established, while the Positive Accounting Theory has strengths in forecasting the motives of agents and principals and translating them into accounting transaction, it does not necessarily offer any recommendation or prescription, or even suggest what should occur. Instead, it only describes and predicts what may occur. Additionally, it only assumes that all actions of the managers and owners’ are motivated by self-interest without considering any adverse effects. Additionally, it is methodological intolerant and narrows the focus of researchers. At any rate, the Positive Accounting Theory can be commended for its capacity to mitigate contracting costs. It also enables firms to select accounting policies perceived to be optimally acknowledging a need to minimize the costs of contracts.

References

Boland, L & Gordon, I1992, “Criticising positive accounting theory,» Contemporary Accounting Research, vol 9 no 1, pp.142-170

Citron, 1995, Positive accounting theory and the study of corporate control: the role of loan covenants and the going concern qualification, viewed 25 Aug 2016, <http://openaccess.city.ac.uk/7733/1/Positive_accounting_theory_and_the_study_of_corporate_control_-_the_role_of_loan_covenants_and_the_going_concern_qualification.pdf>

Dunmore, P 2009, Half a Defence of Positive Accounting Research, viewed 25 Aug 2016, <http://sydney.edu.au/business/__data/assets/pdf_file/0012/59988/Paul_Dunmore_MEAFA_2010.pdf>

Kabir, H 2015, «Positive Accounting Theory and Science,» Journal of Centrum Cathedra, pp.136-149

Sinha, S 2008, «Positive Accounting Theory: A Critique,» The IUP Journal of Accounting Research and Audit Practices, vol 7, is 4, pp.7-16

Watts, R & Zimmerman, J 1990, «Postive accounting theory: A ten year perspective,» The Accounting Review, vol 65 no 1, pp.131-156