Positive Accounting Theory: Understanding Managerial Decisions and Accounting Procedures, Study Guides, Projects, Research of Accounting

Download Positive Accounting Theory: Understanding Managerial Decisions and Accounting Procedures and more Study Guides, Projects, Research Accounting in PDF only on Docsity! Positive Accounting Theory and Agency Costs: A Critical Perspective ISBN: 978-1-943295-14-2 Jagriti Srivastava Pankaj Kumar Baag Indian Institute of Management (jagritis12fpm@iimk.ac.in) (baagpankaj@iimk.ac.in) We study the relevance of Positive Accounting Theory (PAT) in today's dynamic environment. It focuses on firms' choice of accounting techniques. It also considers the manner in which firms will react to proposed accounting records. Even after its huge contribution to the field of accounting, it is not fully developed. In this view, the agency theory breaks down as a positive theory as it does not cater for the theory of accounting regulatory development. We need to develop affluent theories based on either better rationality assumption or which considers a broader view of organisational behaviour Keywords- Positive Accounting Theory, Accounting Standards, Agency Theory, Rationality 1. Introduction International Financial Reporting Standards (IFRS) set regular rules with the goal that financial reports can be steady, straightforward and practically identical around the globe. They indicate how organizations must keep up and report their records, characterizing kinds of exchanges and different occasions with monetary effect. IFRS was built up to make a typical accounting language, with the goal that organizations and their budget summaries can be predictable and solid from organization to organization and nation to nation. In India, notwithstanding fulfilling statutory revelation prerequisites under the Companies Acts fiscal summaries should likewise agree to accounting guidelines all together for those financial statements to give a true and fair view. Accounting guidelines contain codes regarding how certain matters ought to be managed in an organization's financial statements. Ind AS represents Indian Accounting Standard. It provides joined models for IFRS. Ind AS are records and arrangements that give standards to acknowledgement, estimation, treatment, introduction and divulgences of accounting transactions in the Ind AS financial reports. Securities and Exchange Board of India (SEBI) is an administrative body of the Government of India. It controls the securities market. SEBI is basically set up to ensure the interests of investors in the capital market. It advances the improvement of the protections advertise and directs the business. The target of SEBI is to guarantee that the Indian capital market works in a precise way and give investors a straightforward situation for their investment. Essentially, the essential explanation behind setting up SEBI was to avert acts of malpractices in the capital market of India and advance the improvement of the capital markets. 2. Positive Accounting Theory Positive accounting emerged with the accounting studies that generated in late 1960s. This concept was organised as a school of thought by Ross Watts and Jerold Zimmerman. Positive Accounting Theory attempts to make great forecasts of genuine occasions and make an interpretation of them to accounting transactions. While normative theories will, in general, suggest what ought to be done, Positive Theories attempt to clarify and foresee activities, for example, which accounting transactions firms will pick how firms will respond to recently proposed accounting standards. Its general aim is to comprehend and foresee the decision of accounting policies crosswise over varying firms. It perceives that financial outcomes exist. Under this theory, three hypotheses have been brought into light: 1. Keeping all other things constant, managers of firms with reward plans are bound to pick accounting procedures that shift reported income from future periods to the present time frame. 2. Keeping all other things constant, the bigger a company's debt/equity ratio, the more probable the company's manager is to choose accounting procedure that shifts reported earnings from future periods to the present time frame. 3. Keeping all other things constant, the larger the firm, the almost certain the manager is to pick accounting procedures that defer reported earnings from current to future periods. In relation to this, politicians have the power to impact upon organizations earnings re-distributions by method for corporate taxes, guidelines, allowances and so on. Besides, certain groups of voters have motivating forces to allow for the "nationalization, confiscation, separation or rules of an industry or enterprise", which thus are believed to give incentives to politicians to propose such activities (Stigler, 1971). Under PAT, firms need to amplify their prospects for survival, so they compose themselves effectively. Firms are seen as the aggregation of the agreements they have gone into. In connection to PAT, on the grounds that there should be proficiency, the firm will need to minimize expenses related to contracts. In case of an unregulated economy, the promoters and original shareholders have incentives to contract to supply the audited financial statements. These agreements were included in articles of association and in the contracts between the organisation and creditors (Watts, 1977). It leads to decreasing agency costs. 530 Seventeenth AIMS International Conference on Management Continuing with the above discussion, agency costs exists because of the conflict of interests between shareholders and managers, shareholders and bondholders. The managers have the incentives of transferring wealth to themselves at the cost of shareholders and bondholders (Watts & Zimmerman, 1979).Bondholders and investors anticipate the managers' conduct and appropriately discount the cost of the bonds or shares at the time of issue. Consequently, the managers of another corporation get less for the shares and bonds he sells than he would have if he could guarantee that he would keep on going about as he did when he possessed the firm (i.e., when there were no outside investors or bondholders). So, in an unregulated economy, accounting procedures are constructed in such a way to diminish the agency costs of contracts. But as it varies across firms, the accounting procedures also varies across firms giving rise to diversity. There is a demand for expectations of the impacts of accounting procedures on both the managers' and auditors' welfare by means of disclosure to claims. The auditor contracts with the investors (and creditors) to screen the executives, and he is lawfully amenable in the event that he neglects to report breaks of covenants in the company's articles or by-laws. For this purpose, accounting theories are build. Accounting texts (and theories) which detail how managers look to manipulate profits and the ensuing impacts of those manipulations on investors and bondholders not just improve the managers’ capacity to monitor such actions, yet in addition give the auditor readymade contentions to use against such methods in consultation with management(Watts & Zimmerman, 1979). In a regulated economy, private citizens, civil servants, and legislators have motivations to utilize the forces of the state to improve themselves off and to mix for that reason. Financial accounting statements play out a focal job in these riches moves and are influenced both directly and by implication by the political procedure. Government commissions frequently utilize the substance of financial statements in the administrative procedure (rate setting, antitrust, and so forth.). This, thusly, gives the board motivations to choose accounting procedures which either decreases the costs they bear or increases the advantages they get because of the activities of government controllers and officials. Since public utilities have motivating forces to propose accounting procedures for rate-making purposes which boosts the market value of the firm, their contentions are helped if accounting standard-setting bodies order similar accounting procedures for financial reporting. The guidelines and regulations which result from government supervision of business increase the professional and educational demands requests for accounting theories. The justification demand for theories additionally extends with regulation. In continuation with the above discussion, proponents and adversaries of extraordinary intrigue legislation (or aspirants before administrative and regulatory councils) must give contentions for the positions they advocate. In the event that these positions incorporate changes in accounting procedures, accounting theories which fill in as rationale (i.e., justifications) are valuable (L.H., 1972). The controllers (politicians and administrators) are judicious. Nonetheless, they perceive that theory validation has expenses and advantages. The legitimacy of an accounting theory won't be resolved if the expense to evaluate the legitimacy of a hypothesis is more prominent than the advantages. Since the interest is for theories which have an open intrigue direction, when such a basis has been given, the advantages to controllers related with distinguishing a coherent the false notion in accounting theory might be very little. Actually, regardless of whether the theory is known to have a legitimate error, there might be motivations not to perceive the ambiguity. That is, the theories may at present have an incentive as a reason notwithstanding its sensible status. Market failure theories are vital for politicians to legitimize an accounting regulatory procedure over a private market for accounting data. The politicians may not be "fooled" by "theory illusion" and might be uninterested in or reluctant (due to disincentives) to perceive coherent ambiguities (Watts, R. L., & Zimmerman, J. L., 1986). In the economics context, a market failure is said to happen when either the amount or nature of a good delivered in an unregulated market contrasts based on what is indicated to be the social optimum. The social ideal is characterized as that product which boosts total social welfare and is achieved just if the costs of sources of inputs and outputs are equivalent to their social marginal costs. In private markets, makers and buyers seek after their individual interests. In this manner, it is asserted, the output of private markets varies from the social ideal at whatever point social expenses and advantages vary from private expenses and advantages (Leftwich, 1980). So, Positive accounting theory will be helpful only in the case that it can give rich expectations of certain significant phenomenon. We would contend that notwithstanding a few works in the zone positive accounting theory has not helpfully anticipated accounting regulatory development (Benston, 1969). This theory is to a great extent worried about three joint indicators of lobbying behaviour also, accounting method choice dependent on suspicions of self-interested managers’ wealth maximization. Managers of firms making large benefits and conceivably mishandling monopoly powers, it is guessed, are probably going to utilize a heap of accounting strategy decisions to decrease reported income. Their very own reference to social responsibility disclosure and its relationship to their fundamental contentions is dark. None of the examinations utilizes each of the three of the (joint) hypothesis of behaviour. Most, in fact, just utilize the size or political cost hypothesis, and therefore alone they should be thought about the shaky test of the original argument. Second, none of the tests takes the chance to look at the management practices other than the picked disclosure variable that one may hope to exist if self- interested income diminishing methodologies were being received as theorized, in this way further weakening the tests (Milne, 2002). Now, consider the three hypothesis of behaviour. The intellectual predecessor of positive accounting theory is the income smoothing hypothesis (Becker, G. M,DeGroot, M. H, 1964). According to this hypothesis, income smoothing is viewed as a function of rational behaviour of humans with a few assumptions: - a) the managers of the organisation are utility maximizers b) the main reasons for market risk are variation in the income and uncertainty of earnings c) the main stimulus of share value is the dividend payout ratio d) firms’ share value is the main determinant of managers’ utility (Beidleman, 1973; Watts, R. L., Seventeenth AIMS International Conference on Management 533 Seen as such, the firm turns out to be minimal in excess of equilibrium of contending contractual connections went into by people, some of whom may represent different associations. The agency and property rights writing has been an affluent wellspring of testable significance for researchers from a few orders, particularly accounting. The acknowledgment that probably the most evident agency connections in the corporate environment (for example the manager/investor relation and the agent/debt holder connection send) use contracts dependent on accounting numbers has driven accounting analysts to utilize agency theory in endeavours to clarify, in addition to other things, the interest for financial reports, uncertainties in accounting strategy decision, campaigning attempts before administrative firms, and stock market responses to compulsory changes in accounting. In light of agency theory, positive scholars see accounting reporting as a feature of the organisation's contract procedure. Positive scholars don't see assorted variety in financial practices as tricky, yet as a need altogether for "contracting parties to tailor their accounting strategies to their very own particular conditions" Norm setters ought not to view cross-sectional varieties in accounting methods as a sign of administrations' endeavours to control accounting numbers so as to deceive investors (and apparently others). In addition, "Norm-setters ought to consider the impacts of prospective accounting measures on current contracts (so as to maintain a strategic distance from) unexpected wealth moves between parties of the firm (Watts, R. L., & Zimmerman, J. L., 1986). While the agency writing has delivered useful bits of knowledge for accounting analysts, its wide-spread acknowledgement by standard researchers has gotten basic consideration in a few recent investigations related to the profound accountants. Rising up out of these basic investigations is the acknowledgement that accountants have been immensely impacted by neoclassical financial aspects, that underestimated suppositions are precarious to a full comprehension of the socio-political condition of accounting, and that the two of these issues add up fundamentally to belief system in current accounting thought (Hunt III, H. G., & Hogler, R. L., 1990) 4. Positive Accounting Theory, Agency costs and Accounting Regulatory Development Agency theory is limited in its meaning of judicious conduct with regard to its supposition that people want to augment utility and that utility is spoken to by riches. Rather than its narrow presumption about inclinations, it is broad with respect to the distribution of the power. Moreover, it contains conflicting suppositions about the sorts of activities over which power exists. lt is difficult to accept the idea of market failure theories were ignored from a positive point of view. While such oversight is conceivable, it positively isn't plausible. Therefore, doubtlessly it considers ideological inclination to go into what is marketed as intellectual enquiry. The interdisciplinary nature of accounting research gives numerous chances to standardizing investigation into the requirement for as well as the ideal idea of accounting regulations. Contending normative theories can be as advantageous to the public as contending descriptive theories (Ruland, 1984). The irregularity has taken into consideration the particular use of contentions, for example, the market for excuses contentions. It is our assumption that no single theory will totally clarify accounting regulatory development. Rather, we expect the juncture of theories which are equipped for foreseeing probably a few parts of accounting regulatory development will be most useful for regulating normative decisions. The estimation of utilizing different theories to illustrate social phenomena has been perceived by researchers in other sociologies, including economics furthermore, social anthropology (DiMaggio, 1986). So, the theories which focus on the rational behaviour of individuals and groups would be able to predict accounting regulatory development more accurately. The advantage of such theories is to a great extent attached to how explicitly they can demonstrate the idea of inclinations and the appropriation of intensity in the public arena. There are numerous methodologies which may be taken to demonstrate better inclinations and power. Ethical cognition research finds that there are phases of ethical advancement in people extending from the "preconventional" stages where people obey rules and regulations so they won't get rebuffed to the "post-conventional" stage where people pick and pursue ethical standards. Persistent with the recognized performance, management advancement in accounting may result not from a desire with respect to people to boost wealth. Rather, people might be inspired by moral standards which make accounting guideline alluring (Conroy, 2010). The "economic theory of regulation" centres around the sound conduct of people in a more extensive setting than the manager shareholder relationship. Under this theory, people and society are seen as being in competition among themselves for the intensity of government to accomplish wealth transfer by means of the economic guideline. That is, economic guideline is viewed as an item and the allotment of the item is dictated by free-market activity. The key element of the economic theory of guideline is that it requires an examination of all groups influenced by the entry of the revelation demonstrations. The theory holds that guideline speaks to the result of various contending parties arriving at an equilibrium. By concentrating exclusively on investors, past studies may have been excessively confined. For this situation, barring other influenced parties might be viewed as a "omitted variables" issue. The presence of compulsory exposure might be clarified by an increasingly complete examination which contains other influenced parties (Posner, 1974). This economic theory of regulation is consistent with May and Sundem’s model of accounting policy decision. It shows that accounting policy decisions are decided using an aggregate decision rule. Also, the model especially demonstrates that there are numerous and contending parties which impact accounting policy decisions (May R.G., 1976). A model may be meant for looking at financial information disclosure. The model sets that the utilization of power is impacted by the accompanying elements: (a) the relationship among groups; (b) heterogeneous objectives among groups; (c) heterogeneous convictions about innovation among groups, and (d) shortage of assets. At the point when these conditions are met, contention will emerge (Pfeffer, 1981). One consequence of contention among various groups is that party gathering won't have comparative rankings concerning what is to be unveiled for the increasingly complete discourse of the issues prompting differential rankings for information disclosure. A specific group evaluating the 534 Seventeenth AIMS International Conference on Management impacts of disclosure may verify that it is useful, inconvenient or impartial concerning its interests (Jensen T.S., 1985). The basic component in the goals of the contention is the arrangement of people or on the other hand groups with adequate power to drive a decision. By recognizing the sources of power, it is conceivable to foresee what decisions will be made. Institutional Theories Institutional theories have been created in human science to show and clarify hierarchical advancement and change. These theories keep up that institutional improvement is driven by more intricate conduct than self-interest maximisation boosts with respect to people. Two instances of such theories which may help portray the improvement of accounting guideline are organisational legitimacy and the generation of trust. Organisational Legitimacy Organizational legitimacy is characterized as existing when there is a "compatibility between the social qualities related to or suggested by hierarchical exercises and standards of worthy conduct in the bigger social framework of which the associations are a part" (Dowling J., 1975). Fundamental organizational legitimacy is a procedure, legitimation, by which an association looks for endorsement (or evasion of assent) from gatherings in the society. Legitimation might be important to guarantee an association's continuation. It is to the procedure of legitimation that traits the advancement of corporate social disclosure. Theory of accounting regulatory development dependent on organizational legitimacy is obviously conceivable. Business associations, for example, companies could look for exposure guideline with an end goal to show social duty and maintain a strategic distance from cultural approvals which may even incorporate expulsion. Legislators could pass revelation guideline to legitimize themselves as defenders of the public interest when voters are disappointed with corporate conduct. At the point when the quality of their work has been addressed, accounts might look for guidelines to keep up their status as a profession. It is imperative to take note of that cultural desires would not need to be unitary all together for legitimizing action to occur. A few people may not mind one way or the other about corporate execution or corporate disclosure. Be that as it may if a powerful group of individual requests or would be conciliated by an action like disclosure guideline, organisations may look for authenticity with that group notwithstanding when the group is a minority in the society. Organisations may have nothing to lose except for something to pick up by legitimizing exercises under such conditions (Kaplan S.E., 1991). Production of Trust Trust is made out of basic understandings (foundation desires) and "guidelines characterizing the unique circumstance or background" of the exchange (constitutive expectations) (Zucker, 1987). Trust is disrupted when either constitutive or foundation desires are damaged. At the point when conventional methods of trust are disturbed, a third mode, institutional based trust creates. Institutional-based trust development increased during the 1800s and 1900s due to the interruption of conventional methods of trust. The disturbances are established in expanded social heterogeneity brought about by migration and immigration, and a new economic association identified with the insecurity of firms and organizations (Neu, 1991). Production of trust indicates the potential for clarifying institutional advancement through accounting guideline. Institutional trust advancement is relied upon to slack disturbance of trust (similarly as accounting theories which are reasons are relied upon to slack changes in accounting practice). The idea shows guarantee to give more extravagant a theory of guideline than can be given by rationale economics alone (Kaplan S.E., 1991). 5. Conclusion In order to increase the role of research in making correct predictions, both descriptive and normative theories should be created. Positive accounting theory to date has made little commitment to a portrayal of accounting regulatory development and along these lines isn't helpful alone for standardizing decision making. The reason behind this is the assumption of rationality. In real life, this assumption is a bit difficult to observe. With the dynamic environment, new theories also need to be developed. The absence of reality and divergence appears to reflect the description of the theory as a reason to advance the researchers theory. With the blend of both positive theory of accounting and new theories developed, better prediction can be made in this dynamic world. It suggests future implication for research also. Considering the changes and complexities in environment, new theories for a better prediction can be developed. 6. References 1. Amihud, Y., & Mendelson, H. 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