Atma Jaya Makassar University: Richard Wiratama Marselinus Asri
Atma Jaya Makassar University: Richard Wiratama Marselinus Asri
Asri]
Richard Wiratama
Marselinus Asri
Atma Jaya Makassar University
ABSTRACT
This papel reviews the positive accounting theory. The article also discusses development
in accounting theory and research. The philosophical objective of positive accounting theory is
to explain and predict current accounting practice. Positive accounting theory seeks to
understand why accounting practices are employed by accountans in different circumtances
and by different firms. Three hypoteses in positive accounting theory: bonus plan, debt
convenant and political cost. Criticisms of positive accounting theory (1) methodology,
philosophy and economics approach.
This study will discuss PAT as seen from several perspectives, including the history of the
rise of PAT, the shift from normative to positive approaches, then the development of PAT,
research on PAT and criticism of PAT. The paper also describes the economic consequences
related to the emergence of new accounting standards which of course will affect the selection
of the method of accounting by management.
1. INTRODUCTION
Accounting practices have evolved since before Christ. Accounting at that time was
carried out using the single entry method. The next development into documented double
entry since the publication of the writings of Luca Pacioli in the 15th century. Some experts
believe that the double entry bookkeeping was actually used by traders in Italy long before
Pacioli's book was published. The development of accounting practices with double entry
continues to occur, but not accompanied by the development of accounting theory. Writing
and thinking about accounting theory only began to appear in the early 20th century. In 1940 a
book written by Paton & Littleton, entitled An Introduction to Corporate Accounting Standards.
This book is one of the landmarks of thought in the field of financial accounting. Subsequent
developments in accounting theory have led to the use of various theories in other fields such
as finance, economics, management, psycho-logic, sociology and others. Nowadays,
accounting theory has developed rapidly and covers various aspects.
Theory is often used as the basis of an action or practice. Gaffikin (2008) suggests that
the development of a theory is designed to get an understanding and then the theory can
explain a phenomenon that occurs. Manullang (2005) adds that in contrast to natural science
where theories are developed from the results of empirical observations, accounting science
tends to be developed on the basis of value judgments that are influenced by the environment
in which accounting is applied.
The theory that can be stated in the form of words and symbols, which is called in the
philosophy of knowledge as semiology. Semiology consists of 3 theoretical elements, namely
(a) Syntetic: relates to grammar or relations between symbols and symbols, (b) Semantics:
shows the meaning or relationship between words, signs or symbols with objects in the real
world. (c) Pragmatic: shows the influence of words or symbols on a person. In relation to
accounting, accounting theory is closely related to pragmatic aspects, namely how accounting
concepts and practices affect one's behavior (Manullang, 2005). The term accounting theory is
often associated to indicate accounting concepts that are relevant to existing accounting
practices. The development of accounting theory has been done, but none of these theories is
able to completely and thoroughly about what is called accounting theory.
During the 1950s and early 1960s accounting research was done more on policy
recommendations and what should be done, not on analysis and explanation of existing
accounting practices. This normative theory is widely criticized because the rationale used to
analyze this theory is considered too simple and does not provide a strong theoretical basis.
The normative theory of relevance began to be questioned in the 1960s with the
emergence of efficiency market hypotheses (EMH) which had a major influence on the world
of accounting research. Watts and Zimmermen provided an alternative approach to research
in accounting known as positive accounting theory (PAT) by publishing their research article
Toward a Positive Accounting Theory of Accounting Standards in The Accounting Review in
1978.
This study will discuss about PAT viewed from several perspectives, including the history
of the emergence of PAT, the shift from normative to positive approaches, then the
development of PAT, research on PAT and criticism of PAT, and also the consequences of PAT
on accounting economics.
2. LITERATURE REVIEW
2.1 The Rise of Positive Accounting Theory (PAT)
Watts & Zimmermen (1978) say that the history of conflict between changes in business
flow in the US in the 1950s and 1960s. The paradigm negotiations about changes in the flow of
US business in the late 50s and early 60s. The report on business education established by the
Ford Foundation and Carnegie Corporation of New York is a catalyst for this change. Making
and remembering hypotheses needs good research.
In addition, the emergence of PAT is also caused by advances in calculating facilities that
facilitate the process of analyzing large amounts of data used in PAT research as stated by
Watts & Zimmermen (1978) that computers and machine databases that can be read (CRSP
and Compustat) become available in the 60s and responding to the costs coming down from
empirical work, finance and positive economic theory became available to the use of
accounting researchers. This leads to the development of positive accounting research and to
researchers trained in positive theory methodology.
The criticism of normative accounting theory is also the reason for the emergence of
PAT. Jensen & Meckling (1976) states that a theory in accounting is nothing more than a
normative proposition. Accounting theory almost completely contains what accountants
should do. Jensen even added that accounting research is not scientific because the focus of
accounting research is limited to definitional and too normative. From some of the reasons
stated above is the beginning of the emergence of PAT in the accounting world.
Positive accounting research was first discovered by William H. Beaver (1968) with the
publication of an article entitled "The Information Content of Annual Earnings
Announcements" (Jensen & Meckling, 1976). Furthermore, positive accounting theory was
recognized when Watts & Zimmerman published his article entitled "Towards a Positive
Theory of the Determination of Accounting Standards" in 1978. The article had made positive
accounting theory a dominant paradigm of accounting research based on empirical qualitative
and could be used to justify the various accounting techniques or methods that are now used
or find new models for the development of accounting theory in the future.
2.2 Positive Accounting Theory (PAT)
Positive accounting theory seeks to explain a process, which uses the ability,
understanding, and knowledge of accounting and the use of accounting policies that are most
suitable for dealing with certain conditions in the future. Positive accounting theory in
principle assumes that the purpose of accounting theory is to explain and predict accounting
practices.
The purpose of positive accounting theory is to explain (to explain) and predict (to
predict) accounting practices. Explanation means giving reasons for the observed practice. For
example, positive accounting theory seeks to explain why companies continue to use historical
cost accounting and why certain companies change their accounting techniques. While
predictions of accounting practices mean the theory tries to predict phenomena that have not
been observed.
From the description above, it can be stated that PAT emphasizes whether the
accounting theory put forward in the accounting literature can explain the accounting
practices carried out and predict the cause of the phenomenon that is happening now and its
influence in the future.
2.3 Normative Accounting Theory (NAT)
Early developments in accounting theory produced normative theories which were
defined as compulsory theories. In normative theory a minimum value judgment is used which
contains a premise. At the beginning of its development, writing normative accounting theory
did not use a formal investigative approach. Theory is composed primarily to develop
accounting postulates.
Watts & Zimmerman (1986) explain the notion of normative theory as accounting
theorists became much more concerned with prescribing how firm. should report,; the
became more normative - concerned with what should be done. Very little concern was
exhibited for the empirical validity of the hypotheses on which the normative prescriptions
rested. From this understanding, normative theory seeks to explain what information should
is a concept where the capital market is said to be efficient if the stock price truly reflects all
relevant information. In 1970, Fama divided three levels in the EMH concept, namely weak
form efficiency (it is assumed that current stock prices reflect information in the past), semi
strong form efficiency (it is assumed that current stock prices reflect past information and
information published to the public), and strong form efficiency (it is assumed that the current
stock price reflects all information whether published or not).
The second stage, the research included in this stage emphasizes more on the literature
that explains and predicts cross-company practices. The theory developed from research in
this stage is closely related to the company's goal to maximize shareholder prosperity. Famous
research in this stage is about agency cost conducted by Jensen and Meckling in 1976.
Research conducted by Jensen and Meckling found that managers (agents) appointed by
shareholders (principals) often experience conflicts of interest in reality. This conflict of
interest is called the agency problem that will cause agency costs.
Positive Accounting Theory (PAT) in the last four decades developed into a science that
can be used to explain the choice of methods that will be used by managers and other
constituents of financial statements that can be used for decision making.
Deegan (2014) suggested that the development of PAT could not be separated from
papers from Ray Ball and Philip Brown, Ball and Brown's publication in 1968 in the Journal of
Accounting Research led to an interest in positive research that was widespread in capital
market research related to accounting. In addition, the development of PAT is also supported
by the work of Fama theorists related to the development of EMH.
According to Watts & Zimmermen (1986), PAT has two main elements, namely
assumptions and hypotheses. Assumptions are the starting point where a researcher starts
from research. Researchers use assumptions to regulate, analyze, and understand empirical
phenomena related to research focus such as the use of LIFO and FIFO methods to minimize
tax obligations. From this assumption, the researcher can use the hypothesis to be empirically
tested. The assumptions used in PAT are the agreement that the capital market is efficient
(efficient capital markets), behavioral opportunistic and also accounting information is an
economic commodity and political commodity and each individual acts on their own behalf
rationally.
Watts and Zimmermen in their paper entitled "Positive Accounting Theory: A Ten Years
Perspective" (1990) put forward three hypotheses of PAT, namely:
1) The bonus plan hypotheses. This hypothesis suggests that managers will choose
accounting procedures that will shift future income to the present period with the
aim of getting a bonus.
2) The debt agreement hypothesis. This hypothesis suggests that for companies that
would violate a debt agreement, the manager would have the possibility to choose
accounting procedures that shift future income to the current period so as to
increase net income and ultimately avoid technical errors.
3) Political cost hypothesis. This hypothesis suggests that companies that have high
profitability will tend to shift their income from this period to the coming periods to
avoid political costs.
These three hypotheses form an important component of PAT and will lead to
predictions that can be empirically tested.
2.6 Research that Supports Positive Accounting Theory (PAT)
Positive research in accounting began in the mid 1960s and became the dominant
paradigm in the 1970s and 1980s. Since its emergence in the 1970s, PAT has produced several
important studies to explore accounting practices and the behavior of related parties in an
organization empirically. Empirical research on PAT was first conducted by Ball and Brown in
1968 and Beaver in the same year has succeeded in providing empirical evidence that earnings
announcements affect the stock price and trading volume of a company's shares. These two
works are the references for future PAT studies.
Scott (2015) suggests that several studies from PAT include:
1) Lev's research (1979), Lev did not make any recommendations about how companies
and investors should react to the draft exposure of SFAS 19. Lev only emphasizes
how investors react to prospects for oil and gas companies that use the full-cost
method to move to the method succesfull-effort. So Lev's study helps us understand
why different companies choose different accounting policies and why some
managers object to changes in the policies and why investors react to the potential
impact of changes in accounting policies on net income.
2) Healy research (1985) which examines the hypotheses bonus plan. Healy found
evidence that company managers who have bonus plans will systematically adopt
accrual policies to maximize their bonuses.
3) Sweeney's research (1994) concerning debt covenant hypotheses. Sweeney found
that agreements that were most often violated had to do with maintaining working
capital and shareholder equity, while debt to equity ratios and interest coverage
ratios were not violated too often.
4) Jones's (1991) study that examined the hypotheses of political cost. Jones found that
the company reduced the net income it reported during the investigation of import
relief / exemption. This is related to the political cost aspect.
2.7 Research That Criticizes Positive Accounting Theory (PAT)
The PAT idea put forward by Watts and Zimmermen is not only controversial but also
raises criticism and refutation from various parties. Ekowati (2006) argues that there are a
number of criticisms directed at PAT which are viewed from various perspectives, namely:
a) Research Methods Perspective
Ball and Foster in 1982; Holthausen and Leftwich in 1983 and McKee et al. in 1984 it was
suggested that the research method carried out by Watts and Zimmermen was weak in
reducing the strength of the test. The test on PAT is not strong enough because of problems
related to model specifications, problems that arise. While Lev and Ohlson in 1982 viewed PAT
could not be used for multipersonal models, multiperiod equilibria, there was also a gap
between strategic consedirations and game theory approaches that used as the basis for
developing formal theory.
Then Houlthausen and Leftwich in 1983 saw a problematic dichotomy of the dependent
variable that presented approval or disagreement in determining accounting standards.
McKee, Bell and Boatsman in 1984 also viewed that there was a statistical identification bias in
the Watts and Zimmermen study. specify left and right variables, and omitted variables.
b) Research Methodology Perspective
Watts and Zimmermen suggested that PAT is a theory that contains value. Cristenson
(1983) criticized Watts's opinion that "The positive theory in establishing accounting standards
is important to ensure that the prescriptions given by normative theories are correct and
worth applying". (Watts & Zimmermen, 1978).
Cristenson (1983) also added that positive research questions are only focused on the
sociological approach, not on accounting theory, this is because descriptions and predictions
are only about the behavior of accountants and managers, not the behavior of accounting
entities.
c) Scope Perspectives outside Research
Sterling (1990) considers PAT not to qualify as a complete science but only to be
considered a "cottage industry". In terms of accounting practices, PAT aims to explain and
predict. This concept defines the phenomenon of accounting as a mathematical construction
used to present forms of accounting information. For Sterling, this construct is considered to
only describe words and numbers that can be seen in real terms and real events.
Watts and Zimmermen said that accountants will try to maximize individual interests.
Boland and Gordon criticized that in economic theory alone, maximization of individual
interests cannot be fully carried out because it must also consider shared interests.
Whittington (1987) in Lo (2003) criticizes the statement that positive accounting theory
is free from subjective judgments and is scientific while normative theories have high
subjective and unscientific judgments, is unacceptable with two objections as follows, first,
positive accounting theory not free from judgments or prescriptive implications; secondly, the
notion that all non-positive theories are normative in the sense of referring to prescriptions, is
incorrect.
Deegan (2014) writes some criticisms of PAT, including:
a) PAT does not prescribe and therefore does not provide a means to improve
accounting practices. Sterling added that PAT could not provide some answers
because he limited himself to descriptive questions.
b) The second criticism of PAT is that it is not value-free, as confirmed. If we look at
various studies using PAT, we will see no formulation (that is, there are no guidelines
as to what to do).
c) The third criticism of PAT is related to the basic assumption that all actions are
controlled by the desire to maximize one's welfare. For many researchers such an
assumption shows an overly negative perspective of humans
d) Another criticism of PAT is that since the beginning generally in the 70s the problem
discussed did not show any major development. A review of the PAT literature now
shows that this hypothesis continues to be tested in different environments and in
relation to different accounting policy issues even after twenty years have passed
since Watts and Zimmerman in 1978.
e) A further criticism is that PAT is scientifically flawed. It is argued that when
hypotheses produce a pursuit for PAT often the hypotheses proposed are not
supported, then scientifically PAT should be rejected.
A number of criticisms given by some researchers in the field of accounting do not
dampen the amount of attention to this PAT research, to date there are still many accounting
studies that use the PAT approach.
2.8 The Consequences of PAT on Accounting Economics
The main objective of positive accounting theory as described earlier is to be able to
explain (to explain) and predict (to predict) accounting practices, related to individual behavior
in choosing accounting methods that can maximize their utility. To be able to understand the
interests of management in financial reporting, it is necessary to appreciate the concept of
economic consequences in accounting.
Positive accounting theory tries to understand and predict the choice of corporate
accounting policies. In general, the assessment of the accounting policy to be chosen is aimed
at minimizing capital costs and other contract costs. Accounting policies in general are
determined by the company's organizational structure, which is influenced by the environment
in which the company is located. Thus the selection of accounting methods to be used is part
of the entire corporate governance process (Scott, 2015).
Positive accounting theory does not directly determine the appropriate accounting
policy choices for the company. In this case, the selection of accounting policies will be easier if
viewed from the management side. Because management has the flexibility to choose
accounting policies for the company, this also indicates flexibility for management to respond
to changes that occur in the corporate environment, such as the existence of new accounting
standards.
Financial accounting standards were originally created by the standard boards in each
country, consequently accounting standards between one country and another may very
different. However, with globalization and due to differences in environmental, legal, social,
political and economic conditions between countries, international accounting has emerged
which attempts to decipher accounting theories and practices that apply internationally. This
has caused several changes related to accounting methods that management can choose.
As an illustration related to the disclosure of assets and liabilities in the financial
statements. During this historical cost concept established by the Financial Accounting
Standard Board (FASB) is used to measure assets and liabilities based on their initial acquisition
value. This concept is based on the basic assumption that the entity is considered to be going
going concern. Consequently, because the entity will not be liquidated, the values included in
the financial statements are not liquidation values, but the historical cost. The advantage of
the historical cost concept is that it meets the concept of reliability because it is supported by
strong evidence, so that the size of the financial statement post can be proven easily because
it is based on transactions that have occurred. But over time, on some occasions, not always
the performance of a financial statement presented based on historical cost can provide
fairness information from the display of the wealth and liabilities of an entity. Like when
inflation or deflation might occur, the reported post will not reflect this changing value. This
causes the historical cost to be irrelevant.
In order for financial statements to be useful, relevant, and reliable, the International
Accounting Standard Board (IASB) establishes fair value as a basis for measuring assets and
liabilities. Fair value is the price that will be received in the sale of assets or payment to
transfer obligations in an orderly transaction between participants in the market and the
measurement date. There are 3 hierarchies in estimating fair value, namely by using market
value, comparison with market prices of items that can be compared with items being valued,
and by using estimates. Measurement of assets and liabilities is based on fair value, not in the
initial measurement. The initial measurement of the entity's fixed assets and liabilities is
carried out on a cost basis at the time of the transaction. After the initial measurement, that is,
during financial reporting, an entity may choose measurement based on historical cost or
evaluate its assets and liabilities based on fair value and apply the policy to all fixed assets in
the same group (IAI, SAK 16 paragraph 29). In this case fair value is used as a basis when assets
and liabilities can be exchanged, not when assets and liabilities are actually exchanged. The
strength of fair value is that it reflects the real conditions of assets and liabilities. But the
weakness of fair value is not based on historical evidence, so that it has subjective
implications.
The use of fair value on depreciated fixed assets, can have significant economic
consequences. This can occur when fixed assets are revalued, apparently showing a higher
market value than the historical cost. As a result, the value of the company's assets to rise and
its meaning must be balanced with an increase in the debt side. In addition, this also has an
impact on the company's income statement, which will result in taxes that must be paid by the
company.
The emergence of new accounting standards requires managers to be able to
understand them well and be able to choose accounting methods that provide prosperity for
shareholders.
3. CONCLUSION
Positive theories develop due to dissatisfaction with normative theories, namely (1) the
inability of normatives to test empirically; (2) normative focuses more on individual investors'
prosperity than on broader prosperity; (3) normative does not encourage or allow optimal
allocation of economic resources in the capital market.
Current accounting theory is inseparable from the role of Watts and Zimmermen who
introduced PAT into accounting research in 1978 through their paper published by The
Accounting Review entitled Toward a Positive Accounting Theory of accounting Standard
which has shifted the paradigm of accounting research from the normative be positive. Then in
1990 they put forward the Hypothesis of Positive Accounting Theory in which there are bonus
plans, violations of debt agreements and political costs that are the main reference in current
accounting research. Not only the support given in the development of PAT, many critics also
came to Watts and Zimmermen such as from Sterling, Ball and Foster, Lev and Ohlson,
Cristenson and many others. But with the criticism and support given to PAT, PAT itself has
given its own color to the accounting world, especially in the development of accounting
theory.
The presence of a positive accounting theory has made a significant contribution to the
development of accounting, which results in a systematic pattern of accounting choices and
provides a specific explanation of the pattern, provides a clear framework in understanding
accounting, shows the main role of contracting costs in accounting theory, explains why
accounting is used and provides a framework for predicting accounting choices, encourages
relevant research where accounting emphasizes predictions and explanations of accounting
phenomena. Positive accounting theory was also developed towards expanding the scope of
information such as in the fields of HR accounting and social accounting. The development of
theory as it is happening right now should not stop but continue so that the benefits of the
theory can continue to develop so that it can answer all new questions that arise.
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