Accounting theory 9
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Positive Accounting Theory (PAT) seeks to explain and predict accounting practices and choices. It assumes individuals act in self-interest to maximize their own wealth. PAT views organizations as collections of individuals who cooperate through contracts to align interests. These contracts aim to minimize agency costs that arise from delegating decision-making authority from owners (principals) to managers (agents). PAT predicts firms will implement accounting-based mechanisms like financial reporting to bond managers' behavior and reduce agency costs.
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17-1ACCOUNTING THEORYTOPIC 6 CHAPTER 7Positive
1
7-1
ACCOUNTING THEORY
TOPIC 6
CHAPTER 7
Positive Accounting Theory
Learning objectives
7.1 Understand how a positive theory differs from a normative
theory.
7.2 Be aware of the origins of Positive Accounting Theory (PAT).
7.3 Understand that PAT uses insights from agency theory and
why agency theory is of relevance to financial accounting
practices.
7.4 Be aware of the central assumptions of PAT.
7.5 Be aware of the meaning and nature of agency costs.
7.6 Understand why an organisation can usefully be referred to
as a ‘nexus of contracts’.
7.7 Understand the perceived role of accounting in minimising the
transaction costs of an organisation.
continued
Learning objectives (cont.)
7.8 Be aware that accounting policy choices made by
management will be influenced by both efficiency
considerations as well as opportunistic motivations.
7.9 Be able to identify the reasons for the existence of ‘creative
accounting’.
7.10 Be able to explain the meaning of ‘political costs’ and how
accounting can be used to reduce the costs associated with
various political processes.
7.11 Understand the role of accounting-based management
compensation schemes and debt covenants in reducing
potential conflicts (agency costs) within an organisation.
7.12 Understand how particular accounting-based agreements
with parties such as debtholders and managers can provide
incentives for managers to manipulate accounting numbers.
continued
1
2
3
2
Learning objectives (cont.)
7.13 Be aware of what constitutes ‘conservative’ accounting
procedures and why conservative accounting procedures
provide efficient mechanisms for minimising the contracting
costs within an organisation.
7.14 Understand the relevance of PAT to current debates about
how assets and liabilities should be measured.
7.15 Be able to identify some of the criticisms of PAT.
Positive theories compared to
normative theories
• A positive theory seeks to explain and predict
particular phenomena
– Positive Accounting Theory (PAT), which we explore in this
lecture, is one example of a positive theory of accounting.
Other examples are covered in the next lecture (when we
consider theories such as Legitimacy Theory and
institutional theories which are positive theories that can be
applied to explain the practice of accounting)
• By contrast, normative theories (which were
considered in Chapters 5 and 6) prescribe how a
particular practice should be undertaken
– the prescription might depart from existing practice
Positive Accounting Theory
defined
• PAT ‘… is concerned with explaining accounting
practice. It is designed to explain and predict which
firms will and which firms will not use a particular
method … but it says nothing as to which method a
firm should use.’ (Watts and Zimmerman 1986, p. 7)
• Again, positive theories do not prescribe what should
occur – they focus on explaining or predicting what
does occur
continued
4
5
...
Respond to... Companies often try to keep accounting earnings .docx
Respond to...
Companies often try to keep accounting earnings growing at a relatively steady pace in an effort to avoid large swings in earnings from period to period. They also try to manage earnings targets. Reflect on these practices and discuss the following in your discussion post.
Are these practices ethical?
According to Ortega & Grant (2003), “earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company to influence contractual outcomes” (p. 51). Because these practices are used to alter the financials of a firm from actuality, then, no, these practices are not ethical, however there are common practice and, in some circumstances, acceptable.
What are two tactics that a financial manager can use to manage earnings?
Financial managers at times will use certain tactics to manage earnings. Two tactics that financial managers use to manage earnings are the Big Bath technique and the cookie jar reserve. The big-bath technique consists of taking a one-time, large write-offs or restructuring charges against income in order to reduce assets to further lower future expenses (Hope & Wang, 2018). The use of the big bath method can affect a firms’ competitiveness as it is essentially reporting a loss, which can have negative results on stock prices. The other method is the cookie jar reserve occurs when a company saves money from successful years and draws from that money and applies it to bad years in order to bolster earnings reports (CPA Journal, 1999). The method is used as way to smooth income and appear financially better when in actuality the company is having a bad year.
What are the implications for cash flow and shareholder wealth?
Ultimately, financial manager’s job is to maximize profit, because of this conflict of interest may occur. According to Chalak & Mohammadnezhad (2012), “with respect to increase shareholder wealth, free cash flows are of importance because allow managers to seek growth opportunities which increase share value” (p. 430). Therefore, the use of the techniques in the regards to implications for cash flow and shareholder wealth can be detrimental due to unreliable and inaccurate information, which occurs from managers intentionally influencing actual financials.
Using the financial balance sheet as displayed in the text, provide an example of how purchasing an asset or issuing stocks or bonds could potentially impact earnings targets.
When purchasing an asset or issuing stocks earnings targets are impacted due the changes in cash flow. For instance, when purchasing assets, the cash accounts will decrease the purchase amount, while issuing stocks or bonds increases by the amount received for the purchased stocks. These actions can a company to miss or exceed its earnings targets by the amounts of cash flow coming in or going ou.
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17-1ACCOUNTING THEORYTOPIC 6 CHAPTER 7Positive
1
7-1
ACCOUNTING THEORY
TOPIC 6
CHAPTER 7
Positive Accounting Theory
Learning objectives
7.1 Understand how a positive theory differs from a normative
theory.
7.2 Be aware of the origins of Positive Accounting Theory (PAT).
7.3 Understand that PAT uses insights from agency theory and
why agency theory is of relevance to financial accounting
practices.
7.4 Be aware of the central assumptions of PAT.
7.5 Be aware of the meaning and nature of agency costs.
7.6 Understand why an organisation can usefully be referred to
as a ‘nexus of contracts’.
7.7 Understand the perceived role of accounting in minimising the
transaction costs of an organisation.
continued
Learning objectives (cont.)
7.8 Be aware that accounting policy choices made by
management will be influenced by both efficiency
considerations as well as opportunistic motivations.
7.9 Be able to identify the reasons for the existence of ‘creative
accounting’.
7.10 Be able to explain the meaning of ‘political costs’ and how
accounting can be used to reduce the costs associated with
various political processes.
7.11 Understand the role of accounting-based management
compensation schemes and debt covenants in reducing
potential conflicts (agency costs) within an organisation.
7.12 Understand how particular accounting-based agreements
with parties such as debtholders and managers can provide
incentives for managers to manipulate accounting numbers.
continued
1
2
3
2
Learning objectives (cont.)
7.13 Be aware of what constitutes ‘conservative’ accounting
procedures and why conservative accounting procedures
provide efficient mechanisms for minimising the contracting
costs within an organisation.
7.14 Understand the relevance of PAT to current debates about
how assets and liabilities should be measured.
7.15 Be able to identify some of the criticisms of PAT.
Positive theories compared to
normative theories
• A positive theory seeks to explain and predict
particular phenomena
– Positive Accounting Theory (PAT), which we explore in this
lecture, is one example of a positive theory of accounting.
Other examples are covered in the next lecture (when we
consider theories such as Legitimacy Theory and
institutional theories which are positive theories that can be
applied to explain the practice of accounting)
• By contrast, normative theories (which were
considered in Chapters 5 and 6) prescribe how a
particular practice should be undertaken
– the prescription might depart from existing practice
Positive Accounting Theory
defined
• PAT ‘… is concerned with explaining accounting
practice. It is designed to explain and predict which
firms will and which firms will not use a particular
method … but it says nothing as to which method a
firm should use.’ (Watts and Zimmerman 1986, p. 7)
• Again, positive theories do not prescribe what should
occur – they focus on explaining or predicting what
does occur
continued
4
5
...
Respond to... Companies often try to keep accounting earnings .docx
Respond to...
Companies often try to keep accounting earnings growing at a relatively steady pace in an effort to avoid large swings in earnings from period to period. They also try to manage earnings targets. Reflect on these practices and discuss the following in your discussion post.
Are these practices ethical?
According to Ortega & Grant (2003), “earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company to influence contractual outcomes” (p. 51). Because these practices are used to alter the financials of a firm from actuality, then, no, these practices are not ethical, however there are common practice and, in some circumstances, acceptable.
What are two tactics that a financial manager can use to manage earnings?
Financial managers at times will use certain tactics to manage earnings. Two tactics that financial managers use to manage earnings are the Big Bath technique and the cookie jar reserve. The big-bath technique consists of taking a one-time, large write-offs or restructuring charges against income in order to reduce assets to further lower future expenses (Hope & Wang, 2018). The use of the big bath method can affect a firms’ competitiveness as it is essentially reporting a loss, which can have negative results on stock prices. The other method is the cookie jar reserve occurs when a company saves money from successful years and draws from that money and applies it to bad years in order to bolster earnings reports (CPA Journal, 1999). The method is used as way to smooth income and appear financially better when in actuality the company is having a bad year.
What are the implications for cash flow and shareholder wealth?
Ultimately, financial manager’s job is to maximize profit, because of this conflict of interest may occur. According to Chalak & Mohammadnezhad (2012), “with respect to increase shareholder wealth, free cash flows are of importance because allow managers to seek growth opportunities which increase share value” (p. 430). Therefore, the use of the techniques in the regards to implications for cash flow and shareholder wealth can be detrimental due to unreliable and inaccurate information, which occurs from managers intentionally influencing actual financials.
Using the financial balance sheet as displayed in the text, provide an example of how purchasing an asset or issuing stocks or bonds could potentially impact earnings targets.
When purchasing an asset or issuing stocks earnings targets are impacted due the changes in cash flow. For instance, when purchasing assets, the cash accounts will decrease the purchase amount, while issuing stocks or bonds increases by the amount received for the purchased stocks. These actions can a company to miss or exceed its earnings targets by the amounts of cash flow coming in or going ou.
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The working capital management consist of the relationship of the company short-term liabilities & assets. Its goal is to confirm that an organization can maintain its operations in addition has enough capacity to satisfy all evolving short-term debt also potential operational expenses. The working capital management includes managing accounts payable, receivable, cash, and inventories (Studyfinance, 2020, p. para 1). As per the scenario, we take two components: inventory management and cash budget.
Cash Budget
A cash budget fixes the expected cash sources as well as uses it in a future. This budget used to measure either operations of the company and other activities can produce sufficient cash to fulfill the expected requirements of cash. Unless, then management needs to find alternative sources of financing. The cash budget inputs come from various other budgets. The cash budget enumerates debt, investments, and both interest expense and income which result in financing budget.
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The example demonstrates that the company is positioned in a negative cash situation by an excessively large dividend in the second cash budget week, combined with a major asset purchase the next week. Paying such a high dividend may be a challenge for lenders who don't like issuing loans; therefore, businesses can use the money to pay their shareholders and thus undermine their ability to repay the loans. Therefore, accepting a minimal dividend payout and eliminating a negative cash position can be better for the company (Accountingtools, 2019, p. para 2).
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Inventory management is refers to that process which includes storing, organizing, as well as using the inventory of a company. These contain the management of components, finished products, raw materials, as well as processing and warehousing such items. For companies through complex manufacturing processes and supply chains, balancing the inventory shortages and gluts risks is specifically difficult (Hayes, 2019, p. para 1).
References
Accountingtools. (2019). Cash budget. Retrieved from accountingtools: https://www.accountingtools.com/articles/2017/5/15/cash-budget
Hayes, A. (2019). Inventory management. Retrieved from investopedia: https://www.investopedia.com/terms/i/inventory-management.asp
Studyfinance. (2020). Working capital management. Retrieved from studyfinance: https://studyfinance.com/working-capital-management/
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· Introduce a general summary of the project plan that you .
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Budgeting
Using concepts like flexible budgeting and participative budgeting, discuss why it is important for a company to use budgeting techniques. What type of managerial problems can be caused by the use of budgets?
Submission Instructions:
Any written explanations should use complete sentences, and appropriate grammar, punctuation, spelling and word usage.
Your initial post should be at 200-300 words, formatted and cited in current APA style with support from at least 2 academic sources. Your initial post is worth 8 points.
You should respond to at least two of your peers by extending, refuting/correcting, or adding additional nuance to their posts. Your reply posts are worth 2 points (1 point per response.)
Post by classmate 1
Budget is defined as a plan expressed in quantitative/monetary terms for a specific period of time, usually one year period (Anthony, Hawkins & Merchant, 2011). This is the way companies plan their expenditures with the end goal of obtaining a profit and use responsibility centers/departments/cost centers to help structure such budgets. Even nonprofit organizations prepare budgets as they serve as an aid in making and coordinating short-range plans, communicating plans to the different departmental managers, a way to motivate managers in achieving their goals and controlling ongoing activities and expenses. It also serves as a “ basis for evaluating and educating the performance of responsibility centers and their managers”. (Anthony, Hawkins & Merchant, 2011).
In a typical company you will find a master budget which comprises several items such as the operating budget, cash budget and capital expenditure budget. The operating budget includes revenues, expenses, changes in inventory and working capital items for all the planned operations in the upcoming year. The cash budget provides information with regard to the predicted cash that will be used in that year and the sources. A capital expenditure budget will show any changes in property, plant and equipment already planned for.
Many companies use flexible budgeting to prepare for different activities planned for the year, revenues and expenses. These get modified during the year to reflect actual sales, any changes in cost of production and changes in business operating conditions. This flexibility often allows owners and managers to adapt to the changes forthcoming. On the other hand, predictive budgeting can result in a bit of a mess for managers if not handled correctly as this type of budgeting involves a larger number of employees who are not all top-level managers. This is because given the amount of people involved, it can take longer to create a budget and there might be cost associated that can potentially be higher than having the top level managers handle the creation of budgets for the company. A company may also run into a situation where those same employees participating or originating the budget are also the same ones who pe.
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Applying an effective funds control system is an excellent way for many companies to improve their returns. Funds management ensures a company has sufficient proceeds to meet its short-term debt debts and operating expenses
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Accounting theory 9
- 1. An overview of Positive Accounting Theory From Deegan, C. and Samkin, G., Financial Accounting. McGraw-Hill Irwin, New York Prepared By: Dewan Mahboob Hossain; Assistant Professor; Department of Accounting & Information Systems; University of Dhaka; Dhaka; Bangladesh.