Gerard explains the uses and limits of PAT.

1. LO 3: Explain the beneficial
applications of positive accounting
theory, as well as the criticisms made
of it
1 Created by Dr G. L. Ilott, CQUniversity Australia

2. PAT in action
PAT offers accounting academics and practitioners insights and "tools"
for understanding what really happens in accounting practice, as
opposed to what should be happening.
Please remember neither PAT nor Agency theory make any judgment
about morality, greed or ethics.
You may make your own judgment about the usefulness of such a
theory.
2 Created by Dr G. L. Ilott, CQUniversity Australia

3. Two important uses of PAT
PAT allows principals two important perspectives:
1. Efficiency perspective: Provides guidance on the mechanisms
(controls) and incentives to put into place to lead to beneficial
outcomes in the future.
2. Opportunistic perspective: Alerts principals to the opportunistic
and unplanned actions agents could still undertake after controls
and incentives are put into place.
3 Created by Dr G. L. Ilott, CQUniversity Australia

4. The use of hypotheses to view likely agent
performance
PAT provides a series of hypotheses to indicate the most likely agent behaviour
for a particular situation:
1. Bonus hypothesis: Managers on accounting-based bonus schemes will select
accounting methods that lead to an increase in profits.
2. Political cost hypothesis: Managers in firms facing political scrutiny will adopt
accounting methods that reduce reported income.
3. Debt hypothesis: Managers in firms about to breach debt covenants will select
accounting methods that will lead to an increase in reported profits and assets.
4 Created by Dr G. L. Ilott, CQUniversity Australia

5. The role of PAT in developing our accounting
knowledge
PAT has shone a critical light on the opportunistic possibilities for accountants and managers.
Agency contracts, especially with bonus schemes attached, provide incentives for some
managers to be "creative" in their accounting, to the detriment of the firm.
As a result, the usage of conservative accounting practices (e.g. the use of historical cost) have
been seen as a way of countering opportunistic uses of accounting information.
The use of more advanced methods of measurement, such as fair value, might provide
accounting and financial reporting benefits, but also higher risks of opportunistic manipulation.
Remember, higher risk = higher cost of capital.
5 Created by Dr G. L. Ilott, CQUniversity Australia

6. Criticisms of PAT
PAT has come under sustained criticism since it was first published. Criticisms include:
• Research continues to find "more of the same", while at the same time not
providing conclusive evidence in support of the three hypotheses.
• PAT is not as "value-free" as it would like you to believe.
• PAT offers no way to improve accounting practice (nor does it try to).
• The assumption that all professional managers and their accountants are self-
centred, self-interested opportunists is rather depressing and clearly not true in all
cases. Hence PAT is a little too simplistic for predicting something as complex as
human behaviour.
6 Created by Dr G. L. Ilott, CQUniversity Australia

7. In conclusion…
PAT has revolutionised accounting research, but
is not free from criticisms.
You will find many iterations of PAT studies in the
accounting literature. Critics ponder whether they
actually tell us anything new. Some managers
will be self-interested? Is that really a big deal?
However, as a counter to what had been an
overwhelmingly pro-normative field of research,
PAT has shaken up the discipline of accounting
research.
For that alone, it deserves to be taken seriously.
7 Created by Dr G. L. Ilott, CQUniversity Australia