Critique of Positive Accounting Theory

261 views 9 pages ~ 2257 words
Get a Custom Essay Writer Just For You!

Experts in this subject field are ready to write an original essay following your instructions to the dot!

Hire a Writer

The primary purpose of Positive Accounting Theory (PAT) is to explain and predict accounting practices in relation to the rigid, prescriptive accounting theories that are the dominant ideologies in the accounting. PAT was developed by Watts and Zimmerman in 1978. It is an innovative term that challenges a range of issues that have led scholars to discuss methodological aspects of research techniques, issues related to economics-based research, and issues related to the scientific perspective in accounting. did. In particular, Watts and Zimmerman argue that traditional technical criticism has not influenced accounting-related research. The following paper provides a critical evaluation of PAT. The Positive Accounting Theory as proposed by Watts and Zimmerman

Watts and Zimmerman state that the positive accounting theory is entirely based on economics. It is centered on the ideologies of neoclassical maximization and methodological individualism (Milne 2002). The latter is the dedication to illustrate every social factor as a result of decision making by individuals. In summary, people make decisions but things cannot. For instance, when a board of directors arrives at a decision, the paradigm of methodological individualism rationalizes the decision by examining the decision that each member of the board made. Neoclassical maximization goes further and states that individuals make decisions based on certain limitations (Chambers, 1993). In other words, people make decisions so that they can enhance their utility.

There are several reasons that Watts and Zimmerman state to rationalize PAT. First, they state that a theory is a set of hypothesis that have been validated (Mouck 1992). In this sense, they assert that the positive theory is a set of hypotheses that have been empirically examined. In particular, Watts states that a paradigm is a state of hypotheses that have not only been validated but have also undergone formal tests. Second, the scholars state that theories must illustrate, that is, they must explain “why” (Bodland and Gordon 1992). This is a restatement of the debate in the discipline of economics whether the macroeconomic ideologies can illustrate the happenings in an economy without illustrating the factors that occur at the microeconomic level. Third, Watts and Zimmerman state that theories are selected if they offer the most useful forecasts. Further, a paradigm may be selected even it features numerous errors.

The Weaknesses of the Positive Accounting Theory

On account of the two economic theories that rationalize PAT, there are two weaknesses that can be found in the theory. It means that either there is something wrong with the ideology that individuals maximize their advantage or there is something wrong with the technical aspects of methodological individualism (Beattie et al 1994). Since the assumption of maximization is one of the several assumptions in the neoclassical ideologies, it is hard to criticize the notion on its own.

In the neoclassical economics, the concern is never whether individuals are actually maximizers, rather, it is whether it is possible to create techniques that consider this notion and still illustrate the behavior of the individuals being observed (Zmijewski and Hagerman, 1981). The denunciation is whether it is possible for individuals to maximizing their advantage. For instance, a section of economists believe that the suggested process of maximization is not possible in the logical sense because it needs knowledge that is beyond the realms of human understanding (Zmijewski and Hagerman, 1981). Others assert that even though maximization may be logical, it is not realistic.

A larger problem is created by methodological individualism. Whereas it seems rational to state that only people make decisions, it is not apparent that this entails that individuals arrive at decisions at their own will (Beattie et al 1994). In other words, people may make decisions based on the social effects of their actions. For instance, a driver chooses to stop at a zebra crossing since it is the correct social behavior. Another notion is that if people are maximizing their advantage, then the welfare of the wider society must also be at its maximum point. This notion assumes that the entire economy is in a state of equilibrium, therefore, there is no reason for people to change their decisions (Beattie et al 1994). Nonetheless, this ideology of general equilibrium is not consistent with social principles like GAAP. If the ideology of accounting principles is to assist stakeholders observe whether the actions of a corporation adheres to their interests and the tax structure, then it cannot be assumed that what is best for a corporation is best for a country and its citizens.

Critique of The Positive Accounting Theory

Since PAT was established, there have been numerous studies that examine and criticize it. The criticisms are either classified as technical, philosophical, or economical. One of the main technical criticism is from Lev and Ohlosn (1982), who state that the positive accounting studies do not consider the equilibria of multi-period and multi-person. Additionally, they state that the notion lacks strategic concerns and the approaches of game theory that assist in the development of a formal paradigm. Ball and Forster (1982) criticize PAT on the basis of construct rationality, whereby the size of a variable may act as a substitute for other variables that are omitted. Houlthausen and Leftwich (1983) assert that a variable that contradicts with a suggested accounting principle is problematic. McKee, Bell, and Boastman (1984) criticize Watts and Zimmerman (!978) on the basis of the statistical preferences of their study.

The main philosophical criticisms are based on the notion of normative/positive distinction as suggested by Watts and Zimmerman. The most prominent criticisms in this category examine the limitations of reasons that are based on economics. However, most the criticisms in this criticisms in this category have been refuted by Watts and Zimmerman. Since the scholars did not base their arguments on philosophy, criticism from this viewpoint are incorrect. Nonetheless, it is still useful to examine these perspectives since they raise some valid points. Tinker et al (1982) argue that even though Watts and Zimmerman assert that the positive accounting paradigm is descriptive, nonbiased, and objective, the theory is based on the same values as the normative accounting theories that they dispute. Christenson (1983) rejects the idea of positivism since it cannot be rationalized. He claims that an individual should not advocate for anything unless they have an initial justification. Whitely (1988) queried the application of scientific technique from the natural sciences in the social sciences.

It is hard to perceive the usefulness of the aforementioned philosophical criticisms since the perspectives of these philosophers can also be questioned. Many philosophers are not familiar with the discipline of economics and the complexities of the accounting theory. In the same sense, Watts and Zimmerman did not base their ideology on philosophy since this is jot their specialization.

The criticisms based on economics focus on the methodology applied by Watts and Zimmerman and the notion of equilibrium. Even though Demski (1988) sees the usefulness of PAT, he routinely questions the approach used by developers of the paradigm. Demski (1988) bases his argument on the insufficiency of equilibrium-centered economics to illustrate sociological happenings. The main issue with the economics-based criticisms is the application of neoclassical economics as the foundation of the accounting theory. Even though many scholars agree that methodological individualism is critical in the technique of neoclassical economics, they also assert that it is critical to recognize the application of maximization as a technique of examination needs the existence of equilibrium states.

Throughout history, economists have recognized that is logically relevant and simple for a decision maker to consider equilibrium prices on the condition that every market is in an equilibrium state. The question is what it entails to apply equilibrium prices when there is no significant reason to suggest that every market is cleared. In this sense, there is a logical contraction in PAT (Whitely 1988). When a market has not been cleared, the demand is not the same as the supply. This disequilibrium will result in computation complexities because not every demander is maximizing and not every supplier is maximizing (Whitely 1988). Since the condition of general maximization is key to the methodology applied by Watts and Zimmerman, they do not have the ability to regard market failures or other scenarios that result in disequilibrium.

Since markets are rarely in a state of equilibrium, Watts and Zimmerman assume that an imperfect but estimated equilibrium will be sufficient to guarantee prices that are in a state of equilibrium. Further, since a state of equilibrium implies that change is not present, it can be easily comprehended and calculated. In other words, whenever people are maximizing their advantage, there are no reasons to shift decisions. In a state that is not perfectly equilibrium, there are motives for change.

Although a non-perfect equilibrium may temporarily substitute a perfect equilibrium, the fact that it is imperfect creates the chance of instability. Beaver et al (1980) assert that if such a state persists, there are factors such a s income which will be non-existent. Unless there are techniques that are discretely developed to consider behavioral constructs to consider how decision makers react to these imperfections, the models of imperfect equilibrium cannot be regarded as a consistent foundation for assuming the presence of equilibrium prices that are stable.

Neoclassical economics does not have behavioral constructs for dynamic situations like the shift of prices. Additionally, in a disequilibrium state, it not apparent how decision makers can identify this state. This problem is termed as disequilibrium in awareness in the discipline of economics, and it remains an unsolved phenomenon (Whitely 1988). In a state of disequilibrium, it is not clear if a price will be up or down thus is not possible to illustrate the degree to which a price will adjust. This is because there is no maximization in this state thus there is no framework to illustrate which suppliers and demanders are not maximizing. The neoclassical economics was developed to illustrate the states of equilibrium but not disequilibrium. The best that can be achieved is to identify that whenever a price is not stable, this state is a clear sign that economists must be keen when illustrating that behavior is simply a factor of making maximizing decisions. On the account that a state of disequilibrium includes dynamics that cannot be found in an equilibrium state, the realms of positive accounting studies cannot be perceived as simply an estimation of the equilibrium state (Whitely 1988). Keenness necessitates that at the very least economist should identify the restricted usability of models that act on the assumption that all prices are at equilibrium.

The foundation of the criticism offered by Demski (1988) is the acknowledgment that neoclassical economics is lacking in regards to dynamics. In particular, he states that the critical query is not whether the choice of accounting technique vary through scenarios and time, but why corporations have been developed to apply this criterion in their accounting. The logical impact of Demski’s argument is to propose that Watts and Zimmerman are suggesting descriptive paradigms even though they state that they are proposing positive rationalizations. Demski arrives at the conclusion that since the positive accounting theory is based on economic models, it is not sufficient for accounting studies. Even though West and Zimmerman claim that they offer a response to their critics, they do not acknowledge Demski’s argument in their preceding papers. If economic examination is used, then it would be logical to comprehend the restrictions and requirements of economic examination.

Conclusion

Overall, the positive accounting theory by Watts and Zimmerman is limited due to its focus on economic examination. The application of neoclassical economics by the scholars means that their paradigm cannot be applied in the real world since there lacks a state whereby a market is perfectly equilibrium. Nonetheless, PAT is useful in understanding the inherent weaknesses of traditional accounting models.

References

Ball, R. and Foster, G., 1982. Corporate financial reporting: A methodological review of empirical research. Journal of accounting Research, pp.161-234.

Beattie, V., Brown, S., Ewers, D., John, B., Manson, S., Thomas, D. and Turner, M., 1994. Extraordinary items and income smoothing: A positive accounting approach. Journal of Business Finance & Accounting, 21(6), pp.791-811.

Beaver, W.H., Christie, A.A. and Griffin, P.A., 1980. The information content of SEC accounting series release No. 190. Journal of Accounting and Economics, 2(2), pp.127-157.

Boland, L.A. and Gordon, I.M., 1992. Criticizing positive accounting theory. Contemporary accounting research, 9(1), p.142.

Chambers, R.J., 1993. Positive accounting theory and the PA cult. Abacus, 29(1), pp.1-26.

Christenson, C., 1983. The methodology of positive accounting. Accounting Review, pp.1-22.

Demski, J.S., 1988. Positive accounting theory: A review. Accounting, Organizations and Society, 13(6), pp.623-629.

Holthausen, R.W. and Leftwich, R.W., 1983. The economic consequences of accounting choice implications of costly contracting and monitoring. Journal of Accounting and Economics, 5, pp.77-117.

Lev, B. and Ohlson, J.A., 1982. Market-based empirical research in accounting: A review, interpretation, and extension. Journal of Accounting Research, pp.249-322.

McKee Jr, A.J., Bell, T.B. and Boatsman, J.R., 1984. Management preferences over accounting standards: A replication and additional tests. Accounting Review, pp.647-659.

Milne, M.J., 2002. Positive accounting theory, political costs and social disclosure analyses: A critical look. Critical perspectives on accounting, 13(3), pp.369-395.

Tinker, A.M., Merino, B.D. and Neimark, M.D., 1982. The normative origins of positive theories: ideology and accounting thought. Accounting, Organizations and Society, 7(2), pp.167-200.

Watts, R.L. and Zimmerman, J.L., 1978. Towards a positive theory of the determination of accounting standards. Accounting review, pp.112-134.

Whitley, R.D., 1988. The possibility and utility of positive accounting theory. Accounting, organizations and Society, 13(6), pp.631-645.

Zmijewski, M.E. and Hagerman, R.L., 1981. An income strategy approach to the positive theory of accounting standard setting/choice. Journal of accounting and Economics, 3(2), pp.129-149.

March 15, 2023
Category:

Science Business

Subject area:

Theory Accounting Audit

Number of pages

9

Number of words

2257

Downloads:

34

Writer #

Rate:

5

Expertise Audit
Verified writer

LuckyStrike has helped me with my English and grammar as I asked him for editing and proofreading tasks. When I need professional fixing of my papers, I contact my writer. A great writer who will make your writing perfect.

Hire Writer

This sample could have been used by your fellow student... Get your own unique essay on any topic and submit it by the deadline.

Eliminate the stress of Research and Writing!

Hire one of our experts to create a completely original paper even in 3 hours!

Hire a Pro