The paper "Positive Accounting Theory" is a good example of a finance and accounting coursework. In regard to the positive accounting theory (PAT), accounting numbers form an essential aspect of a company’ s effective contracting technology. Majority of the covenants, conditions and terms that are contained in contracts makes use of accounting variables. As such, the theory positive accounting theory suggests that contractual arrangements and related costs are the main determinants of the choice of an accounting method (Watts and Zimmerman, 1986). In this regard, by making use of proposals of contracting theory, it is possible to forecast and choice of accounting as suggested by the positive theory of accounting.
Managers of a company are capable of obtaining different accounting numbers by using distinct accounting methods that are within the accepted principles of accounting. As a result, it is prudent to argue hypothesize that the choice of accounting method is affected by contractual arrangements. There are three kinds of contracts that are related to the choice of accounting method; contracts between owners and management, debt holders and management, and political parties and management.
In this regard, there are three hypothetical arguments based on positive accounting theory that explains the choice of accounting method; management compensation plan hypothesis, debt hypothesis and political cost hypothesis. As such, researchers in the accounting discipline have over the years been empirically testing the positive accounting theory as proposed by Watts and Zimmerman (1990). According to Watts and Zimmerman (1990), tests of accounting choice method provides evidence that the political process, debt and bonus variables are statistically significant in regard to positive accounting theory. At the time they instituted the positive accounting theory Watts and Zimmerman suggested that it lacks strong support.
This is evidenced by flaws in research methodology (Watts and Zimmerman, 1990). On the other hand, the dependent variable, which is an accounting choice variable, has not yet been sufficiently specified. In that case, the net accruals are the most encouraging measure because they reflect comparative impacts on earnings generated by different accounting choices. However, such a measure consists of a non-discretionary element; therefore, it is considered a noisy amount of the net accrual amount that managers can manipulate (Watts and Zimmerman, 1990).
In that aspect, positive accounting is deficient in some way leading to Watts and Zimmerman recommending the following need: that it is necessary to measure net accruals relative to what they would amount to without manipulation in order to exclude the variations from dependent variables. In that case, it would call for the use of a specific model that is non-existent at the moment (Martens and Stevens, 1993). Consequently, it is also relevant to criticize the explanatory variables for instance the employment of a zero-one variable to amount a bonus plan which is considered simplistic.
Additionally, the use of firms’ size to measure the level of political sensitivity it wholly inadequate. Consequently, using the debt-to-equity ratio may, on the other hand, fail to capture its exact relation with debt covenant itself according to Watts and Zimmerman (1990). It is worth noting that a lot of models have as well ignored the probable impacts of interaction among explanatory variables. In the same note, variables that have been omitted can cause biased coefficients for explanatory variables and thereby hamper correlated interactions.
A notable aspect of accounting is the information perspective in which case it is perceived that accounting data should provide information to creditors, investors and other interested stakeholders.