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Synopsis:
The paper discusses the outlining of positive theory of accounting by understanding the
factors that influence the attitude of the senior level management in the process of setting and
adopting accounting standards for the organization. The firm is an outcome of the
management’s decisions which is why it becomes important to study this. There are various
factors including taxes, regulation, management compensation plans, bookkeeping costs, and
political costs, which affect an organization’s cash flows, which in turn are affected by the
choice of accounting standards. This paper designs a model by combining these factors which
is able to predict that large firms favor the change, when they see a reduction in their earnings
ecause of change in accounting standards. In general, all other firms will oppose the change
if they incur additional bookkeeping costs, which can justify the cost of accounting standards
lo
ying. This hypothesis was tested with the use of corporate submissions to the FASB's
Discussion Memorandum on General Price Level Adjustments. The authors found that the
empirical results were consistent with their theory.
Introduction:
We will describe the concept of the generally accepted theory of positive accounting i.e.
PAT. In this paper we will critically analyze the theory and see what influences management
ehavior in the process of accounting standards setting. Also we will compare it with normative
accounting theory. We will attempt to understand the relevance of accounting theories used in
the corporate world and will align them with the requirements of the organization. The theory
gives a direction for financial reporting function in an organization and therefore has
contributed significantly to the financial reporting standards. Here we will try to understand
the management’s role in the process of accounting standard setting and on the basis of it
develop a theory to rationalize the design of accounting standards. Before the emergence of
positive accounting theory, the accounting field was dominated by the normative accounting
theory. They are both important in their own ways and have their own significance in the
industry.
Summary of the article:
This paper builds up in the initial work done around the study of management incentives
elated to accounting standards. This study focuses on the cost-benefit analysis of accounting
standards from the management’s perspective. Management is motivated by various
incentives, which drives their choice of these standards. Also, we cannot underestimate the
management’s role in the determination of the accounting standards. Their view is critical to
any discussion related to financial reporting in an organization. Therefore, the pre-requisite
to understanding the positive theory of standard-setting is to analyze the incentives that sway
management's actions.
For simplification, the initial assumption is that the interests of the management align with
that of the shareholders. Second assumption is that management's utility (or the satisfaction in
layman terms) is a positive function of the expected compensation in future periods (or
wealth), which means that satisfaction increases with increase in compensation. It adds that
utility is a negative function of the dispersion of future compensation (or wealth), or decrease
of wealth. This assumptions helps bifurcate the mechanisms which increases management’s
compensation by increase in share price and by increase in incentive cash bonuses.
We
iefly discuss the factors (e.g., tax, regulatory, political considerations) which are
elieved to be the motivator of management actions. They decide how management utilizes
the resource sit has to achieve its desired outcomes and therefore affects the process of setting
standards.
 Taxes: Tax laws do not affect the financial accounting standards directly except in
some cases but they have a very well established indirect relationship. The
management will try to get the most conducive tax rate to get...