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ACCA THEORY - 1 10 Discount $0 Positive accounting theory...

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1 (+10% Discount) $0 Positive accounting theory Positive accounting theory (PAT) is a general term for any theory that provides descriptive information regarding the behavior of accountants. The title has been used by Watts and Zimmerman and this is largely an expansion of previous studies carried out firstly by Fama and later by Ball & Brown in the 1960’s. In looking at the apparent acceptance by politicians, firms and wide publication in academic journals PAT could easily be mistaken as being a success. A deeper analysis of the premises of PAT, its questionable scientific status, and the groups upon whom this theory has appealed to would suggest that it is flawed on many levels and is little more than an argument for deregulation and market capitalism. This opposes its claim to be a useful theory used regularly by those concerned with the effects of accounting policy on the status of the firm. The Premises of Positive Accounting Theory. Positive Accounting Theory finds its roots with the Efficient Market Hypothesis (EMH). The EMH was developed by Fama in the 1960’s and is based on economic principles and assumes a perfect market where there is information symmetry and no transaction costs. The semi strong form of EMH argues that capital markets will reflect all information that is publicly available and it is this form that Watts and Zimmerman claim to be predominant. The EMH was used in a study performed by Ball and Brown during the same period. The Ball and Brown study rejected the argument put forward by normative theorists that present accounting results were misleading and irrelevant and stated that historical cost accounting is actually useful (Deegan 2000). This was because their study demonstrated that unexpected accounting earnings produced abnormal returns in capital markets. This was also the case for unexpected poor earnings as they produced abnormal losses in capital markets. This was measured using the Capital Assets Pricing Model (CAPM). Watts and Zimmerman used this research in developing PAT to illustrate that because there was a reaction in capital markets when accounting information showing abnormal results was released this information was
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2 useful and those who wanted to change the present system of measurement failed to appreciate the incumbents usefulness. They claimed that capital markets could see through changes in accounting policy and see the bigger picture of firms, therefore rendering them impervious to misleading accounting methods (Watts & Zimmerman 1986). This was then used to form and anti regulatory stance. As capital markets could ‘see through’ the accounting methods being used, regulation was considered little more than an inefficiency that interfered with the function of free markets and was costly to firms. These firms could determine the best ways to report for themselves and it is believed under this theory that auditing will also occur without regulation because users of information will demand audited information so as to give it some value (Mouck 1992).
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