Accounting Theory: The Philosophy Of Positive Accounting Theory

Positive Accounting Theory
Philosophy of PAT
Million Friedman championed positive theories in economics.
He stated that: (part 3 Empirical Research in Accounts of Accounting theory from Jayne Godfrey) The ultimate goal of positive science (i.e. INDUCTIVE) is
 The development of a ‘theory ‘ or ‘hypothesis’;
 that yields valid and meaningful “Predictions’
 about phenomena not yet “observed”.
Consistent with Friedman’s view, Watts and Zimmerman asserts that: The objective of “positive accounting theory” is to “explain” and “predict” accounting practice.
 “Explanation” means providing reasons for observed practice.
For example, positive accounting theory seeks to explain why firms continue to use historical cost accounting and why certain

Given an assumption that ‘self-interest” drives all individual actions, PAT predicts that organization will seek to put in place mechanisms that aligns the interests of the manages of the firm (agent) with the interests of the owners of the firm (the principal).
EMH – Efficient market hypothesis
The genesis of positive accounting theory is the Efficient Market Hypothesis (EMH). According to Fama, the EMH is based on the assumption that capital markets react in an efficient and unbiased manner to publicly available information.

The perspective taken is that security prices reflect the information content of publicly available information and this information is not restricted to accounting disclosures.
The capital market is considered to be highly competitive, and as a result, newly released public information is expected to be quickly impound into share

Agency theory provided a necessary explanation of why the selection of particular accounting methods might matter, and focused on the relationships between principals and agents, a relationship which, due to various information asymmetries, created much uncertainty.
Agency theory accepted that transaction costs and information costs exist.
Relying upon traditional economic literature (i.e. maximize own wealth), Jensen and Meckling considered the “relationship” and “conflicts” between agents and principals and how efficient markets and various contractual mechanisms can assist in minimizing the cost to the firm of these potential conflicts.
It is assumed within Agency Theory that principles will assume that the agent will be driven by self-interest, and therefore the principle will anticipate that the manager, unless restricted from doing otherwise, will undertake self-serving activities that could be detrimental to the economic welfare of the