7. Positive accounting theory Flashcards
What is Agency relationship?
Involving the delegation of decision making from the principal to an agent.
What is Positive Accounting Theory (PAT)?
Developed by Watts and Zimmerman and others, it is concerned with explaining accounting practice. It is designed to explain and predict which firms will and which firms will not use a particular accounting method, but says nothing about which method a firm should use. It is based on the central economics-based assumption that all individuals’ actions are driven by self-interest.
What is Political costs?
Costs that groups external to an organisation might be able to impose on the organisation as a result of political actions. For example, if an organisation reports high profits then these profits might be used as an excuse by trade unions, lobby groups, or government to justify efforts to transfer wealth away from the organisation.
What is Price protect?
An individual or organisation ‘price protects’ when it requires a higher rate of return to compensate it for a higher risk investment (or vice versa).
What is Information asymmetry?
Where some individuals have access to certain information that is not available to others.
What is Perquisite consumption?
A perquisite is something of value which is a right, privilege or benefit received as a result of holding a particular position, title or job. Perquisite consumption is often used to refer to a situation where managers give themselves more ‘luxury’ items than would seem reasonable from the principal’s point of view.
What is Opportunistic perspective?
From a Positive Accounting Theory viewpoint, it is referred to as an ex post perspective (after the fact) as it considers opportunistic actions that could be undertaken once various contractual arrangements have been put in place.
What is Principal?
The principal delegates work to another person, known as the agent, who performs the work. For example, an owner of a business (the principal) might delegate work to an agent.
What is Agency problem?
Relates to the difficulties or problems in motivating one party (the agent) to work in the best interests of another party (the principal). Agency problems arise because of inefficiencies and incomplete information.
What is Ceteris paribus?
A latin phrase, literally translated as ‘all other things being equal or held constant’.
What is Debt hypothesis?
Developed from Positive Accounting Theory, it proposes that organisations close to breaching accounting-based debt covenants will select accounting methods that lead to an increase in profits and assets.
What is Debt covenants?
Undertakings provided by a borrower as part of a contract associated with a loan, and these undertakings (covenants) either specifically restrict the borrower from taking particular actions or specifically require the borrower to take particular actions.
What is Technical default?
In relation to debt agreements, a technical default occurs when one party, the borrower, breaches a particular requirement (covenant) that has been negotiated with the lender.
What is Bonus hypothesis?
Developed from Positive Accounting Theory, it proposes that managers on accounting-based bonus schemes will select accounting methods that lead to an increase in profits.
What is Political cost hypothesis?
Developed from Positive Accounting Theory, it proposes that firms subject to political scrutiny will adopt accounting methods that reduce reported income.
What is Efficiency perspective?
From a Positive Accounting Theory viewpoint, it is often referred to as an ex ante perspective (before the fact) as it considers what mechanisms are put in place up front, with the objective of minimising future agency and contracting costs.
What is an Agent?
An individual (or organisation) appointed to act on behalf of another party (the principal).
What is Agency theory?
A theory explaining the relationship between principals and agents. In this relationship, the principal delegates or employs an agent to perform work in the best interest of the principal. The delegation of decision-making authority can lead to a loss of efficiency and consequently increased costs, often referred to as ‘agency costs’.
What is Abnormal returns?
In capital markets research, abnormal returns are the realised (actual) rate of return, less the expected rate of return (as calculated by reference to a market model).
What is Efficient Markets Hypothesis (EMH)?
EMH is based on the assumption that capital markets react in an efficient and unbiased manner to publicly available information.
What is Hypothesis?
A proposition typically derived from theory which can be tested for causality or association using empirical data.
What is Residual cost?
As PAT assumes that not all opportunistic actions of agents can be controlled by contractual arrangements, there will always be some residual costs associated with appointing an agent. These occur despite the potential use of various bonding and monitoring mechanisms.
What is Agency cost?
Costs incurred by owners because of asymmetric information, or conflicts of interest, between principals (owners) and agents (managers). There are three commonly cited agency costs: monitoring costs, bonding costs and residual costs.
What is Bonding cost?
Bonding costs are typically thought of as costs that are borne by the agent. Bonding occurs when the agent gives a guarantee to undertake, or not to undertake, certain activities.
What is Monitoring cost?
Costs incurred in monitoring the performance of others. In PAT and agency theory they refer to costs incurred when principals attempt to monitor the actions of agents.
What are the four general strategies that owners/managers might adopt that can disadvantage Debt Holders?
payment of excessive dividends
claim dilution
asset substitution
underinvestment.
