PAT 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 Information asymmetry?
Where some individuals have access to certain information that is not available to others.
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 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 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 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 PAT in watts & Zimmerman (PFEND)
1) PAT attempts to explain & predict accounting practice & methods firm used
2) Focuses on relationship between various individual & how accounting assist the functions.
3) Focus on cost on contracting where there is agency relationship.
4) Assumption is,
- No loyalty, morality
- Driven by self-interest
Agency theory (ADA)
Monitoring & Bonding activites:
Managers compensation scheme (FAT)
1) Form of Remuneration
— Cash
— Shares
2) Bond & Align interest :When management act in its self-interest, they also act in the interest of S/H
3) Type of remuneration scheme
— Fixed basis : Set salary
— Basis of result from audited financial statements (areas) : Profits , sales , ROA, Share price
Agency theory (ADA)
1) Focus on agency relationship: Arise where there is a contract where the principle seek for agent to perform some service, making decision on behalf of the principle : e.g separation of management and control in a corporation.
2) Agent may undertake divergent behaviour due to self interest
3) Result in Agency cost arises - information asymmetries
4) PAT focus on cost of contracting when there is agency relation.
Agency cost : Monitoring cost
By observing, measuring, monitoring agent behaviour thru
1) Setting budget
2) Auditing the accounts
3) management compensation scheme
The role of financial reporting in PAT
1) Ensure there are compliance to the contract
2) To reduce agency cost
3) Monitor manager performance
Bonus scheme
1) Tied to firm performance
2) Aim to reduce agency cost of equity
3) Can be in cash/shares/shares option
4) Can be based on accounting numbers/share price
5) Type of incentive
- Depends on type of firm
- Depends on level of manager
Problem with Bonus ; Hypothesis (HOD)
Unlikely to overcome all divergent behaviour: - Bonus hypothesis
1) Manipulate the accounts to maximise performance bonus : Opportunistic perspective
2) Horizon Problem : short term focus especially where bonus are short-term or they are near retirement
PAT research hypothesis
Hypothesis assumes managers act opportunistically
1) Bonus plan
- Managers more likely to use accounting method to increase reported income.
2) Debt/equity
- Predict the higher the firm debt/equity ratio, managers more likely to use A/C that increase income, increase asset and reduce liabilities.
3) Political costs
- Large firm more likely to use a/c methods that reduce reporting profit to divert negative attention.
