Accounting Issue
Instructions:
Read the extract from Stewart Oldfield’s article ‘A step too far crucifies small business’ (from attached file) and answer the following question:
(a) Applying the political cost hypothesis of Positive Accounting Theory, explain the claim in the article that ‘The banks have promoted studies that find small-business is getting a better deal from the banks, perhaps in fear that the federal government might introduce legislation to improve service to the country’s 1.2 million small-business operators, as has the government in the UK’.
Solution.
POSITIVE ACCOUNTING THEORY
Positive Accounting Theory
Consistent with Watts and Zimmerman original views of the Positive accounting theory, the theory objectively seeks to explain why firms depend on historical costing data to predict the most preferable and unobserved phenomena likely to occur even when evidence has not been collected (Kabir 2010). Using the political cost hypothesis, the incentives put in place for firms to adopt a fair value measure tend to be specific to the firms due to the pressures exerted to the firms by external circumstances (Milne 2009). As a result, small SME’s and banks that report huge profits are more likely to fall under scrutiny from a specific source or government agencies seeking reasons for the increase in pay or a regulator looking to monopolize the industry. This explains the claim that, “The banks have promoted studies that find small-business is getting a better deal from the banks, perhaps in fear that the federal government might introduce legislation to improve service to the country’s 1.2 million small-business operators, as has the government in the UK”.
Positive Accounting theory tries to explain and predict real world events and translate the events into accounting transactions that can be expressed as viable predictions for future occurrences (Kabir 2010). Normative theories fail to capture future predictions. As a result, an opportunistic behavior is natured to favor personal management interests. The greater the political costs are to a firm, the more likely are the managers of the firm to adopt accounting procedures that are likely to shift the earnings expected in future to the current period. According to Milne (2009), high profits can easily lead to increased political heat and new tax measures which would make large banks to have high reporting standards.
When the pressure to report low profits mounts, firms adopt the revaluation model as described in the positive accounting theory to provide depreciation charges on the non-current assets (Kabir 2010). This does not affect the income statement. However, if not exploited, the firm resolves to wage reduction as reported in the case of the National Australia Bank.
Reference list
Kabir, H 2010, ‘Positive accounting theory and science,’ Journal of CENTRUM Cathedra, vol. 3, no. 2, 136-149.
Milne, M 2009, Positive accounting theory, political costs and social disclosure analyses: A critical look. Available at: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.199.7620&rep=rep1&type=pdf [Accessed 27 September 2016]