The Development Of Accounting Practices In Firms Research Report

Executive Summary

The main purpose of this article is to explain the development of accounting practices in firms. Evolution in accounting practices started in the 1960s when there are implications of the empirical financial model in financial accounting theory. Moreover, it seeks to explain “positive accounting theory” which outlines the actual accounting practices. The research methods used in this document are based on empirical regulation. The authors’ Ross Watts and Jerold Zimmerman try to give future direction for the “positive accounting” as they believe that companies nowadays lobbying on the accounting standard. They believe that the company is using the accounting policies in which they can survive like they tend to follow that accounting framework which lowers their contracting costs and increase their profitability. The author tries to explain the opportunist perspective on the behavior of the manager who uses the accounting standard for their own use and interest instead of using an efficiency perspective of positive accounting where they would choose those accounting standards that would give a true representation of their organization.

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Introduction

The article tells about the ten-year perspective on the positive accounting framework. Like it suggests the importance of contracting costs that arises from market transactions like selling new debts, equity’s legal costs or underwriting costs, an internal transaction of the company, and transaction which is done on political purposes. In article contracting cost is used in broad terms which replaces the term agency costs. Moreover, this article tries to explain and predict accounting practice by the discovery of previously unknown empirical regulations. In the article, the author tries to develop and improve the models in which the other variables could change an important variable in the regressors. Thirdly, in the article author tries to reduce measurement errors in both the dependent and independent variables in the model.

Research methodology and methods

The research in this article is based on previous accounting practices and information given in the article is endorsed from past research work conducted on “positive accounting theory”. The research also based on various hypotheses such as bonus plans hypothesis, debt-equity hypothesis, and political cost hypothesis.

The author’s methodology in the article is that they try to predict the position of the companies based on voluntary disclosure which they published whenever they are affected by the new accounting standards. The authors try to refer to some studies from Davidson and Weil (1975) and Davidson, Stickney, and Weil (1976) where they used modified procedures that only contain the published financial statements and GNP deflators.

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Research method issues

There had been 2 issues in research methods which are reduction of test’s power and there is a possibility that some results are not stated by a hypothesis which are obtained in the positive accounting literature and its due to unknown alternative hypotheses.

The first issue named “reduction of test ‘power was due to problems in the four areas which are model specification, left-hand-side variable, right-hand side variable, and omitted variables.

There had been two errors in model specifications. The first error was that in regression the accounting method depends on the effect of the choice on the wealth of the manager. The explanatory variables which explain the wealth effects were compensation plans, debt agreements, and the political environment. The compensation plans variable interpreted as manger’s opportunism while the political environment interpreted both manager’s efficiency and opportunisms, so model is misspecified. The second error was the omission of the interaction impact among the right-hand variables.

The problems in the left-hand side variable were that the accounting methods used as variables, which were used to check the effects on earnings, have low explanatory power. While the problem in the right-hand side variable is the mismeasurement of some variables related to accounting choice studies. Lastly, the main problem in the reduction of test’ power is due to the omission of three variables like it omits accounting-based contracts, less standard contracts, and accepted contracts as variables.

The theoretical framework according to Financial accounting

In this research paper, there are some factors that influence financial accounting standards due to the behavior of the management. The assumption is that the management influence those accounting standards which maximizes their own utility (Zimmerman, 1978). In this research, the author explained that expected forms of compensation or wealth for management are incentive compensation and capital gains in stocks. Moreover, there are some factors that affect compensation and wealth. Like taxes, government regulations, political costs, information costs, and other forms of management compensation plans. Due to these factors managers tends to change their attitude toward different accounting standards they choose. The point which the researcher wants to prove is that managers don’t have the objective to choose those accounting standards which report higher earnings for the organization as they mostly tend to choose those accounting standards that increase the firm’s value and welfare due to the factors above. The author also argued that political pressure and imposition of regulations on the firms will give a prediction on management’s attitude towards accounting standards (Zimmerman, 1978).

The authors in this research only focus on shareholder, creditors, and government in order to explain positive accounting theory in which management influence accounting choice. As there are many external and internal users of the financial statement which haven’t been mentioned in this research paper such as creditors, suppliers, employees, customers, competitors, and the community. The article doesn’t include those people such as other community or special interest groups such as political parties and local pressure groups and they all influence the organization. These stakeholders can change the accounting choice taken by the organization. For example, the accounting standards which are used to report higher earnings for the firm will influence employees to ask for more bonuses or increment in their salaries. And it will also influence employees in another way around when the firm chooses those accounting standards which report lower earnings so these employees will worry about their job security. (Zimmerman, 1978)

Research findings

There are many facts which we can find from this article. Firstly, according to the hypothesis empirical evidence, the political and regulatory considerations are the main factors through which the company tends to opt for those accounting standards which lowers their reported earnings. Those companies are often regulated by the government directly and they are also indirectly interfered by the government and large firms are always subject to this interference. Government intervention sometimes increases the costs for the company and affects its investment related decisions.

Some researchers (McKee, et al., 1984) recreate this research by using large sample but results don’t come out satisfactory. The author of this research argued that there had been problems regarding test procedures and its underlying theories, and it is said that authors argument doesn’t supported by the evidences.

This research shows that conducting researches in accounting especially regarding management’s earning has now become an important consideration as this type of researches tends to find companies that choose those accounting standards which will impact their reported income. So, most of the researchers don’t include regulated companies such as financial services companies in their research as they want to reduce the effects of political and regulatory considerations. (Madhogarhia, et al., 2009)

Conclusion

This article or paper is one of the influential research works related to the subject of accounting. It is believed it was the first paper that introduced the idea of positive accounting theory. The positive accounting theory was discussed to investigate factors that how management behavior affects the accounting choice. The theoretical framework is the area where the authors need more improvement in this research. It is the fact that the users of the financial statements are both internal and external, so it means accounting standard choices have both internal and external influences. Internal influences consist of factors like the working environment in the organization or internal growth of the company while changes in tax policies, regulation, information cost, and the management’s compensation costs are the external influences. The combination of all these influences changes the mechanism of the company which consists of a mechanism of change of certain accounting standards due to internal and external factors.

There was more development in this research by (Fields, et al., 2001) who made three implications. Firstly, the researcher wants to give more shots on the investigation of the nature of the implications of alternative accounting methods. Secondly, the researchers don’t want research to be focused on just one accounting issue as it will give better development towards a theoretical framework. Finally, there should be the use of more powerful statistics tools in empirical research which will improve research design.

References

Anon., 2018. Critical Review Determination Of Accounting Standards Accounting Essay. [Online] Available at: https://www.ukessays.com/essays/accounting/critical-review-determination-of-accounting-standards-accounting-essay.php?vref=1

Fields, T. D., Lys, T. Z. & Vincent, L., 2001. Empirical research on accounting choice. Journal of Accounting and Economics, 31(1-3), pp. 255-307.

Madhogarhia, . P., Ninon, K. S. & Theodor, K., 2009. Earnings Management Practices Among Growth and Value Firms, Applied Financial Economics. 19(22), pp. 1767-1778.

McKee, A. J., T. B., B. & J. R., B., 1984. Management preferences over accounting standards: A replication and additional tests. he Accounting Review, October.pp. 647-659.

Zimmerman, w. a., 1978. Towards a Positive Theory of the Determination of Accounting Standards. s.l.:American Accounting Association.