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Individual Assignment: Accounting Theory and Current Issue

Module Code: H16025

Accounting theory examines the various theories to understand the importance of accounting in
the process of decision making. Theoretically if there is no financial regulation then the methods
that are used to determine the accounting methods and the disclosure of financial information is
what accounting theory is. The accounting theory has both normative and positive theories in it
that deal with accounting. The theory also studies several current issues in accounting that have
surfaced and appears to be common in most accounting issues in different businesses. The
purpose of account theories and its place in current issues is to enable individuals to think
analytically and critically to integrate the knowledge in the work place environment.
Assignment Question 1
The mere discovery of a problem is not sufficient to assure that the Financial Accounting
Standards Board will undertake its solution There must be a suitably high likelihood that the
Board can resolve the issues in a manner that will be acceptable to the constituencywithout
some prior sense of the likelihood that the Board members will be able to reach a consensus, it is
generally not advisable to undertake a formal project.
The above is a quotation that has been taken from the book of Professor Miller which was
published in 1986. The quotation is from page 64. What Professor meant by the above mentioned
quotation is that identifying a problem is the audit process is no surety that a solution will be
found to the problem. The problem that is referred to in the above quotation is the problems that
emerge during an audit that is performed in a business entity.
What professor Miller tries to explain is that even if the issue is placed in front of the Financial
Accounting Standards Board there is no surety that the Board will take action or responsibility in
finding a solution to the problem. When a problem is presented to the Financial Accounting
Standards Board there must be reason to believe that the Board members will be able to
understand the problem collectively and create a solution to the problem by consensus, if
however the likelihood is not there then an individual or an audit firm should not take up a
project formally to try and find resolution though the Financial Accounting Standards Board.

Financial Accounting Standards Board

The main responsibilities of the Board are to establish the financial accounting procedures for the
public companies and to improve the existing procedures that exist. The aim is to provide useful
information to the investors of companies so that the investments that the public makes are sound
investments that will provide financial returns to the investor. The Board is answerable only to
the Financial Accounting Foundation's Board of Trustees. The scope is to build independent
processes without any bias by taking the objective considerations of all stakeholders into account
but with the reality of a business environment it is only natural to accept the fact that neutrality
and representational faithfulness will not remain the same when confronted with public interest.
The Neutrality and the Representational Faithfulness of Reports Generated
According to Professor Miller, constituency support is necessary before approached to
accounting techniques can be included in the Accounting Standards. Since the constituency
support is necessary then it does affect the neutrality of the members of the Financial Accounting
Standards Board cannot remain neutral and objective to the approaches that have been presented
to the Board, they have to rely on the constituency support to make it part of the Financial
Accounting Standards and create the procedure for uniform use of the accepted accounting
The representational faithfulness of the approach is also affected as the Financial Accounting
Standards Board is not the only entity that can decide, the consensus has to be built within the
constituents, the Board members the business entities and also with the other organizations that
represent the financial accounting standards in different capacities. Some of the organizations
with which the Financial Accounting Standards Board has to build a consensus are: The
American Institute of Certified Public Accountants, The Governmental Standards Accounting
Board, The Securities & Exchange Commission, the American Accounting Association, The
Financial Executives Institute and the Institute of management Accountants (IMA).
Neutrality in accounting is the financial accounting and audit of business that is free from bias,
but there could also be deliberate bias of which Professor Miller talks about in the above quote.
In most cases of financial accounting deliberate bias is sued by the management to cover up for

mistakes and fraudulent or illegal transactions that are running though the accounting records of
a business entity. The second type of bias in accounting that could affect the neutrality of the
accounting procedures when one type of system is favored because it has been traditionally sued
by the organization and is part of the organizational culture of the company. (AS,2015)
Representational Faithfulness has to do with the correct representation of facts and figures during
accounting and this generally is based on the conceptual premise of substance over form. When
placing a formal project in front of the Board there is no surety that there will not be any bias or
that the facts will be represented as they should be because the representation of facts will be
tailored to place weight behind the accounting approach that is being presented to the Board and
which the Board should look at favorable to gain constituent support and the consensus of other
accounting standards authorizes before it can resolve the issue.
Professor Miller is absolutely correct in showing that every business entity has its own vested
interests in the way the finances of an entity are accounted for. There are many aspects of the
workings of a entity that they may not like to place before the public or the government and yet
they are bound by codes of conduct that should be practiced, ethical standards that needs to be
practiced and the regulatory standards that must be complied with to avoid any type of legislative
violation of accounting practices. The draw back as to why it affects the neutrality and the
faithfulness of the representation of facts and figures is due to the vested interests and the need to
hold on to its stakeholders and investors.
Assignment Question 2
Positive accounting theory has to do with accounting research possibilities to be able to study the
accounting practices in depth and to finds explanations that will allow accountants to predict the
financial accounting practices that are used in different business entities. It is slightly different
from normative accounting which tries to develop the best accounting standards that should be
used by the international business community.(Watts,Zimmerman,1986)

Perspectives of Positive Accounting Theory

There are two basic types of positive accounting theory perspectives. One is the efficiency
perspective and the second one is the opportunistic perspective. This is a perspective that is sued
by the researchers to show how financial managers use different methods of accounting to place
their financial figures in the best possible light in the eyes of the stakeholders and the investors.
The purpose is to study and find the best accounting techniques that provide a true representation
of the financial condition of a business entity even if all the financial details are unavailable to
study and to audit. It finds pathways and loopholes by which the true financial performance of a
company can be seen despite cover ups.
The second type is the opportunistic perspective who holds the assumption that the financial
managers are only the agents for the principal business entity and therefore act in their own self
interest. This is true because, the professional career path of financial a manager depends on the
financial performance of the company in which they are working as financial managers.
The Quotation
The Watts, Zimmerman quote has been taken from the book Positive Accounting Theory which
was published in 1986. The quote has been taken from page 7 of the book and is quoted below
for reference.
As Watts and Zimmerman (1986, p. 7) state, Positive Accounting Theory 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 it says nothing as to which
method a firm should use
The positive accounting theory tries to explain the accounting approaches of different business
entities without making any suggestions as to what should be the method that a business entity
should use to maximize its financial reporting standards and performance.(Christenson,1983)

Watts and Zimmerman have focused on the relationship between the financial manager and the
owner or the financial manager (agents) and the debt capital providers. Their study deals with the
relationships that provide resources to a business entity.
The purpose is to put accounting methods into place that will lower the costs of hiring an agent
to perform the financial details of a business entity. There is no loyalty attached to the actions
because the motivation is increase the wealth of the business entity as the agents and the
principals are drive by self interest.
The assumption that Watts and Zimmerman refer to in the quote is that the organizations and
business entities are contractually bound to each person who works in the organization and who
work collectively to achieve the business goals of the entity. The cooperation that exists in an
organization stems only from the self interests of each of those individuals who are contractually
bound to the business goals of the organization.
The organization on the other hand provides good compensation packages and incentive to gain
this motivated cooperation from the employees who work in the organization.
Besides the agent cost the bonding cost is there also which is an expense for the accountants to
bond in the interests of the organization to provide the results that the principal wants out of them
for which they are being provided an excellent compensation package for their efforts and
expertise in accounting.
Under the Positive Account Theory it is assumed that the financial managers will be responsible
for creating the financial statements that place the organization in a good light and that the
financial statements will be monitored and audited.
The second assumption is that they will act in their own self interest to gain better prospects
within the organization and therefore will create the type of financial statements that will please
the stakeholders and the investors. There is a cost attached to auditing and this is known as the
monitoring costs.

The theory according to Watts and Zimmerman also assumes that all the opportunistic actions
that are taken cannot be fully monitored or controlled by the contractual agreements that have
been made with the accountants and therefore there is no residual expense attached or else if all
activities could be controlled there would be a residual expense incurred by the organization.
The Agency relationship as illustrated in Illustration (1) makes it necessary for the self interest of
the agent and the self interest of the principal to be served which is why in many cases where the
contractual agreements are insufficient, the self interests of both the principal and the agents are

Illustration (1) Agency Relationship, Source: Hossein, 2011

From the above facts that have been highlighted about the Positive Accounting Theory it does
appear that no codes of conduct of business ethics that are contrary to the self interests of the
business entity and its agents will be followed by the principal or the agents, it is also clear that
while the theory predicts what type of accounting method will be used by which type of entity , it
fails to mention the reason why a particular accounting method is being sued by a business entity
and its agents, therefore it is an abrogation for the academics to serve a self interested
community who will justify the means they use only if it serves their self interest. From the point
of abrogation of the academics duty one cannot contradict the statement made by Watts and

Christenson, C. (1983), The Methodology of Positive Accounting The Accounting Review
(January), pp122
Edwards, H.(2011) Accounting Principles: A Business Perspective, Financial Accounting
,Chapter 1 to 8 Pub: Textbook Equity Inc.
FASB(2014) Facts About FASB,, retrieved on January 7th 2015
Hossein,(2011) An Overview of Positive Accounting Theory, Pub: McGraw-Hill, retrieved on
January 7th 2015
RMIT(2015) Financial Accounting Theory,, retrieved on January
7th 2015
Watts, R. and Zimmerman, J. (1986), Positive Accounting Theory, Edgewood Cliffs, NJ: Prentice

Watts, R. and Zimmerman, J. (1978)Towards a Positive Theory of the Determination of

Accounting Standards, The Accounting Review 53 (January), pp112134.