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Stream 1 Reading Towards A Positive Theory Of The Determination Of Accounting Standards – Notes

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Towards a positive theory of the determination of accounting standards - (Watts and Zimmerman, 1978)

Towards a positve theory of the determinaton of accountng standards - (Wats and Zimmerman, 1978) Introducton

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Parties have in the past and continue to expend resources to influence the setting of accounting standards Moonitz (1974), Horngren (1973) document sometimes intense pressure exerted on the accounting standard-setting bodies Positive theory of the determination of accounting standards: o Helps us to understand better:
? the source of the pressures driving the accounting standardsetting process
? the effects of various accounting standards on different groups of individuals
? The allocation of resources, and why various groups are willing to expend resources trying to affect the standard-setting process o Necessary to determine if prescriptions from normative theories (e.g. current cash equivalents) are feasible Watts and Zimmerman believe that management plays a central role in the determination of standards o Moonitz supports this view A precondition of a positive theory of standard-setting is understanding management's incentives

Factors influencing management attitudes towards financial accountng standards

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Watts and Zimmerman assume that individuals act to maximize their own utility o Implication of this is that management lobbies on accounting standards based on its own self-interest One function of financial reporting is to constrain management to act in the shareholders' interest Assuming congruence of management and shareholder interests without further investigation may cause us to omit from our lobbying model important predictive variables Assumption that management selects accounting procedures to maximize its own utility is used by Gordon (1964) in an early attempt to derive a positive theory of accounting o Gordon's model and its variants are called the 'smoothing' literature by Watts and Zimmerman o Lack of confirmation o Assumed that shareholder satisfaction (and presumably, wealth) is solely a positive function of accounting income

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