Changes To Accounting Standards
Changes to accounting standards can be quite controversial as sometimes those changes have significant impacts on companies’ financial statements. Positive accounting theory as a branch of accounting academic research that seeks to explain and predict actual accounting practices can be used to explain the effects of changes to accounting requirements and the reactions of some parties to those changes.
This paper analyses effects of AASB 2 “Share Based Payments” on organizations and management from the perspective of positive accounting theory.
Positive Accounting Theory
Positive accounting theory is a branch of accounting academic research that seeks to explain and predict actual accounting practices, rather then prescribed practices. Positive accounting can be best understood by contrasting with normative accounting concerned with search of “optimal” accounting standards regulators attempt to prescribe. While positive theory seeks to find explanation to particular phenomena and predict them, normative theories seek to prescribe particular practices. Accordingly a gap between prescription and existing practice may exist regarding particular accounting items.
One of the distinctive features of positive accounting theory is its focus on relationships between various stakeholders and the role of the accounting in functioning of these relationships.
One of the core assumptions underlying positive accounting theory is that “All individuals’ action is driven by self-interest and individuals will act in an opportunistic manner to the extent that the actions will increase their wealth” (Deegan 2009).
From practical point of view one of the most important types of the relationships within positive accounting theory is shareholders-management relationships. According to the core assumption of positive accounting theory provide above, both shareholders and managers seek to maximize their wealth. Important thing is that their interests may be not congruent. There are basically to major perspectives adopted in positive accounting theory research: efficiency perspective and opportunistic perspective.
Efficiency perspective (also known as ex ante perspective) assumes that contracting mechanisms put in place up front to minimise future agency and contracting costs induce managers to be efficient. In this case efficiency means choosing accounting policies to attain corporate governance objectives of the firm, i.e. reflecting firm real performance.
Opportunistic perspective (also known as ex post perspective) assumes that it is not possible to write complete contracts and accordingly managers are able to act opportunistically in order to maximise own wealth.
As owners are driven by self-interest they expect managers (“agents”) to undertake activities always in the interest of owners (“principal”). However, as managers are involved directly in company operations, they may to some extend act in own interests. Moreover, managers have access to information not always available to owners (phenomenon often reffered to as “information asymmetry”), which allows them to undertake activities beneficial to themselves. Costs incurred by principals diverging from agent’s actions focused on own interests are known as agency costs. One way to reduce opportunistic behaviour of agents (managers) relate to corporate governance and internal controls.
Management’s compensation may be fixed or performance-based (i.e. salary plus bonus for reaching certain targets). While fixed basis guarantees relatively high amount of income and does not expose management to risks of lower remuneration, management does not share potential gains with owners and may be under motivated.
Bonus schemes provide higher motivation to improve performance, however it may induce management to reach targets not only through improved performance, but also through manipulations with accounting data or approaches. In principal bonus schemes can be tied to outputs of accounting system or to market price of the firm’s shares. Another issue
According to opportunistic perspective, there are three key hypotheses of positive accounting theory which are used to explain and predict support or opposition to an accounting method: bonus plan hypothesis, debt hypothesis and political cost hypothesis. Among these three hypothesis two hypothesis are relevant for the purposes of the discussion in this paper: bonus plan hypothesis and debt hypothesis.
Bonus plan hypothesis postulates that managers of firms whose compensations depend on performance (i.e. with bonus plans) are more likely to select accounting methods that increase current period reported income. Increase of current period income may be achieved via various approaches that shift future earnings to current period. Incentive for managers in this case is increasing the present value of bonuses paid to management, as according to time value for money concept a dollar today worth more then a dollar tomorrow. It should be noted that such manipulation can be used in both types of bonus schemes, accounting and market-based, as higher incomes are usually positively correlated with share market price.
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