A Critical Analysis of Accounting Theory and Accountability

This report critically analyzes the importance and significance of Watts and Zimmerman's positive accounting theory, particularly their 1978 paper, and its influence on understanding accounting practices. The report highlights the generation of positive accounting literature, which offers explanations of accounting practices, emphasizes the role of contracting costs, and has led to the discovery of previously unknown empirical regularities. The analysis stresses the importance of tighter links between theory and empirical tests, the development of models recognizing endogeneity, and the reduction of measurement errors. It discusses the evolution of positive accounting research, recognizing the significance of contracting costs in explaining accounting choices and emphasizes the role of incentives for managers. The report also mentions the significance of this theory in the context of corporate accounting and the existing opportunities for further research in the field.

Running Head: ACCOUNTING THEORY AND ACCOUNTABILITY
ACCOUNTING THEORY AND ACCOUNTABILITY
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Table of Contents
Importance and Significance of Watts and Zimmerman paper and PAT..................................2
Reference....................................................................................................................................4

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Importance and Significance of Watts and Zimmerman paper and PAT
The paper published by Watts and Zimmerman in 1978 has helped in generating
literature of positive accounting that offered explanation of the accounting practice, has led
towards discovering of some prior unknown empirical regularities and suggested importance
of the contracting cost. The publishing of two papers “Demand for and Supply of the
Accounting Theories” as well as “Towards Positive Theory of Determination of Accounting
Standards” were faced controversy 10 years back and this controversy remains today. The
papers have contributed to the literature, which tried for uncovering empirical regularities in
the practice of accounting. It has attempted for removing some of the common
misconceptions regarding methodology. The paper has suggested the ways for improving
positive research in the choice of accounting. One of the most significant improvements is
tighter linkage between theory and empirical tests (Watts & Zimmerman, 1990).
In the contemporaneous PAT, contracting costs concept and accounting method
notion as part of the efficient technology of organization plays vital role. More recently,
positive accounting research has recognized contracting costs importance for explaining
accounting. Most of the accounting choice assumes the managers for choosing methods of
accounting for transferring wealth to themselves at other party expenses to company due to
the fact that they can take observed contracts of company as given. This helps in determining
incentives of manages for the choice of accounting (Zhou, 2019). The existence of
accounting would not be possible without the contracting costs and hence, it becomes
difficult for producing theory, which predicts as well as explains accounting despite of
making assumptions regarding relative magnitude of these particular costs. The significant
role of the contracting costs is highlighted by the research of positive accounting, which
makes it quite difficult for ignoring these particular costs in the theories of accounting. It

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helps in directing attention of researchers to appropriate issues (Schroeder, Clark & Cathey,
2019).
The literature of positive accounting has yielded empirical regularities as well as
explanations for the regularities. This is clear and evident that there are various available
opportunities beyond those, which are exploited currently. The test of the hypotheses of
political costs, bonus and debt, represents limited exploration. Further, incorporating ex ante
incentives of contracting efficiency with the ex post effects of redistribution likely proves to
be useful. Therefore, it can be said that for laying down important foundation, the focus
should be on stressing link between theory and empirical tests as well as investigating intra
and inter industrial variations in the methods of accounting and choices of other organization
(Beattie, 2014).

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Reference
Beattie, V. (2014). Accounting narratives and the narrative turn in accounting research:
Issues, theory, methodology, methods and a research framework. The British
Accounting Review, 46(2), 111-134.
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial accounting theory and
analysis: text and cases. John Wiley & Sons.
Watts, R. L., & Zimmerman, J. L. (1990). Positive accounting theory: a ten year
perspective. Accounting review, 131-156.
Zhou, Y. (2019). A Concept Tree of Accounting Theory:(Re) Design for the Curriculum
Development. Education Sciences, 9(2), 111.