Chapter 07 Positive Accounting Theory

Chapter 07 Positive Accounting Theory
1. Watts and Zimmerman's Positive Accounting Theory is:

A. One of several normative theories of accounting
B. One of several positive theories of accounting
C. One of several critical theories of accounting
D. None of the given options are correct.
2. Which of the following is a central assumption of Positive Accounting Theory?

A. Individuals act solely on the basis of self-interest.
B. Firms seek to maximise profits.
C. The interests of principals and agents are not aligned.
D. Financial statements will be audited regardless of legal requirements.
3. To test whether accounting information is useful, researchers such as Ball and Brown tested whether share
prices responded to:
A. Expected earnings announcements
B. Forecast earnings announcements
C. Unexpected earnings announcements
D. All of the given options are correct.
4. The key theory that underpins Positive Accounting Theory is:

A. The Efficient Markets Hypothesis
B. Agency theory
C. Normative ethical theory
5. The principal's expectation of opportunistic behaviour by his or her agent results in lower payments to:
A. The agent
B. The principal
C. The principal and the agent
D. Neither the principal nor the agent
6. According to agency theory, contracts that align the interests of the principal and agent primarily benefit:
A. The agent
B. The principal
C. Both the principal and the agent
7. Agency theory suggests that government regulation is:

A. Necessary, because principals know that agents may not act in their interests
B. Necessary, because agents know that principals may not act in their interests
C. Unnecessary, because principals know that agents may not act in their interests
D. Unnecessary, because agents know that principals may not act in their interests
8. The 'political cost hypothesis' of Positive Accounting Theory suggests which of the following?
A. Large firms are more likely to use accounting choices that reduce reported profits.
B. Small firms are more likely to use accounting choices that reduce reported profits.
C. Neither large nor small firms are more likely to use accounting choices that reduce reported profits.
D. Both large and small firms are more likely to use accounting choices that reduce reported profits.
9. The 'bonus plan hypothesis' of Positive Accounting Theory suggests managers of firms with bonus plans tied
to reported income are more likely to use accounting methods that:
A. Increase prior period reported income
B. Increase current period reported income
C. Increase future period reported income
10. The 'debt/equity hypothesis' of Positive Accounting Theory predicts which of the following?
A. The higher the firm's debt/equity ratio, the more likely managers are to use accounting methods that lower
income.
B. The lower the firm's debt/equity ratio, the more likely managers are to use accounting methods that increase
income.
C. The higher the firm's debt/equity ratio, the more likely managers are to use accounting methods that increase
income.
11. The 'efficiency perspective' of Positive Accounting Theory suggests that firms will:
A. Adopt the accounting methods that require the least resources to implement
B. Adopt the accounting methods that result in the highest reported earnings
C. Adopt the accounting methods that result in the lowest reported earnings
D. Adopt the accounting methods that best reflect the underlying economic performance of the entity
12. Which of the following is correct in respect of Positive Accounting Theory?

A. The opportunistic perspective is ex-post, and the efficiency perspective is ex-ante.
B. The opportunistic perspective is ex-ante, and the efficiency perspective is ex-post.
C. Both the opportunistic and efficiency perspectives are ex-ante.
D. Both the opportunistic and efficiency perspectives are ex-post.
13. A manager electing to adopt a depreciation method that increases income, but does not reflect the actual use
of the asset, is consistent with:
A. The efficiency perspective of Positive Accounting Theory
B. The opportunistic perspective of Positive Accounting Theory
C. Both the opportunity and the efficiency perspectives of Positive Accounting Theory
D. Neither the opportunity nor the efficiency perspectives of Positive Accounting Theory
14. Which of the following parties desire the firm to take the most risks?
A. Managers
B. Debtholders
C. Owners
D. All parties desire the firm to take the same level of risk.
15. Positive Accounting Theory suggests that bonus schemes benefit:

A. Only managers
B. Only owners
C. Both managers and owners
D. Neither managers nor owners
16. Which of the following is the main advantage of using accounting earnings instead of share prices to
determine bonuses?
A. Share prices are influenced by market forces that are outside the control of management.
B. Accounting information is independently audited.
C. Accounting information is unbiased.
D. Share prices may be manipulated by managers engaging in insider trading.
17. According to Positive Accounting Theory, using stock prices to determine bonuses:
A. Increases the likelihood of management disclosing good news
B. Increases the likelihood of management disclosing of bad news
C. Increases the likelihood of management disclosing both good and bad news
D. Has no effect on the likelihood of management disclosures
18. According to Positive Accounting Theory, the existence of debt covenants:

A. Can be explained from an efficiency perspective, and gives management an incentive to manipulate
accounting information from an opportunistic perspective
B. Can be explained from an opportunistic perspective, and gives management an incentive to manipulate
accounting information from an efficiency perspective
C. Can be explained from both efficiency and opportunistic perspectives
D. Cannot be explained
19. Which of the following is a problem with Positive Accounting Theory?

A. It is not testable.
B. It has been empirically discredited.
C. It contributes little to improving accounting practice.
20. Which of the following is not a criticism of Positive Accounting Theory?

A. It is based on the assumption that all action is driven by wealth maximisation.
B. It is not value-free.
C. It has developed little in the past 30 years.
D. Its claims cannot be objectively verified.
21. A contribution of Positive Theory is that it enables us to understand:

A. Why interest groups expend resources lobbying for or against particular standards
B. Why a manager adopts particular accounting techniques over others
C. The effect accounting standards have on different groups and resource allocation
22. Which of the following is an example of political costs under the PAT perspective?
A. Wage and salary deductions paid to unions
B. Contributions to political parties
C. Costs associated with increased wage claims
D. The cost of remaining largely unnoticed by government regulatory agencies
23. Which of the following is not an example of a Positive Accounting Theory or research?
A. True income theories
B. Legitimacy Theory
24. Which of the following statements is not true about Positive Accounting Theory?
A. It is used to distinguish research aimed at explanation and prediction.
B. It is designed to explain and predict which firms will, and which firms will not, use a particular method, and
also prescribes which method a firm should use.
C. It focuses on the relationships between the various individuals involved in providing resources to an
organisation, and how accounting is used to assist in the functioning of these relationships.
D. One of the key theories that underpins Positive Accounting Theory is Agency theory.
25. Which of the following statements is true regarding the origins and development of Positive Accounting
Theory?
A. Positive research in accounting started coming to prominence around the mid-1960s, and appeared to
become the dominant research paradigm within financial accounting in the 1970s and 1980s.
B. The introduction of positive research into accounting represented a paradigm shift from normative research
to positive research.
C. Currently, almost all papers in Accounting Review and most other leading academic journals are positive
research-based.
26. Which of the following is not true about Positive Accounting Theory?
A. A positive theory seeks to explain and predict particular phenomena.
B. A positive theory focuses on the relationships between various individuals and how accounting is used to
assist in the functioning of these relationships.
C. A positive theory prescribes how a particular practice should be undertaken.
27. Which of the following statements is true about what caused the shift in paradigm from normative to
positive research?
A. The shift resulted from US reports on business education, and improved computing facilities enabling
large-scale statistical analysis.
B. The shift occurred because positive accounting researchers are not concerned with explaining or predicting
what is (i.e. that which could be tested empirically); rather, they are concerned with what should be.
C. The shift occurred because in positive research, falsifiable hypotheses are not generated from theory.
28. It is common practice for managers to be rewarded in a way that is tied to the profits of the firm, the sales of
the firm, or the return on assets. That is, their remuneration is based on the output of the accounting system.
Which of the following is a drawback for such bonus schemes?
A. Bonus schemes tied to the performance of the firm will be put in place to align the interests of the owners
and the managers.
B. Rewarding managers on the basis of accounting profits may induce them to manipulate accounting numbers.
C. There would be limited incentives for the manager to adopt risky strategies that increase the value of the
firm.
D. The manager may be reluctant to take on optimal levels of debt.
29. Which of the following bonus schemes would be appropriate for the managers of a biotechnology research
company?
A. A market-based bonus scheme, as it is more appropriate to reward the manager in terms of the market value
of the firm's securities, which are assumed to be influenced by expectations about the net present value of
expected future cash flows, and the manager will be given an incentive to increase the value of the firm.
B. A fixed basis scheme, so that the managers would not take great risks, reject risky projects, and be reluctant
to take on optimal levels of debt as it may be beneficial to those with equity in the firm.
C. An accounting-based bonus scheme as this will be in the interest of the manager, as that manager will
potentially receive greater rewards and will not have to bear the costs of the perceived opportunistic behaviours.
D. A combination of fixed basis and accounting-based scheme, as assuming that self-interest drives the actions
of the managers, it may be necessary to put in place remuneration schemes that reward the managers in a way
that is, at least in part, tied to the performance of the firm.
30. Which of the following can be used as an accounting measure by the government and other interest groups
that a particular organisation (typically large) is generating excessive profits and not paying its 'fair share' to
other segments of the community?
A. Total sales
B. Total profits
C. Total assets
Chapter 07 Positive Accounting Theory Key

1. Watts and Zimmerman's Positive Accounting Theory is:
A. One of several normative theories of accounting
B. One of several positive theories of accounting
C. One of several critical theories of accounting
Deegan - Chapter 07 #1
Difficulty: Easy
2. Which of the following is a central assumption of Positive Accounting Theory?

A. Individuals act solely on the basis of self-interest.
B. Firms seek to maximise profits.
C. The interests of principals and agents are not aligned.
D. Financial statements will be audited regardless of legal requirements.
Difficulty: Easy
3. To test whether accounting information is useful, researchers such as Ball and Brown tested whether share
prices responded to:
A. Expected earnings announcements
B. Forecast earnings announcements
C. Unexpected earnings announcements
Difficulty: Easy
4. The key theory that underpins Positive Accounting Theory is:

A. The Efficient Markets Hypothesis
B. Agency theory
C. Normative ethical theory
Difficulty: Easy
5. The principal's expectation of opportunistic behaviour by his or her agent results in lower payments to:
A. The agent
B. The principal
C. The principal and the agent
Difficulty: Easy
6. According to agency theory, contracts that align the interests of the principal and agent primarily benefit:
A. The agent
B. The principal
C. Both the principal and the agent
Difficulty: Easy
7. Agency theory suggests that government regulation is:

A. Necessary, because principals know that agents may not act in their interests
B. Necessary, because agents know that principals may not act in their interests
C. Unnecessary, because principals know that agents may not act in their interests
D. Unnecessary, because agents know that principals may not act in their interests
Difficulty: Medium
8. The 'political cost hypothesis' of Positive Accounting Theory suggests which of the following?
A. Large firms are more likely to use accounting choices that reduce reported profits.
B. Small firms are more likely to use accounting choices that reduce reported profits.
C. Neither large nor small firms are more likely to use accounting choices that reduce reported profits.
D. Both large and small firms are more likely to use accounting choices that reduce reported profits.
Difficulty: Easy
9. The 'bonus plan hypothesis' of Positive Accounting Theory suggests managers of firms with bonus plans tied
to reported income are more likely to use accounting methods that:
A. Increase prior period reported income
B. Increase current period reported income
C. Increase future period reported income
Difficulty: Easy
10. The 'debt/equity hypothesis' of Positive Accounting Theory predicts which of the following?
A. The higher the firm's debt/equity ratio, the more likely managers are to use accounting methods that lower
income.
B. The lower the firm's debt/equity ratio, the more likely managers are to use accounting methods that increase
income.
C. The higher the firm's debt/equity ratio, the more likely managers are to use accounting methods that increase
income.

Difficulty: Easy
11. The 'efficiency perspective' of Positive Accounting Theory suggests that firms will:
A. Adopt the accounting methods that require the least resources to implement
B. Adopt the accounting methods that result in the highest reported earnings
C. Adopt the accounting methods that result in the lowest reported earnings
D. Adopt the accounting methods that best reflect the underlying economic performance of the entity

Difficulty: Easy
12. Which of the following is correct in respect of Positive Accounting Theory?

A. The opportunistic perspective is ex-post, and the efficiency perspective is ex-ante.
B. The opportunistic perspective is ex-ante, and the efficiency perspective is ex-post.
C. Both the opportunistic and efficiency perspectives are ex-ante.
D. Both the opportunistic and efficiency perspectives are ex-post.

Difficulty: Easy
13. A manager electing to adopt a depreciation method that increases income, but does not reflect the actual use
of the asset, is consistent with:
A. The efficiency perspective of Positive Accounting Theory
B. The opportunistic perspective of Positive Accounting Theory
C. Both the opportunity and the efficiency perspectives of Positive Accounting Theory
D. Neither the opportunity nor the efficiency perspectives of Positive Accounting Theory

Difficulty: Hard
14. Which of the following parties desire the firm to take the most risks?
A. Managers
B. Debtholders
C. Owners
D. All parties desire the firm to take the same level of risk.

Difficulty: Easy
15. Positive Accounting Theory suggests that bonus schemes benefit:

A. Only managers
B. Only owners
C. Both managers and owners
D. Neither managers nor owners

Difficulty: Easy
16. Which of the following is the main advantage of using accounting earnings instead of share prices to
determine bonuses?
A. Share prices are influenced by market forces that are outside the control of management.
B. Accounting information is independently audited.
C. Accounting information is unbiased.
D. Share prices may be manipulated by managers engaging in insider trading.

Difficulty: Medium
17. According to Positive Accounting Theory, using stock prices to determine bonuses:
A. Increases the likelihood of management disclosing good news
B. Increases the likelihood of management disclosing of bad news
C. Increases the likelihood of management disclosing both good and bad news
D. Has no effect on the likelihood of management disclosures

Difficulty: Medium
18. According to Positive Accounting Theory, the existence of debt covenants:

A. Can be explained from an efficiency perspective, and gives management an incentive to manipulate
accounting information from an opportunistic perspective
B. Can be explained from an opportunistic perspective, and gives management an incentive to manipulate
accounting information from an efficiency perspective
C. Can be explained from both efficiency and opportunistic perspectives
D. Cannot be explained

Difficulty: Hard
19. Which of the following is a problem with Positive Accounting Theory?

A. It is not testable.
B. It has been empirically discredited.
C. It contributes little to improving accounting practice.

Difficulty: Easy
20. Which of the following is not a criticism of Positive Accounting Theory?

A. It is based on the assumption that all action is driven by wealth maximisation.
B. It is not value-free.
C. It has developed little in the past 30 years.
D. Its claims cannot be objectively verified.

Difficulty: Easy
21. A contribution of Positive Theory is that it enables us to understand:

A. Why interest groups expend resources lobbying for or against particular standards
B. Why a manager adopts particular accounting techniques over others
C. The effect accounting standards have on different groups and resource allocation

Difficulty: Easy
22. Which of the following is an example of political costs under the PAT perspective?
A. Wage and salary deductions paid to unions
B. Contributions to political parties

Difficulty: Medium
23. Which of the following is not an example of a Positive Accounting Theory or research?
A. True income theories
B. Legitimacy Theory

Difficulty: Medium
24. Which of the following statements is not true about Positive Accounting Theory?
A. It is used to distinguish research aimed at explanation and prediction.
B. It is designed to explain and predict which firms will, and which firms will not, use a particular method, and
also prescribes which method a firm should use.
C. It focuses on the relationships between the various individuals involved in providing resources to an
organisation, and how accounting is used to assist in the functioning of these relationships.
D. One of the key theories that underpins Positive Accounting Theory is Agency theory.

Difficulty: Hard
25. Which of the following statements is true regarding the origins and development of Positive Accounting
Theory?
A. Positive research in accounting started coming to prominence around the mid-1960s, and appeared to
become the dominant research paradigm within financial accounting in the 1970s and 1980s.
B. The introduction of positive research into accounting represented a paradigm shift from normative research
to positive research.
C. Currently, almost all papers in Accounting Review and most other leading academic journals are positive
research-based.

Difficulty: Easy
26. Which of the following is not true about Positive Accounting Theory?
A. A positive theory seeks to explain and predict particular phenomena.
B. A positive theory focuses on the relationships between various individuals and how accounting is used to
assist in the functioning of these relationships.
C. A positive theory prescribes how a particular practice should be undertaken.

Difficulty: Easy
27. Which of the following statements is true about what caused the shift in paradigm from normative to
positive research?
A. The shift resulted from US reports on business education, and improved computing facilities enabling
large-scale statistical analysis.
B. The shift occurred because positive accounting researchers are not concerned with explaining or predicting
what is (i.e. that which could be tested empirically); rather, they are concerned with what should be.
C. The shift occurred because in positive research, falsifiable hypotheses are not generated from theory.

Difficulty: Easy
28. It is common practice for managers to be rewarded in a way that is tied to the profits of the firm, the sales of
the firm, or the return on assets. That is, their remuneration is based on the output of the accounting system.
Which of the following is a drawback for such bonus schemes?
A. Bonus schemes tied to the performance of the firm will be put in place to align the interests of the owners
and the managers.
B. Rewarding managers on the basis of accounting profits may induce them to manipulate accounting numbers.
C. There would be limited incentives for the manager to adopt risky strategies that increase the value of the
firm.
D. The manager may be reluctant to take on optimal levels of debt.

Difficulty: Medium
29. Which of the following bonus schemes would be appropriate for the managers of a biotechnology research
company?
A. A market-based bonus scheme, as it is more appropriate to reward the manager in terms of the market value
of the firm's securities, which are assumed to be influenced by expectations about the net present value of
expected future cash flows, and the manager will be given an incentive to increase the value of the firm.
B. A fixed basis scheme, so that the managers would not take great risks, reject risky projects, and be reluctant
to take on optimal levels of debt as it may be beneficial to those with equity in the firm.
C. An accounting-based bonus scheme as this will be in the interest of the manager, as that manager will
potentially receive greater rewards and will not have to bear the costs of the perceived opportunistic behaviours.
D. A combination of fixed basis and accounting-based scheme, as assuming that self-interest drives the actions
of the managers, it may be necessary to put in place remuneration schemes that reward the managers in a way
that is, at least in part, tied to the performance of the firm.

Difficulty: Hard
30. Which of the following can be used as an accounting measure by the government and other interest groups
that a particular organisation (typically large) is generating excessive profits and not paying its 'fair share' to
other segments of the community?
A. Total sales
B. Total profits
C. Total assets

Difficulty: Easy
Chapter 07 Positive Accounting Theory Summary

Category
# of Questions
Deegan - Chapter 07
30
Difficulty: Easy
20
Difficulty: Hard
Difficulty: Medium

Chapter 07 Positive Accounting Theory

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Chapter 07 Positive Accounting Theory

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Chapter 07 Positive Accounting Theory

1. Watts and Zimmerman's Positive Accounting Theory is:

2. Which of the following is a central assumption of Positive Accounting Theory?

4. The key theory that underpins Positive Accounting Theory is:

7. Agency theory suggests that government regulation is:

12. Which of the following is correct in respect of Positive Accounting Theory?

15. Positive Accounting Theory suggests that bonus schemes benefit:

18. According to Positive Accounting Theory, the existence of debt covenants:

19. Which of the following is a problem with Positive Accounting Theory?

20. Which of the following is not a criticism of Positive Accounting Theory?

21. A contribution of Positive Theory is that it enables us to understand: