The primary objective of Positive Accounting Theory (PAT) is to explain as well as predict accounting practices in contrast to the Normative Accounting Theories, which are prescriptive in nature and which were a dominant part of accounting research till the two controversial articles were published by Watts and Zimmerman in 1978. It was a revolutionary idea, which raised a number of issues prompting researchers to debate the technical issues concerning research methods, issues related to philosophy of science and issues concerning economics-based research in accounting. This paper attempts to review these issues and the validity of the questions raised from such issues involved. As pointed out by various authors, there is a need to integrate the two approaches of the discipline to evolve its full potential. The best theory or the approach emerges not in isolation, but as a result of intense arguments, giving due weight to the others’ view point.

Positive Accounting Research (PAR) refers to a particular mode of empirical research designed to explain accounting practices of companies. The primary objective of PAR is the development of a Positive Accounting Theory (PAT), which can explain as well as predict accounting practices in contrast to the Normative Accounting Theories, which are prescriptive in nature and which were a dominant part of accounting research till the two controversial articles —“Towards a Positive Theory of the Determination of Accounting Standards” and “The Demand for and Supply of Accounting Theories: The Market for Excuses” by Watts and Zimmerman in 1978 were published in the Accounting Review.

The three basic hypotheses as outlined by Watts and Zimmerman (1978) underlying PAT are: the bonus plan hypothesis, the debt/equity hypothesis and the political cost hypothesis. The bonus plan hypothesis is that managers of firms with bonus plans are more likely to use accounting methods that increase current period reported income. Such selection presumably increase the present value of bonuses if the compensation committee of the board of directors does not adjust to the method chosen. The debt/equity hypothesis predicts that the higher the firm’s debt/equity ratio, the more likely that the managers use accounting methods that increase income. The political cost hypothesis predicts that large firms rather than small firms are more likely to use accounting choices that reduce reported profits. Size is a proxy variable for political attention. Underlying this hypothesis is the assumption that it costs individuals to become informed about whether accounting profits really represent monopoly profits and to contract with others in the political process to enact laws and regulations that enhance their welfare.

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