396 Int. J. Critical Accounting, Vol. 6, No.

4, 2014

Positive accounting theory: theoretical and critical

perspectives

Donatien Avelé
Faculty of Administration,
University of Moncton,
Moncton (New Brunswick) E1A 3E9, Canada
Fax: 1-506-858-4093
Email: donatien.avele@umoncton.ca

Abstract: This article presents the evolution of positive accounting theory

since its founding works by Littleton (1953). From the reasoned practice to
Chambers’ (1966) normative theory and the PAT initiated by Watts and
Zimmerman (1978, 1979), the article discusses the tug of war through multiple
reviews of the main approaches that are reported in accounting research in the
past few decades. The study then proceeds to a comparative analysis of the two
theories (normative and positive) that have been the subject of numerous
criticisms. Furthermore, one of the main goals of this study is to examine the
possibility of reconciling the PAT and the agency theory in the allocation of
indirect manufacturing costs. Overall, this paper shows that the PAT is the one
that is the most controversial in the history of accounting theory.

Keywords: positive theory accounting; agency theory; indirect manufacturing

costs; normative accounting theory.

Reference to this paper should be made as follows: Avelé, D. (2014) ‘Positive

accounting theory: theoretical and critical perspectives’, Int. J. Critical
Accounting, Vol. 6, No. 4, pp.396–415.

Biographical notes: Donatien Avelé holds a PhD in Management Sciences

(Management Control) from the University of Bordeaux-France. He is a
specialist in accounting and management control. He is presently an Assistant
Professor at the Department of Accounting, University of Moncton (Canada),
and teaches accounting. He has also authored papers published in scientific
journals.

1 Introduction

Financial accounting has undergone significant changes in the late ‘60s. Prior to this, it
was perceived as uniquely useful to users, which is why accounting research was mainly
normative, i.e., it only focused on useful and relevant accounting methods. This new
period was marked by an interest in empirical accounting research. Empirical tests
conducted have highlighted the important market expectation of the information content
of the data before their release. On the other hand, the introduction of a positive approach
required the use of new instruments; the first experiments of which have focused on the
validation of the hypothesis of accounting information decision-usefulness. In addition,
one of the major problems raised at that time was the institutional role of accounting as a

Copyright © 2014 Inderscience Enterprises Ltd.

 Positive accounting theory 397

system of production of financial information. It is in this context that a new vision of the
contractual usefulness of accounting figures was born in 1970. Moreover, the content of
the research programme ‘Positive Accounting Theory (PAT)’ formulated by Watts and
Zimmerman (1978, 1979, 1986) proposed to explain the practices and predicting
accounting choices made by both leaders and the standardisation bodies. This programme
has led to the creation in 1980 of a stream of thoughts named ‘Rochester School’. This
school has borrowed several related fields such as organisation theory, economic theory
or the theory to allow financial accounting research to gain status and scientific
recognition. Thus, positive theory has played a crucial role in the construction of
accounting research, even though it was later questioned. Authors like Littleton (1953),
Chambers (1955), and Watts and Zimmerman (1978, 1979) undoubtedly influenced the
development of accounting researcher. Their texts can be considered representative of the
accounting categorisation theories identified by Colasse (2000): “descriptive theories,
normative theories and explanatory theories”. In contrast, we observed that most studies
so far have focused on the PAT initiated by Watts and Zimmerman and the financial
accounting. What about this theory and managerial accounting? The fundamental focus
of research on the allocation of costs in management accounting is essentially normative.
One would then find the best methods for expenses balancing or propose optimal
allocation keys. However, the existing literature rather attempts to understand and explain
the practices in organisations with respect to allocation methods instead of providing an
ideal model. In this context, the allocation of costs may be determined by other
arguments: an attempt to improve the accuracy of the calculated costs (motivation of
stakeholders, estimating opportunity costs, regulation of competition, pricing sale, etc...).
Thus, research works that are akin to the positive theory of accounting are primarily
intended to explain why accounting is what it is and why accountants do what they do
(Colasse, 2000, citing Jensen, 1976). Resource allocation policy and costs balancing
suppose that we are more interested in the choice of accounting stakeholders rather than
accounting objects (reports, accounting methods, etc.). The main objective of the positive
theory of management accounting is to explain and predict the behaviour of generators
and users of accounting information. This is thus analysed by Zimmerman (1979),
making use of the agency relationship as defined by Jensen and Meckling (1976). Part of
the research on costing practices draw on epistemological orientation of Watts and
Zimmerman’s (1978) PAT. In addition, the main assumption made by Zimmerman
(1979, p.506) in this regard is that of the MMER – organisational stakeholders are all
resourceful, evaluative, maximising men (REMM). According to this model, each player
tries to dynamically maximise his usefulness or personal interest. In this context, it is not
excluded that the usefulness function of an individual partially integrates the interests of
other stakeholders. To this end, Jensen and Meckling (1994) explicitly cite altruism as the
primary source of potential usefulness.
This article has a threefold objective: the first is to trace the evolution of the positive
theory of accounting (2). To this end, we try to answer the question of whether the PAT
comes from Jensen and Meckling’’s (1976) theory? Next, we will do a comparative
analysis between normative and positive theories of accounting? The second objective is
to see in what context it is possible to reconcile the positive theory of accounting with the
agency theory in the allocation of indirect manufacturing costs (3). Finally, we will
discuss criticisms: from the normative theory to the positive theory of accounting, which
makes the third objective of our study (4).
398 D. Avelé

2 Evolution of PAT

Accounting writings consisted mainly in a description of the accounting methods in effect

until the late 19th century and early 20th century. Modern positive accounting research
began in 1960 (Watts and Zimmerman, 1990) when researchers such as Ball and Brown
(1968), or Beaver (1968) introduced empirical research methods adapted to finance in
financial accounting. Following the enactment of the US Securities Acts of 1933 and
1934, which was aimed at regulating business corporations [Tremblay et al., (1993),
p.120], accounting theories of that period focused more on the prescriptive dimension.
Thus, we can say that accounting research based on politico-contractual or positive
theories are fairly recent. Until the early 1960s, accounting research was primarily
normative and oriented towards purely theoretical choices in regards to accounting
methods and policies (Tremblay et al., 1993). It is in the late ‘60s that positivist
accounting will undergo deep changes. Financial accounting was then seen as only useful
to users. Very quickly, the normative approach promoted by Chambers (1955) was
replaced by the empirical research philosophy in need of scientific bases. Empirical tests
were conducted to highlight the market important expectation in terms of the data
informative content before their release. PAT attempted to explain and predict the
behaviour of producers and users of accounting data (Casta, 2000). It also attempted to
bring more accuracy in the preparation of financial statements. A major problem raised at
that time was the institutional role of accounting as a system of financial information
production.
It is in this context that was born, in 1970, a new vision of the contractual usefulness
of accounting figures. Indeed, the content of the research programme ‘PAT’ formulated
by Watts and Zimmerman (1978, 1979, 1986) proposed to explain the practices and
predicting accounting choices made by both leaders and standardisation organisations.
This programme resulted, in 1980, in the creation of a school of thought called ‘School of
Rochester’. For this purpose, its models were borrowed from the positive theory of
agency (TPA) and the regulation’s economic theory. Thus, according to Jensen and
Meckling (1976), the accounting positive theory derived from the shareholder’s vision
allows for a reduction of agency costs. The agency’s positive theory views the company
as a node of contracts among stakeholders (shareholders, managers, funders, suppliers,
and customers) guided by their interests’ maximisation. Watts and Zimmerman (1978)
have then borrowed several related fields such as organisation theory, economic theory or
the financial theory to allow accounting research acquiring a status and scientific
recognition.

2.1 Is PAT a result of agency theory?

If accounting allows for a reduction of agency costs, accounts’ audit represents a
mechanism for management of customs clearance and budgetary control, a way to reduce
the discretionary latitude of the latter, according to Jensen and Meckling (1976). Thereby,
the accounting implies the opinions of financial analysts (Charreaux, 1999). The analysis
of accounting will therefore devote itself to this perspective (Degos, 1998; Charreaux,
1999). Watts and Zimmerman worked out a report on ten years of accounting research
inspired by the TPA. Both authors, pioneers of the positive theory of accounting, also
showed interest on the theory of public choices and annuity-seeking (Charreaux and
Desbrières, 1998). Watts and Zimmerman (1986) suggest following the analysis of
 Positive accounting theory 399

accounting practices relating to the consequences of conflicts of interest associated with

formal and informal agreements between managers and creditors, to explain accounting
practices in relation with two formal contracts: systems of executive compensation and
debt contracts. The basic purpose of choosing these practices is to minimise agency costs
generated from signing these agreements. The agency theory also perceives the company
as a contract’s node (Jensen, 1983).
It assumes a difference of interest between the manager and the shareholder. In their
seminal work on the PAT, Watt and Zimmerman (1978) proposed a framework that is not
included in the TPA. The proposed framework is based on the theory of public choices
for explaining the production of legal accounting regulations. This theory assumes that
those in charge of the production, identified as politicians, seek to maximise their own
interests (Jensen and Meckling, 1976; Charreaux, 1997). Politics is represented as a
competitive process for which the issue is the control of wealth transfers, through
taxation and regulation (Milgrom and Roberts, 1992). While seeking to be elected,
politicians will seek to promote the adoption of measures enabling them to make transfers
favourable to their electoral support (Arrow et al., 1997), for example, by highly taxing
corporate earnings (Charreaux and Desbrières, 1998). In this context, the leaders will
seek to produce accounting figures to underestimate these transfers. Legal accounting
regulations would thus be dictated by the objectives of politicians (Jensen and Meckling,
1976). This approach therefore claims that there could be collusion between the
government and accounting professionals interests. If the creation and distribution of
value is thus reduced to shareholders and stakeholders, other actors in the positive theory
of accounting (politicians, financial analysts, rating agencies and accounting
professionals) only have a secondary role. Therefore, not being direct players in the
game, their role would exclusively be restricted to setting some parameters defining the
level of agency costs.
In light of the above, it may be noted that PAT initiated by Watt and Zimmerman
(1978) has its origins in the theory of agency. In fact, the PAT represents the most known
research vision in financial accounting and aims to explain “why accounting is what it is,
why accountants do what they do and what impact these events have on people and the
allocation of resources” (Jensen, 1976), cited by Colasse et al. (2001, p.20). The positive
theory of accounting therefore considers the financial statements as part of the contractual
process around the company. Thus, the objective of financial accounting allows
facilitating the settlement and follow-up of contracts by reducing agency costs related to
the contractual process, and therefore the control of other stakeholders (Walkers, 1989;
Fama and Jensen, 1983). In a bid to explain the accounting practices, PAT refers to the
agency and regulation theory (Casta, 2000). Conflicts between shareholders and
creditors, shareholders and managers but also political environments inspire the
assumptions formulated by Watts and Zimmerman (1978). The maximising and
opportunistic behaviours of agents are also assumed. The corporate debt, executive
compensation or size, and the approximation of the ‘political visibility’ are generally
used in explaining accounting choices by the PAT (Raffournier, 1990).

2.2 Comparative analysis of normative and positive theories of accounting

“Designing a theory unrelated to reality is entirely possible but the theorist of a
discipline that has practical applications may not be as delightfully irresponsible as
Lewis Carroll. Make theory is not tantamount to detaching oneself from reality. It is
400 D. Avelé

actually one of the greatest pleasures of a theorist to submit its assumptions to the test of
reality” [Chambers, (1955), p.19], cited by Colasse (2005).
Eglem (2005, p.25) identified three major trends that coexist within the positive
approach:

• a trend which studies the impact of accounting information on financial markets

• a trend which analyses the link between accounting information and human
behaviour

• politico-contractual theory studying the organisational, economic and political

determinants of choices made by accountants.

Keynes (1995), repeated by Friedman (1953), makes a distinction between normative and
positive theories. Firstly, a “positive science may be defined as a systematic body of
knowledge on what is, whereas a normative or regulatory approach to science is defined
as a systematic body of knowledge concerning the criterion on what must be, therefore
concerned with an ideal that must be distinguished from what is”. Normative theory is
characterised as prescriptive while the so-called positive theory seeks to model an ideal
situation by explaining real practices and thus validate hypotheses. Watts and
Zimmerman (1986) refuse to fix an ideal since, according to them, “science has little to
say about values”. The founders of the Rochester School followed the opinion of Jensen
(1976), which was cited by Christenson (1983), “Accounting Research was unscientific,
because the emphasis was laid on the normative and definitional aspects”.
According to Sterling (1990) and Chambers (1993), the distinction between positive
and normative is not always obvious. They believe that it is easy to transform a normative
sentence into a positive one and vice versa, simply by replacing ‘shall’ with ‘should’ in a
simple sentence. It is therefore not obvious to differentiate whether the formulation is
scientific or not. However, the important point of the positive approach is to emphasise
the refutability of the statements and not the meaning of the words. To be classified as
scientific, a proposal must demonstrate that it is refutable, i.e., it should be possible to
disprove the predictions either by observation or by discussion (Popper, 1981; Jacob,
1989; Boyer, 1990). Normative statements are not necessarily unscientific because some
can be refuted, while others are rejected because they are not debatable (Sterling, 1990;
Whittington, 1987).

2.3 Foundations of the politico-contractual approach

Watts’ and Zimmerman’s initial question is: How to explain companies’ accounting
choices? The steps of their reasoning according to Colasse (2005) are as follows:
• The company is a node of contracts between stakeholders (managers, creditors,
shareholders, state, etc.) that have diverging interests and find themselves in
asymmetrical information relationships. Shareholders can only imperfectly judge the
actions of managers and creditors; the creditors not being sure of the quality of their
debtors, etc. These findings are at the origin of the agency theory developed by
Jensen and Meckling (1976) and the theory of regulation by Posner (1974).
 Positive accounting theory 401

• To overcome these agency conflicts, stakeholders may enter into agreements with
the purpose of aligning their interests: contractual debt (debt covenants) and
contracts for incentive compensation (compensation contacts).
• Such contracts implicitly or explicitly use accounting information.
• Seeking to maximise their usefulness, agents are willing to use tricks, lies and
manipulation (they are opportunistic).
• The leader has some flexibility in operating accounting options. Information
asymmetry makes his actions partially uncontrollable. From their framework, Watts
and Zimmerman (1986) have developed three hypotheses as follows.

2.3.1 The size hypothesis

Watts and Zimmerman took Posner’s (1974) idea, that the laws do not express interest,
but answers to the demands of various interest groups seeking to maximise profits for
their groups. Looking for re-election, politicians make decisions that minimise the risk of
losing votes. It is therefore in their interest to tax corporations (as they do not vote) and
penalise companies whose attitude or excessive earnings could offend the public opinion.
This ability of the political sector to make transfers of wealth between stakeholder groups
is called ‘political costs’ by Watts and Zimmerman. These political costs are even more
important now that businesses are visible on the political market. Both authors make the
assumption that the size is an indicator of political visibility “The bigger the company,
the more it will tend to choose accounting procedures that delay the reporting of income
to future periods”.

2.3.2 The debt hypothesis

This hypothesis results from the existence of contractual debt clauses (frequent in the
USA). This is a clause limiting for example dividends to be paid until the debt is
reimbursed. According to the agency theory, there are two reasons for their existence:
• To avoid transfer of wealth from creditors to shareholders. Indeed, managers can
distribute the funds provided by creditors as dividends. A solution to this agency
conflict would be to write contracts providing either a maximum distribution rate or
payment of dividends, subject to the condition that earnings exceed a certain
threshold.
• To prevent a transfer of wealth from old to new creditors. By increasing its debt, the
company dilutes guarantees to creditors. To resolve these conflicts, creditors may,
for example, specify a maximum debt ratio. Watts and Zimmerman pointed out that
the violation of debt covenants is costly for the manager (loss of reputation,
employment ...). The manager should therefore avoid being in default, possibly by
manipulating accounting data. The authors thus hypothesised that the profitability of
violation of ‘debt covenants’ increases with debt, “The higher the debt/equity ratio,
the higher the company’s tendency to defer current period of profits to future
periods”.
402 D. Avelé

2.3.3 The compensation hypothesis

This also comes from the agency theory. The so-called incentive contracts are put in
place to compensate executives. The existence of these contracts is due to the divergence
of interests between shareholders and managers. The latter may have an interest to invest
in projects that do not create value for shareholders, but with a positive usefulness for
them (for example, a luxury car service). To avoid these conflicts, leaders should be
compensated in proportion to the shareholders’ variation of wealth. It is common that
incentive contracts tie executive compensation to accounting income (as an estimation of
the change in shareholders’ wealth). This results in an incentive for managers to increase
the reported earnings in order to increase their compensation, “the managers of
companies where there is an incentive contract are more likely to choose the procedures
that delay income in future periods toward the current period”.

2.4 A new approach: the normative theory

The main shortcomings of accounting in this era were marked by the economic crisis of
1929. From the ‘30s, US scholars devoted themselves to the explanation of the main
principles that govern accounting in hope that it would contribute to the development of
accounting practices. This explanation was based on their professional experience as
practitioners of accounting [Eglem, (2005), p.48].

2.4.1 The foundations of normative theory

Rational practice does allow neither the development of accounting theory nor the
operation of practices, as it is a descriptive and classification approach that does not
allow one to establish a hierarchy in principles that are often wobbly (Chambers, 1966).
Chambers (1955) therefore devoted himself to criticising rational practice illustrated by
the works of renowned authors such as Norris, Bray and Littleton. Subsequently,
Chambers thus proposed a new approach according to which accounting theory should
provide the best context to the practice and should be based on a set of propols relating to
the company and its context (Colasse, 2005, citing Chambers). This proposition is
essentially economic analysis and is external to accounting. Research does not aim at
describing an often contestable and contradictory practice (Chambers, 1966). It must be a
solid, rational and scientific theoretical framework. It does not involve theorising or
rationalising the practice a posteriori, but to theorise it a priori; its approach is thus
normative. In his book ‘Accounting, Evaluation and Economic Behavior’, he states that
according to Colasse (2005), four proposals which are the premises of a ‘meta-theory’ of
accounting may be broken down into more specific theories, e.g., adapted to a particular
type of organisation and/or the environment:
• “Some organized activities are implemented in entities that exist in the willingness
and cooperation of their participants”: characteristics of each entity should be
considered in structuring an accounting information system which is appropriate.
• “These entities are managed rationally, in the sense that they aim at effectively
satisfying their participants’ demands”: the information system must be logically
consistent and the information it provides must meet the needs of users.
 Positive accounting theory 403

• “The statements in terms of money, transactions and relationships of the entity are
one of the ways that facilitates rational management”. This statement comes from
monetary accounting as a weighing instrument.
• “The development of such statements is a function of service”: accounting is a service
activity. For Chambers, accounting theory is based on a number of axioms related to
the business and its environment, and made of deducting assumptions from these
axioms that need to be confronted with the reality.

2.4.2 Is contractual or politico-contractual theory an equivalent of the PAT

developed by Watts and Zimmerman (1978)?
By conducting a reflection on both positive and contractual theories, we could certainly
find answers to our own questions. Most articles and books that we read in financial
accounting that deal with the issues of the PAT strives to assimilate these issues to
contractual theory. Casta (2000) explains that the origin of the PAT is due to traditional
research not being able to explain the accounting policies or practices or the smoothing of
results observed despite the low information content of financial statements to investors.
Continuing his reflection Casta thinks that the positive theory of accounting should be
titled contractual theory (Tremblay et al., 1993) or politico-contractual theory
(Raffournier, 1990). Some have gone as far as to give it the name of theory of the
economic consequences of accounting choices (Holthausen and Leftwich, 1983).
In order to properly carry on our thinking, let’s position ourselves on the foundations
and objectives of the two theories.
Firstly, by closely examining the objectives of the two theories, we can notice that the
main objective of PAT is to explain and predict the behaviour of producers and users of
accounting information in order to provide more accuracy in the preparation of financial
statements (Casta, 2000; Kabir, 2010). According to Charreaux (2000), the contractual
theory aims at explaining the differences in structure adopted by organisations and
determines a set of organisational characteristics that allow us to understand how they
work. Accounting theory according to Watts and Zimmerman (1978) refers to empirical
studies. Without any exaggeration we can even call it ‘empirical theory’.
Next, with respect to the fundamentals of both theories, the PAT is based on its
explanatory and predictive ability. The agency theory thus apprehends the organisation as
a balanced ‘node of contracts’ concluded between shareholders and rational stakeholders
(employees, clients, lenders, and suppliers) and guided by the maximisation of their
interests (Jensen and Meckling, 1976). Conflicts of interest and monitoring or
opportunities costs are arising from the opportunistic behaviour of agents give, as a
warning to accounting measures (Casta, 2000), a key role in the monitoring of contracts,
and therefore places accounting at the heart of agency relationships (Jensen and
Meckling, 1976; Fama and Jensen, 1983). However, Charreaux’s (2000) contractual
theory is based on two fundamental principles: contractual vision of the organisation and
the principle of natural selection. Contractual theory thus abandons what Charreaux calls
the black box, i.e., the sterile vision of organisations adopted by the traditional theory of
the company. Following the analysis of contracts linked to the notion of complexity of
the organisation and the criterion of minimising agency costs, Fama and Jensen (1983)
made two fundamental proposals [Charreaux, (1985), p.6]:
404 D. Avelé

• The separation of ownership/decision-making leading to decisions for which there is

a separation of decision (initiation and implementation) as well as control
(ratification and monitoring) functions.
• The concentration of decision and control functions in the hands of a limited number
of agents leads to a distribution of property titles which favours these agents. These
two proposals are probably at the very heart of the contractual theory.
Following these analyses, we can conclude that the contractual theory cannot be
equivalent to the PAT, initiated by Watts and Zimmerman (1978), due to differences
from targets and the foundations of these two theories. Moreover, the premises of the
contractual theory provide no prescription for accounting practice, but rather try to
explain it. Conversely, this theory seeks to understand why companies use a specific
method and to predict outcomes and attitudes to the application of different accounting
practices (Tremblay et al., 1993). Although Rochester School took support on both the
nature of the contracts regulating agency relationships and the political vulnerability of
companies facing new regulations in order to formulate a number of hypotheses on the
behaviour of accounting users, contractual theory is in our opinion a sub-element of the
PAT.

3 Reconciling PAT and agency theory in the allocation of manufacturing

overhead

In any organisation, cost allocation works as an internal tax system to reduce waste of
resources. Thus, the distribution is an instrument used by the principal in the agency
relationship to control the activity of the agent (Jensen, 2004). Allocated expenses exert
psychological pressure on sales managers, encouraging them to take steps to improve the
efficiency of profit centres. The allocation of indirect costs is quite important in any
system of cost calculation. The indirect cost allocation system becomes a management
tool that determines the way that the players act toward pursuing the company’s goals. In
most of the literature, researchers have most often studied the problems between the PAT
initiated by Watts and Zimmerman (1978) and financial accounting, or even the agency
theory developed by Jensen and Meckling (1976) and financial accounting. Also, issues
related to the behaviour of the organisation’s stakeholders are not ignored. Thus, in this
sub-section, we examine the various works and their contributions to the theories
mentioned above in management accounting, i.e., the allocation of indirect costs of
production or manufacturing overheads.

3.1 PAT and management accounting

The positive research on the allocation of manufacturing overheads was signed by
Zimmerman (1979), the initiator, along with Watts, of the PAT trend. A very large part of
the research devoted to the practices of cost calculations inherits the epistemological
orientation of the PAT. It is a neoclassical economic and positivist tradition, centred on
micro-economic rationality and on the vision of the firm as a node of contracts between
rational actors. Quantitative research methodology (essentially mathematical modelling)
is also borrowed from economics. The main hypothesis posed by Zimmerman (1979,
p.506) is that of the REMM – organisational actors are all REMM, so they will act
 Positive accounting theory 405

rationally to maximise their own usefulness. According to Jensen and Meckling (1994),
cited by Charreaux (2005), the ‘nature of man’ has a precise representation of the REMM
model. This model – REMM – fits into the paradigm of rational approaches to
organisations. REMM model deviates from both the substantive rationality model
characterising mainstream economics and sociological and political behavioural patterns
(Langlois, 1998). It is based on four assumptions:
• Individuals are concerned with everything that is a source of usefulness or
uselessness and are ‘evaluators’. They are able to make trade-offs between the
different sources of usefulness and their preferences are transitive.
• Individuals are insatiable.
• Individuals are maximisers. They are supposed to maximise a usefulness function
whose arguments are not exclusively financial, under constraints. These constraints
can be cognitive and choices reflect the acquisition cost of knowledge and
information.
• Individuals are creative and can adapt; they are able to anticipate changes in their
environment, to assess their impact and respond by creating new opportunities for
which they are able to appreciate the interest.
Positive research on the distribution of manufacturing overheads, especially those that
mobilise the agency theory (Jensen and Meckling, 1976), respect the principles of
methodological individualism and the founders of the neoclassical view of economic
behaviour (Coriat and Weinstein, 1995). However, these studies are based on simplistic,
formal and abstract models and do not reflect the complexity of companies’ accounting
practices. Some amount of research activities on the PAT, having focused on the
allocation of manufacturing overheads, sketch some answers about the role of burden
sharing in the different cost centres in management accounting. The allocation of indirect
costs aims at guiding the behaviour of actors, especially those in charge of managing
costs to the achievement of desired objectives. The inclusion of distributed expenses in
the performance measurement centres will depend on the actions taken by the various
managers (Zimmerman, 1979; Hiromoroto, 1979, 1991). Another role played by the
allocation of indirect costs is oriented, according to Zimmerman (1979, 2003), by
introducing certain categories of costs that are difficult to measure in the calculation
(opportunity costs and long-term costs). These costs are measured indirectly. For
Bouquin (1995), the allocation of indirect costs has the role of regulating competition; it
is the ‘private normalisation’ of managerial accounting. The widespread and normalised
distribution of overheads regulates competition; this idea was popular in France among
engineers of the period between the two wars, and also present in the USA in the 1950s
(Detoeuf, 1937; Bouquin, 1995). Finally, the establishment of the sale price is important
for the allocation of indirect costs. The total cost added to a reasonable margin serves as a
basis in certain cases with regards to setting a sale price (Govindarajan and Anthony,
1983).
In contrast, management accounting, and more specifically the costing system, is
approached from two main dimensions (Horngren et al., 2005; Bouquin, 1997, 2004); a
technical dimension used to model business processes and to try understanding costs, and
a behavioural dimension influencing and motivating organisational behaviour. Research
on the behavioural approach to costing has attracted the attention of researchers in recent
406 D. Avelé

years. According to Zimmerman (2003), the allocation of indirect costs of production

affects the motivation of managers. What really counts in the technique of cost
calculations, according to Anthony (1957), is not the allocation of manufacturing
overheads, but the main purpose it serves, i.e., the motivation of actors. Moreover, laying
aside behavioural aspects by promotors of the ‘new management accounting’ is deplored
(Ferrara 1990). The behavioural approach is quite important to establishment of a
management accounting system based on the allocation of manufacturing overheads. The
use of Jensen and Meckling’s agency theory is therefore essential to understanding the
behaviour of agents in the distribution of indirect costs.

3.2 Agency theory and management accounting based on the allocation of

manufacturing overheads
Works done on financial performance measures are as many as those with an interest in
management accounting. The choice of a performance measure must be based on a theory
in order to determine what the best measure is in terms of efficiency (Jensen, 1998).
According to Zimmerman (2003), the allocation of indirect costs may or may not
encourage cooperation between responsibility centres. In fact, the centres are motivated
to cooperate if the costs allocated to a centre depend on the operating performance of
other centres. The allocation procedure can influence how responsibility centres use the
services of a support department (Horngren et al., 2005). Selecting the type of centre
depends on the distribution of specific knowledge, since the TPA depends on the
efficiency of the right use of knowledge. Decentralisation of decision making in a
division assumes it has the specific knowledge, such as knowing how to allow the
creation of maximum value in production. For a cost centre, the measure is based either
on cost minimisation for a given level of production, or on maximising production for a
defined production budget. The task of the division manager in this type of centre is
therefore to supply his inputs with regards to his objectives at the best cost and to the best
use. Thus, relying on the agency theory to explain the political system of management
accounting based on the allocation of manufacturing overheads is rather marked by a
positive research framework (Zimmerman, 1979; Magee, 1988; Baiman, 1990; Hemmer,
1996, Rajan, 1992; Wagenhofer, 1996). In the allocation of manufacturing overhead costs
policy, in relation with the agency theory of Jensen and Meckling (1976), the emphasis is
not on the allocation process itself, but on how this allocation is integrated into the
performance measurement of different centres. To analyse issues related to the
principal-agent relationship with regards to the allocation of indirect costs of
manufacturing, we take the first definition of the agency relationship. Jensen and
Meckling (1976) defined the agency relationship as “a contract in which one (or several
people) use the services of another person to perform any task on his behalf, which
implies a decisional type delegation of the agent”.
The agency relationship, in this representation, involves only two people, one of
them, the principal, delegates the right of decision-making to another, the agent. Thus, in
our study, we assume the relationship between the director and the managers of the
various responsibility centres. The director will thus pass over the job of performing
certain tasks to managers of centres, by delegating some decision-making power and by
providing the necessary resources. The strong asymmetry of information exists in favour
of the agent. This will therefore lead to divergent interests of both parties. However, the
decentralised allocation of decision-making rights creates agency relationships which
 Positive accounting theory 407

cause conflicts of interest and agency costs. The notion of agency costs is sometimes
considered one of the major contributions of the positive agency theory (Charreaux,
2005). These costs, according to Jensen and Meckling (1992, p.262), cited by Charreaux
(2005), represent the costs of conflicts of interest in cooperative situations and are equal
to the sum of the costs of designing, implementing and maintaining incentive systems,
control and residual loss, i.e., the shortfall due to the imperfect resolution of these
conflicts.
The agency relationship will therefore allow the principal (director), given the
objective of cost distribution, to better manage the choices of the agent (the manager) and
to benefit from the knowledge of the use of allocated resources by the agent
(Wagenhofer, 1996; Magee, 1988). The choices of the agent are therefore based on
efforts to accomplish his mission and the use of allocated resources by the principal.
According to Wagenhofer (1996), three factors must be taken into account for an efficient
allocation of indirect costs:
• the willingness expressed by the principal to use the resources allocated to the agent
• risk sharing between the principal and the agent
• the decisions that the agent makes (excluding resources), i.e., efforts to optimise his
activity.
In the principal-agent relationship (in our case director-manager), the purpose of the risk
of collusion is to influence uncontrollable costs and it is in the interest of the principal to
allocate the costs to the agents (Suh, 1987; Rajan, 1992). This allocation of
uncontrollable costs to agents could provide an approximation of the effects of certain
unobservable actions to the principal (Baiman and Noel, 1985; Suh, 1988). According to
Baiman and Noel (1985), by using agency theory, if it were to be applied over several
periods, it would be advantageous for the organisation to allocate indirect fixed costs to
responsibility centres in order to measure their performance. After reviewing the
contributions of the positive theory and agency theory in management accounting, it
would be interesting to review the criticisms addressed at both normative and positive
theories of accounting as successively initiated by Chambers (1955), then Watts and
Zimmerman (1978).

4 Reviews: from the normative theory to the PAT

Talking about accounting today without mentioning the works of Littleton would be
illusory since he is one of the major North American authors who have influenced the
development of financial accounting. From his thoughts based on reasoned practice,
Littleton will show that the accounting policies are developed through practice. This
practice proceeds by trial and error to identify the most appropriate accounting policies
(Colasse et al., 2001). According to Degos and Previts (2004), Littleton describes the
practices because they are related to the objectives and one can deduce principles that
justify such practices. However, Littleton’s thought does not allow one to make
predictions (Degos, 1998, 2004). It leads to a system of justification and rationalisation
rather than a theoretical approach. However, Chambers, in his article published in 1955 in
Accounting Research, entitled ‘Blueprint for a Theory of Accounting’, will launch a
genuine critique of reasoned practice developed in the works of great American authors
408 D. Avelé

such as Norris (Accounting Theory), Bray (Four Essays in Accounting Theory) and
Littleton (Structure of Accounting Theory), in which he denounces the lack of scientific
rigour (Colasse, 2005). According to Colasse (2004), citing Chambers (1955), “reasoned
practice can lead to the development of a coherent accounting theory or the development
of practices, as it is a simple descriptive and classification approach that does not allow
one to establish a hierarchy between accounting principles which are often unsound”.
Subsequently, Chambers (1966) wrote an article that is said to have marked the history of
accounting theory. In this article, the author demonstrated that accounting theory should
be based on a number of axioms in connection with the organisation and its environment,
and built for deducting axioms from hypotheses that should be confronted to the reality.
Chambers has identified this new scientific approach as the normative theory of
accounting. Thus, in the evolution of his scientific thought, Chambers cannot imagine
one moment that his theory will be the subject of many debates and especially virulent
criticism by a new research direction led by young researchers Watts and Zimmerman
(1978), for which the goal is to make accounting theory empirical and scientific. Thus,
from the reasoned practice to the normative approach of Chambers (1953) through the
PAT of Watts and Zimmerman (1978), a struggle based on critical precursors of the two
theories (normative and positive) will follow.

4.1 Critical review of Chambers’ (1953) normative theory

The normative theory initiated by Chambers was severely criticised by Watts and
Zimmerman (1979). This criticism is classified by Colasse (2005) at two levels (scientific
and utilitarian). On the scientific level, the two researchers from the School of Rochester
criticise Chambers for having initiated a line of research that they believe is not a real
theory. The theory founded by Chambers is a succession of intellectual ideas with no
scientific value for which the main goal is to argue accounting issues for various interest
groups (Watts and Zimmerman, 1979). Moreover, one should not forget that Watts, in an
article published in the Australian Journal of Management, already criticised Chambers’
normative theory because according to him, “the [normative] literature is unscientific”
[Watts, (1977), p.53, cited by Jeanjean (1999)]. While following the opinion of Jensen
(1976), the two researchers from the School of Rochester will continue their criticism
considering that “accounting research was (with one or two exceptions) unscientific
because the emphasis was laid on the normative and decision-making aspects”
(Christenson, 1983). On the utilitarian front, for Watts and Zimmerman (1979), inversely
to its objectives, the normative research has very little effect on accounting practice. The
Financial Accounting Standards Board (FASB) has only published one of the elements of
its conceptual framework; the other elements being published subsequently such as the
International Accounting Standards Board which published its framework in 1989. Thus,
according to Colasse (2005), “it seems that the finding of Watts and Zimmerman is no
longer valid today because if normative research does not directly influence practices, it
indirectly and strongly influences them through the many conceptual frameworks that it
helped to develop”.
 Positive accounting theory 409

4.2 Critical reviews of the PAT by Watts and Zimmerman (1978)

From the rational practice to the normative theory and through the PAT, the fight
between different critical reviews did not stop at Chambers’ normative theory. After
having rejected the thoughts of Chambers with ‘violence’, who had boldly criticised the
founding works of the forefathers of accounting theory like Littleton, Bray or Norris,
Watts and Zimmerman went through a series of some of the boldest critics ever seen in
the history of financial accounting. Thus, the positive theory of accounting has been
criticised by several lines of research in recent decades. First of all, the developers of the
PAT were criticised for rejecting any other concept of accounting (Sterling, 1990;
Chambers, 1993). Watts and Zimmerman’s attitude was perceived as sectarian by the
research community and they had a huge amount of opponents. Chambers (1993),
following Watts’ and Zimmerman’s critics, in turn unreservedly criticised the works of
the Rochester School by contesting their concept of accounting. For Chambers, their view
of accounting was narrow and useless. He also deplores the distinction they make
regarding normative and positive theory by simply considering that any scientific
knowledge is simultaneously normative and positive (Colasse, 2005). He also takes a
critical look at the empirical quality of their research because, according to him, their
research does not make any direct observations. Finally, according to Colasse (2005), the
rhetorical nature of their processes and their proselytism were strongly criticised by
Chambers (1993). As a result of these criticisms, Christenson (1983) made a number of
criticisms to the researchers of the Rochester School. For Christenson, the PAT initiated
by Watts and Zimmerman is not relevant. He deplored the fact that the positive theory is
only interested in accountants’ and executives’ behaviour regarding their methods’
choice, whereas it should instead focus on the financial statements. This led him to
rename accounting theory ‘accounting sociology’. In this review, Watts and Zimmerman
(1990) answered that accounting practices influence financial statements and as a result,
it is important to understand the interests that drive executives and accountants to choose
these methods. The list of criticisms against researchers from the Rochester School is far
from exhaustive. We cannot conclude this section on criticism without mentioning those
who focused on the approach and methodology used by Watts and Zimmerman.
According to Christenson (1983), researchers from the Rochester School have used
inappropriate methods and methodologies for the construction of explanatory theories.
Christenson’s criticism lies on a theory that comes from hard science and its modelling
was borrowed from economic sciences. Furthermore, Watts and Zimmerman have
created their concept of ‘positive theory’ from the ‘gurus’ formed by economists the
Chicago’s school, such as Milton Friedman (Christenson, 1983). On this criticism,
Whittington (1987, p.331) declares that “Watts and Zimmerman are not the only
intellectuals to have made use of the vision of economists of the Chicago school. The
majority of North American researchers who have conducted empirical studies in
accounting have fallen in this category, and their achievements are great”. Several articles
listed in Table 1 have criticised the methodology used by researchers from the School of
Rochester (Tinker et al., 1982; Christenson, 1983; Lowe et al., 1983; Whittington, 1987;
Hines, 1988).
 410
Authors Number of references Topic Major criticisms
Table 1
Ball and Foster WZ (1978) WZ (1979) Review of empirical accounting research • Firm size and bonus plans can proxy for omitted variables
(1982) and Tinker 13 1
• Weak theoretical underpinning for size political cost construct
et al. (1982)
• Holdout sample not used
1 4 Positive versus normative theories • Positives theories are value-laden and mask a conservative bias
D. Avelé

• Ignores underlying class struggles

Christenson (1983) 6 9 M ethodology of positive accounting • Logical positivism is an obsolete methodological approach
• Approach is a ‘sociology of accounting’ instead of accounting
theory
• Tests introduce ad hoc arguments to excuse the exceptions to the
theory
• Inappropriate methods are used for constructing explanatory
theories
Summary of papers reviewing

Holthausen and 7 0 Review of economic consequences literature Interpretation of results limited because:
Leftwich (1983)
• Incomplete political and contracting theories
• Specification problems in left-hand-side and right-hand-side
variables
Lowe et al. (1983) 0 12 WZ (1979) • Economic framework is unjustified
• Positive approach open to dispute
• Nature of proof is unscientific, contrary evidence presented
M ckee et al. (1984) 4 0 Replications of WZ (1978) • Results do not hold a new sample – holdout sample nor used –
Foreknowledge of sample proportions biases parameter estimates
Whittington (1987) 0 7 Review of WZ (1986) • Presentation of arguments and evidence is unbalanced
• Extreme methodological stance
• Positive theories are value-laden
• Approach is a ‘sociology of accounting’ instead of accounting
theory
Hines (1988) 4 0 Christenson (1983) and methodology • Popper is not a practical evaluate guideline for empirical
accounting approach research
Source: Watts and Zimmerman (1978, 1979, 1990, pp.141–142)
 Positive accounting theory 411

The methodological criticisms addressed to Watts and Zimmerman have completely

failed because they did not influence accounting research. In addition, researchers have
never changed their methodological approaches despite the criticism. As stated by Watts
and Zimmerman (1990, p.149), “although the methodology we used is derived from
economics, finance or general science, it has been successful in accounting...” Finally,
with respect to the concept of ‘PAT’, the positive accounting research existed long before
the publication of articles in 1978 and 1979 (Watts and Zimmerman, 1990). Several
accounting researchers were already using this concept, for example, Gordon (1964),
Gordon et al. (1966) and Gagnon (1967). Watts and Zimmerman explained that they used
the label ‘positive’ to expose the existence of accounting research. In their article entitled
‘Towards a positive theory of the determination of accounting standards’, they explained
that their main objective was to lay an emphasis on the role of accounting theory and
provide explanation and prediction of accounting practices (Watts and Zimmerman,
1990).

5 Conclusions

The evolution of accounting theory dates back to the works by Littleton (1955) from what
he called rational practice. Littleton demonstrates that accounting policies are developed
through practice. Thus, his line of research, as reported by Colasse et al. (2001), seeks to
identify the fundamental principles of accounting from practice and to formulate them. A
few years later, Littleton was criticised by Chambers (1966). He promoted a normative
approach while denouncing the lack of scientific basis of Chambers’ rational practice.
Subsequently, Watts and Zimmerman, two young researchers from the School of
Rochester had as main goal to make accounting research empirical and scientific. They
therefore initiated, in 1978, a new line of research called PAT. Watts and Zimmerman
(1978, 1979) therefore vehemently criticised the normative theory of Chambers,
considering that it was a succession of intellectual ideas with no scientific value whose
purpose was to argue for the accounting issues to various interest groups. Then, followed
a fight among several critical reviews of the three approaches promoted by the people
who have influenced the evolution of accounting theory: Littleton with rational practice,
Chambers with normative theory and Watts and Zimmerman with the PAT. We can still
remember that following these approaches, the PAT is one that has been the most
criticised in the history of accounting theory over the past two decades. These critics have
also led Watts and Zimmerman to come back with an article published in 1990 entitled
‘PAT: A Ten Year Perspective’ in order to re-examine the critics made to them in their
preliminary articles published respectively in 1978 and 1979. Besides the development of
PAT and its many critiques, our study has also examined the possibility of reconciling the
positive and agency accounting theories in the allocation of manufacturing overheads.
412 D. Avelé

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