Fraud

Positive Accounting Theory

The positive theory of accounting is contrasted with the normative theory of accounting -- it predicts what accounting practices actually happen, as opposed to stating prescriptivist optimal accounting practices. The positive theory of accounting contains three major hypotheses within the opportunistic perspective, that is, the idea that managers act in their own self-interests.

First, the "management compensation hypothesis" predicts that managers whose pay is tied up with their firm's performance will tend to manipulate the accounting method so that their performance will seem better than it actually was. In other words, they will move profits from future periods into the current period.

Second, the "debt hypothesis" predicts that managers will attempt to pay the interest and principal of the debt they have accumulated in the business, so tying the bonus to debt makes the firm manager more likely to select accounting procedures that shift reported earnings from future periods to the current period.

Finally, the "political cost hypothesis" predicts that managers will attempt to choose accounting procedures that defer reported earnings from current to future periods if the firm will suffer political costs because of profits.

Each of these hypotheses explains a different incentive structure for the manager to commit accounting statement fraud. In the first, the manager will move profits from future periods into the current period. Even if they would receive a bonus on that money in the next period, that future dollar is discounted so the manager is incentivized to move it to the current period. In the second, the manager also movies earnings to the current period from the future period, making it less likely to violate a debt agreement -- though technically they are incentivized to attempt to move the earnings into any period that would not violate the agreement. In the final one, having more earnings can lead to increased political pressure. This could also lead to new taxes or even regulations for large firms or industries.