Question

B) What is the political cost hypothesis of Positive Accounting Theory? Why is accounting important in political processes? Explain.

Answer 1

The political cost hypothesis makes a prediction that those companies who are under political scrutiny will perform the actions on the minimisation of the possibility of any adverse cash flows linked to such scrutiny. These political costs refer to the costs that specific groups external to an organisation may be able to impose on an organisation as a result of numerous actions such as costs linked to the community lobbying, the government to reduce the support of subsidy for an organisation, costs linked to the labour unions taking actions to hike the wages for the members, or costs associated with boycotts by consumer with the products of the form.

The accounting is vital in political processes because the higher the political costs faced by an organisation, the more likely the management may choose the procedures in accounting that defer reported earnings from current period to future periods. Furthermore an increase in profitability may cause increased political “heat”, and result to new rules or taxes especially for large organisations which may be held to higher standards in the reporting.