Watts and Zimmerman (1986, p.7) state, Positive Accounting Theory (hereafter referred to as PAT): ... is concerned with explaining accounting practice. It is designed to explain and predict which firms will and which firms will not use a particular method ... but it says nothing as to which method a firm should use. Required: (a) Refer to the statement above, identify TWO (2) main elements employed by the Positive Accounting Theory and explain how these elements are used to explain and predict which firms will and which firms will not use a particular accounting method. (15 marks)

The 2 elements must be:

1. Agency theory

2. Contract