Bennett, Bradbury and Pragnell argue that no sensible distinction is to be drawn between principles-based and rules-basedaccounting standards, except in respect of the degree of judgment required for the implementation of each In contrast, Benston, Bromwich and Wagenhofer can
identify such a distinction, arguing for a 'principles-based approach' with a 'true
and fair override' to facilitate the exercise of 'professional judgment
Alexander and Jermakowicz illustrate that 'much of the debate . . . is at best vague
and confused, more likely disingenuous, and possibly intellectually dishonest . . .
the basic [SEC] question [is] whether the financial statements perform the function
of enlightenment . . .'
And falling back on the notion that it means whatever
the outcome from complying with the prevailing Standards, it is quite likely that
they will be 'nailed to the wall' once 'true and fair' is expected to have some sensible
implications. That is the function of the 'true and fair override' that Benston et al support.
principle& rule based（US&UK）
U.K. law is based on the duty of a (limited liability) company, regardless of
whether its securities are publicly traded, to its shareholders. Consequently, U.K. accounting and auditing is directed
toward stewardship-providing shareholders with information about the state of resources entrusted to the managers
and directors and how efficiently their company has been run. Emphasis in the U.K. Companies Acts, therefore,
has been on the balance sheet.
In contrast, Bush states that corporate law in the United States is governed by the individual states. Because
of ''a constitutional quirk, the US federal reporting model does not address in enforceable law the fundamental
capitalist proposition 'do the accounts show how efficiently a company is run on its capital resources?' '' (p. 2).
Instead, U.S. federal securities laws must be and are concerned with securities markets and trades by investors in
those markets. The consequences of this difference are profound, he writes: ''Instead of a commonsense commercial
view of what is relevant accounting and truthful reporting for shareholders, the US regime has become rigid and
rules based'' (p. 3).
A US perspective on principle based and rule based judgement
A major reason is that fair values require many rules to provide sufficient guidance, they invite manipulation, and they often cannot be assured by auditors.
The second shortcoming is the dismissal of a true-and-fair override that we
argue is a necessary requirement for any standard setting approach. The more
rules the standards include, the more an override provision is necessary to avoid
allowing or even requiring accountants to follow rules by letter but not by
intention. The override gives accountants more professional responsibility for
financial statement content, and its disclosure gives sufficient transparency for
users to understand and, perhaps, challenge its application. We present evidence
on the use of a true-and-fair override from the United Kingdom's experience
and discuss how International Financial Reporting Standards (IFRSs) cope with
the issue.
The Proposal makes particular mention of FAS 133,
Accounting for
Derivative Instruments and Hedging Activities
, the complexities of which resulted
from the Board having to make numerous exceptions from the general principles
promulgated in FAS 133, para. 3. The extensive guidance, it says, results from
having to fulfill the objectives of comparability and verifiability. The Proposal
rejects 'principles-only' standards, because these 'could lead to situations in which
professional judgments, made in good faith, result in different interpretations for
similar transactions and events, raising concerns about comparability' (p. 9). Comparability
may be seen as especially important in an international environment, as
there is the danger that local accountants and regulators arrive at differing views
on the interpretation of contentious accounting issues.
Critics on rule based
For these reasons, and based on an example of how corporations (mis)used
the 'bright lines' given in APB Opinion No. 16 that specify when a business
combination could be accounted for with the pooling of interests method rather
than the purchase method, the Report concludes that a rules-based system is
not desirable.
Other critics of rules-based standards have pointed out that rules can become
useless and, worse yet, dysfunctional when the economic environment changes or
as managers create innovative transactions around them (Kershaw, 2005, pp. 596-
7). Moreover, such standards need not reduce earnings management and increase
the value relevance of financial reports in so far as the rules increase managers'
ability to structure transactions that meet these rules while violating the intent
(e.g., Nelson
et al.
, 2002) and real earnings management may overcompensate for
judgmental discretion (see Ewert and Wagenhofer, 2005).
The Report therefore examines what it terms 'principles-only
Twenty questions on International Financial Reporting Standards
By Heidi Tribunella
What Is the Difference Between
Principles-Based Standards and
Rules-Based Standards?
Principles-based standards require
management to apply judgment and expertise
when applying accounting principles.
Rules-based accounting standards, on the
other hand, give strict rules that must be
adhered to in order to properly account for
particular transactions.
For example, lease accounting in the
United States gives four criteria for determining
if a lease is a capital lease. If a
lease contains any of the following, then it
is considered a capital lease and must be
accounted for as such: 1 ) a bargain purehase
option; 2) ownership transfers at the end of
the lease; 3) minimum lease payments
with a present value of at least 90% of the
FMV of the asset; or 4) a lease length of at
least 75% of the economic life of the asset.
This is an example of very specific niles for
accounting for leases. IFRS, because it is
principles-based, does not list specific percentages.
(Question 9 offers a more detailed
discussion of leases.)
The treatment of goodwill was changed
from a rules-based standard, where goodwill
was amortized over 40 years, to a principles-
based standard, where goodwill is
merely tested for impairment and, if
impaired, is written down to its current fair
value (Richard G. Schroeder, Myrtle W.
Clark, and Jack M. Cathey, Financial
Accounting Theory and Analysis: Text and
Cases. 9th edition, Wiley. 2009).
