by Glenn Cheney

Norwalk, Conn. — The Securities and Exchange Commission has spoken, the Financial Accounting Standards Board has listened, and the shift to principles-based accounting standards is about to take a stride forward.

FASB’s conceptual framework is the focal point of the recommended changes. The SEC would like to see FASB address deficiencies in the framework and to clearly state the accounting objective of every standard.

And FASB thinks that’s a good idea.

“We fully support these recommendations,” said FASB chairman Robert Herz. “We agree with most of what’s in the SEC study. The question is, how quickly can you effect the changes, particularly given the behavioral aspects?”

The behavior aspects of the recommendations refer to reluctance among the preparers and auditors of financial reports to apply judgment to principles, rather than to depend on specific rules, bright-line limits and cookie-cutter definitions. Such behavior tends to be outside of FASB’s influence.

“The board believes that it may take several years or more for such attitudes and behavioral changes to take root,” the FASB response stated. The paper cited the common and continued practice of preparers requesting scope exceptions, scope exemptions and treatment alternatives.

The SEC issued its recommendations in a staff document titled “Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-based Accounting System,” which was sent to Congress.

Unlike the call for more responsible behavior in the profession, most of the recommendations are well within FASB’s capacity as a standard-setter, and the board agrees with just about all of them.

The study recommended that FASB:


  • Issue objectives-oriented standards;
  • Address deficiencies in the conceptual framework;
  • Be the only promulgator of accounting standards;
  • Continue its convergence toward international standards;
  • Redefine the hierarchy of generally accepted accounting principles; and,
  • Move to change its mostly rules-based standards to an objectives orientation.

In a written response to the recommendations, FASB noted that the concepts behind principles-based standards and objectives-oriented standards are very similar.The board’s response explained that the board agreed that, “although its existing standards are based on concepts and principles, the understandability of its standards could be improved by writing its standards in ways that (a) clearly state the accounting objective(s), (b) clearly articulate the underlying principles, and (c) improve the explanation of the rationale behind those principles and how they relate to the conceptual framework.”
A new look
To facilitate the interpretation of its standards, the board plans to modify their format. A new, improved format might, for example, state an objective in bold print in an introductory paragraph. When the board issues its upcoming exposure draft on business combinations, it may use a lettering format similar to that used by the International Accounting Standards Board.

It might also provide a glossary of technical terms while trying to minimize the use of terms that are not readily understood.

“A good standard is one that lays out the key principles and objectives and explains them and then provides implementation guidance, but not in excruciating detail that covers every possible situation, because that’s impossible,” Herz said. “In the last 10 or 15 years in the U.S. we’ve engendered an approach where everybody wants a cookie-cutter example that they try to fit their situations into. Principles-based or objectives-oriented standards make people think a little more.”

Tinkering with GAAP
FASB is also considering changing the hierarchy of generally accepted accounting principles. The board has met with the Public Company Accounting Oversight Board and the American Institute of CPAs to discuss possible improvements. The SEC has suggested that various levels of the hierarchy be eliminated and that the conceptual framework be given more prominence.

The board is also considering creating two basic levels of accounting literature: authoritative and non-authoritative. Any such change, however, would have to be preceded by the completion of the board’s ongoing long-term codification and simplification project.

Any proposal to change the GAAP hierarchy, the FASB document said, would necessarily involve the due process of open meetings and public discussion.

Modification of the hierarchy may be part of a major GAAP codification project to integrate, categorize and interrelate all accounting literature.

“A lot of people think [a GAAP codification project] would be a good idea,” Herz said, “It’s a massive undertaking, but I, personally, am in favor of it.”

The board does not expect standards based on principles and objectives to eliminate the need for implementation guidance. The board expects to produce whatever guidance is necessary to render a standard operational, but it will avoid building a structure of detailed rules.

The board expects to continue using its Emerging Issues Task Force and staff position papers to produce guidance when it sees standards being misinterpreted.

The SEC would also like FASB to reconsider the extent to which it writes scope exceptions into standards. FASB agreed with the commission that exceptions are a slippery slope into a thicket of rules. The board said that it would try to more precisely and appropriately define the scope of future projects.

Back to behavior
Again, much of the problem comes down to an accounting environment that makes judgment seem risky.

“Today there are behaviors that seem to be induced by fear of second-guessing,” Herz said. “People want rules, and then they want exceptions. We get those requests all day. People are in favor of principles-based standards as long as it suits them. As soon as it doesn’t, they want an exception. We have to be fairly determined on that. It’s not that we should never grant exceptions, but we have to be disciplined and determined not to proceed in that direction. Maybe, over time, people will get used to it. But it’s slow. You’re not going to change the cultural behavior overnight.”

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