Two years ago, the Financial Accounting Standards Board announced that it would strive to write standards that depended more on principles than on specific rules or guidance.

The idea was to encourage the preparers of financial reports to use their judgment to fulfill the spirit of generally accepted accounting principles.

Two years was a long time ago.

The accounting profession has undergone an upheaval in attitude. If the upheaval had a name, it would be "Fear," the son of Sarbanes-Oxley.

The Sarbanes-Oxley Act is putting a heavy responsibility load on the shoulders of corporate financial officers in terms of reporting, and subsequently, accountants have been looking increasingly for specific rules that they can use to defend their decisions.

And that, said FASB member Michael Crooch, is making it hard for the board to depart from its dependence on rules.

"I think we are in circumstances right now where the system is under a lot of stress," Crooch said. "The application of SOX Section 404 is very high on the list of companies. Penalties for being wrong are not good. As a result, there is, on the one side, a desire to apply a concept or objective. On the other end of the scale is the desire to be able to have comfort that you have, in fact, applied a standard in such a way as to be sure that you will be able to pass all the judgment filters as to whether, in fact, you did apply it correctly. There's a lot more comfort in being able to point to a particular sentence in a particular standard as the correct answer than to rely on judgment and defend it later."

The call for principles-based standards, Crooch said, went back to what he calls "the Enron era." The Enron fraud, many say, resulted from a company using the bright lines of specific guidance to justify financial reporting that defied the underlying principles of accounting.

The Securities and Exchange Commission suggested that one solution to override attempts to scam the system would be to write standards with principles that needed less guidance.

Crooch emphasized that all FASB standards are based on principles. The issue is over how much specific guidance to offer in explanation or exception to the principles behind a given standard.

"You'll never be able to give examples for everything," Crooch said. "The risk is that the examples that you give are analogized in a manner that was not intended. I won't admit that our standards aren't principles-based. They are. People are using buzzwords about 'principles-based' when the real issue is how you determine when you have sufficient guidance for preparers and others to apply the standard in the manner that was intended."

What usually happens in the development of a standard, Crooch explained, is that a proposed standard, issued as an exposure draft, comes up against myriad requests for more specific rules, especially for exceptions to the principle. The board's work on a standard on derivatives is an example of a statement that became heavily dependent on rules and exceptions. FASB's book on derivatives and guidance is over 850 pages long, with more than 50 pages dedicated to definitions of derivatives.

Options, again

The white-hot controversy over a proposed statement on accounting for share-based employee compensation has been criticized for not being sufficiently specific. The principle behind the standard is that employee stock option compensation must be measured at fair value. The proposed standard allows companies to pick the valuation method, that, in their judgment, is most appropriate.

"The principle was to come up with fair value," Crooch said. "But that was taken by the lobbyists as proof that the board doesn't know how to measure stock options because it can't even choose a valuation model."

While the proposed statement requires companies to use their judgment in determining fair value, it has also taken on a ponderous body of guidance as it tries to deal with the multiple and ever-multiplying forms of share-based payments. The standard could be seen as simultaneously principles-based and rules-based.

Crooch suggested that that's pretty much the way it's going to have to be: "The goal for us, from my personal point of view, is to stick to our guns but continue to base our standards on principles and do the best we can to give what we believe is the appropriate amount of guidance on how to apply them. That's the best that we'll be able to do in this environment."

FASB has made little overt effort to restrict itself to the issuing of principles-based standards that require judgment rather than specific guidance. Making that shift isn't a defined project. It's merely an intent that infuses FASB's work, an intent that is apparently still in a state of evolution. Meanwhile, FASB is cranking out the rules as much as it needs to.

"Our mission is to provide high-quality financial information to people who make decisions," Crooch said. "People are going to disagree on how much guidance is needed to reach that goal. That's what this issue is all about."

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