New York (July 30, 2003) -- The Securities and Exchange Commission’s endorsement of a principles-based approach to accounting standards setting has rekindled discussion in the profession about “principles-based” versus “rules-based” standards.

In its study on the adoption of a principles-based accounting system by the U. S. financial reporting system, which was required under last year’s Sarbanes-Oxley Act, the SEC staff recommended developing accounting standards under a principles-based approach, which it labeled "objectives-oriented."

“A pure rules-based approach has got lot of nitty-gritty rules with some bright lines. There are some advantages to that -- you know where lines are and whether you’re OK,” said former SEC chief accountant Lynn E. Turner, now managing director at financial consulting firm Kroll Zolfo Cooper. “A principles based approach has some advantages as well. People know where they need to be, but there’s not enough guidance to implement it in the same way. If you couple the certifications required under Sarbanes-Oxley with what the SEC has proposed here, you get the best of all worlds, but only if there’s rigorous enforcement.”

Under the approach outlined by the SEC, such standards should:

  • Be based on an improved and consistently applied conceptual framework clearly state the accounting objective of the standard;
  • provide sufficient detail and structure so that the standard can be applied on a consistent basis;
  • minimize the use of exceptions from the standard;
  • and avoid use of percentage tests, or "bright-lines", that allow financial engineers to achieve technical compliance with the standard while evading the intent of the standard.

“The SEC staff are absolutely correct that neither the IASB or the FASB standards are optimal today, and changes are needed,” Turner added. “The changes recommended by the SEC staff will require changes not only to the IASB and FASB, but also the Emerging Issues Task Force.”-- Melissa Klein

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