Arguably one of the most frequently heard debates in the accounting profession over the past year has been one over the “principles- vs. rules-based” standards.
Lately that argument has been heard more often than, “Do you come here often?” at happy hour.
And just when many folks were resigned to the fact that the argument would be resolved in the same manner as achieving peace in the Middle East or the eliminating the designated hitter, along comes the Securities and Exchange Commission endorsing the principles-based approach.
The regulator’s stamp of approval has sort of resurrected the age-old debate on the issue prompting opponents and proponents alike to come out of their corners swinging.
And those on each side have salient points.
Critics of rules-based standards maintain that they allow loopholes for those seeking to deftly wend their way around the standards’ intent. They also cite the costs and degree of implementation difficulty.
By contrast, principles-based standards, which requires that auditors exercise judgment, are often assailed for providing scant guidance in order to be applied consistently.
The issue also has attracted a lot of attention, as the International Accounting Standards Board strives toward convergence on a single set of global accounting standards.
And recently, the Financial Accounting Standards Board issued a proposal for a principles-based approach to standard setting in the fall.
In its study of a principles-based accounting system — a study, incidentally, that was mandated by Sarbanes-Oxley — the financial watchdog recommended developing accounting standards under a principles-based approach, which it has since labeled "objectives-oriented."
Briefly, under the SEC’s outline, principles-based or “objectives oriented” standards should:
• Be based on an improved and consistently applied conceptual framework, clearly stating the accounting objective of the standard;
• Provide sufficient detail and structure so that the standard can be applied on a consistent basis; and,
• Minimize the use of exceptions from the standard.
But let’s face it, the rule vs. principles debate is rendered moot in the absence of a thorough enforcement policy, because financial reporting fraud really doesn’t have a preference which method a company’s auditors and preparers are using.
You can have the most contemporary and technology-savvy reporting method available but all it takes is one auditor without principles to break the rules.
