International Federation of Female Lawyers

The Future of Standards Setting

Rules-based accounting is a rigid method where balance sheets are made based on predefined rules and guidelines. The next section provides background about the principles-based versus rules-based standard setting debate and develops the hypotheses. The third section details the experimental methodology and the fourth section presents the results. The final section discusses implications of the results, limitations, and opportunities for future research. The study’s authors found that in order to be accurate and effective, principles-based accounting can rely on the accounting manager’s professional judgement; otherwise, a strict rule should be applied, keeping it more more in line with rules-based accounting.

  1. The company needs to adjust their accounting transactions to ensure that they have complied with the standard.
  2. To settle the critics, FASB was created
    and began work on the Conceptual Framework project, which resulted in the issuance
    of a series of SFACs.
  3. It does not provide a strict guideline to the company to follow but a basic understanding which can apply to different companies.

McEnroe and Sullivan (2013) surveyed auditors and CFOs regarding their perceptions of rules-based and principles-based accounting standards. Lease classification represented the only situation where respondents were more likely to favor the elimination of a specific rule. In accounting, a principles-based on approach is the most popular accounting method globally because it is usually better to adjust accounting principles to a company’s transactions, rather than adjusting a company’s operations to accounting rules. When one looks at the cause of the problem in cases such as WorldCom,
it is clear that the problem was not with unsatisfactory standards but with
a blatant disregard for the current standards. WorldCom improperly capitalized
certain expenses, which resulted in lower operating expenses, increasing the
company’s net income.

Principles-Based Accounting vs. Rules-Based Accounting

The major example of rule-based accounting is the Generally Accepted Accounting Principles (GAAP), which is a system broadly used in the U.S. Rules-based accounting involves – as the name implies – that users follow a list of strict and specific rules that accountants must apply when creating financial statements and other financial documents. To explain the difference between rules-based accounting and principles-based accounting, it is necessary to ask yourself which system you think should be adopted. Indeed, most rules-based vs principles-based accounting companies must prepare their financial statements as dictated by the Financial Accounting Standards Board (FASB), which generally takes a principles-based approach in its standards. Rules-based accounting may initially appear to provide a clear and unambiguous decision-making framework, but this can be misleading. Adopting a rules-based accounting approach involves establishing rigid boundaries that can enable those responsible for financial reporting to exploit loopholes at the expense of the underlying principles.

We have successfully worked with over 5 lakh customers, and have now registered over 10% of all the companies registered in India. Of course, option awards are complex and while the above provides all the necessary critical guidance, there are usually lower-level decisions which also need to be made, which I’ll now discuss. I’m not saying that detailed rules are never necessary but in general I believe they cannot be relied upon to consistently achieve their objectives and often sink under their own weight. All the companies and organizations, small or big, needs to prepare their financial statement or end expense statements. In every circumstance, the company can use the standard to translate apply to their current operation.

When contemplating which accounting method is best, make certain that the information provided in the financial statements is relevant, reliable, and comparable across reporting periods and entities. Although there are benefits to principle-based accounting, it is recognized that the method may need to be modified to make it more effective and efficient. When considering the choice of an accounting method, it is crucial to ensure that the information presented in financial statements is relevant, reliable, and comparable across different reporting periods and entities.

Financial reporting outcomes under rules-based and principles-based accounting standards

IASs are principles-based,
and adoption of a similar approach in the United States might help bridge the
gap between these standards and lead to one global set of standards. It is important
to note, however, that there are other differences between IASs and U.S. standards,
such as IASs’ use of a fair value approach. Simply adopting a principles-based
approach in the United States is only one step toward global standards. It means every company following this system must comply by the set principles and if a company fails to comply it must present a reasonable explanation for deviation from the principles. The IFRS’s (International Financial Reporting Standards) are a principles based accounting system.

The fundamental advantage of principles-based accounting is that its broad guidelines can be practical for a variety of circumstances. Precise requirements can sometimes compel managers to manipulate the statements to fit what is compulsory. Some of the largest financial accounting frauds of the past 15 years included some on-the-edge transactions, which were models of literal, technical compliance. Also, if the bad behavior mindset is ‘stop me if you can’ it really doesn’t matter what the rules say. Remember the Derivatives Implementation Group which created several hundred pages of hair-splitting rules!


Excessive rules can limit the comptroller or accountant’s ability to exercise their professional judgement. The presence of extensive and detailed rules often leads to complexity, causing users to focus on adhering to the letter of the standard rather than its intended purpose. Another criticism of standards issued under a rules-based approach
is that they take too long to be issued. Principles-based standards would be
more efficient in addressing emerging issues since they would be less specific
and less detailed.

To settle the critics, FASB was created
and began work on the Conceptual Framework project, which resulted in the issuance
of a series of SFACs. These concepts provided the general accounting principles
to be followed when preparing financial statements. The profession, however, is unlikely to benefit from a
project that would mirror the Conceptual Framework.

About the IFRS Foundation

When preparing their financial statements, companies and their accountants are obliged to adhere to these rules. This ensures that investors can easily compare the financial information of different companies. In the early 1970s, as with today, accounting problems raised
concern within the accounting profession.

We choose the interest cost accounting because it enables us to compare the same accounting outcome (capitalisation or expense) within and across jurisdictions. Critics of principles-based accounting systems say they can give companies far too much freedom and do not prescribe transparency. They believe because companies do not have to follow specific rules that have been set out, their reporting may provide an inaccurate picture of its financial health. Compliance to GAAP helps to ensure transparency in the financial reporting process by standardizing the various methods, terminology, definitions, and financial ratios.

The possibility of a Securities and Exchange Commission (SEC) investigation does not affect auditors’ agreement with their auditee’s accounting treatment. However, auditors are more confident in the rules-based scenario when they have no knowledge of a possible SEC investigation. Thus, the lack of precision inherent in a principles-based, interest capitalization standard may initially persuade auditors to agree with auditee judgments, but this perception may be moderated by a reduced level of confidence. Those interested in the standard setting process should look beyond the traditional lease structuring scenario and consider the possible effects of other principles-based standards on auditors’ judgments and confidence. The Global Accounting Alliance has raised a call for different perspectives on principles-based accounting standards. Based on prior studies this paper identifies a number of characteristics of principles-based accounting standards.