ACCOUNTING SYSTEM

Principles-Based Accounting System

Principles-Based Accounting System

Introduction

At the end of accounting period, companies have to prepare financial statements according to the rules set by the Financial Accounting Standards Board. In early 2000s, the reporting scandals have encouraged to the SEC to reconsider existing accounting methods and techniques. Currently, the development of the principles-based accounting is in used, more famous and used instead of rules-based method. The new technique and method provide companies accounting advantages and disadvantages due to its flexibility.

Discussion

These financial reporting failures led to a decreased confidence of external investors in financial markets, and in corporate management in particular. The management of Enron deliberately misled stakeholders by adjusting financial numbers in their annual report. To restore the confidence of external stakeholders, and responding to the corporate failures, financial reporting standards were adjusted and 'new' accounting standards were introduced; resulting in two major institutional changes.

Principles-Based Systems

Why Principles Principles-based accounting standards is termed as reporting of the system of financial which is based accounting fundamentals (substance over form, true and fair view, going concern, decision usefulness with an appropriate level of specificity). An important principle here is the “true and fair view”.

Although these fundamentals are important to consider for financial reporting, on several topics standard setters define additional specifications (rules) to improve the quality of financial reports. By adding specifications, bright lines and numerical thresholds standards become more rules-based (Nelson, 2003). Rules can be defined as specific criteria to increase the accuracy of financial reporting.

Rules-based and principles-based distinct in many respects, but one of the most important differences relates to professional judgment. Principles-based accounting standards are relatively soft, leaving much room for professional judgment. On the other hand, Rules-based standards, are very strict, simply requiring strict application with limited professional judgment. For example, consider both IAS 17 and SFAS 13 on lease accounting. IAS 17 (principles-based) states that “at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset” (IAS 17, 2009, pp. 9). Nowadays the discussion on principles-based and rules-based accounting standards again gains importance following US debate concerning whether or not to adopt IFRS as opposed to US Generally Accepted Accounting Principles (US GAAP) for their own financial reports; (potentially) resulting in an acceptance of more principles based accounting standards.

Principles-based accounting standards Advantage

Principles-based accounting standards can serve the needs for business and public interest;

Complete comparability is never possible in accounting, therefore one should emphasize

on explaining key judgments being made;

Principles-based accounting standards need a clear hierarchy of overarching concepts with limited additional guidance;

Rules-based accounting standards add unnecessary complexity;

Principles-based standards offer a inclusive foundation and have the flexibility to deal with new and different situations;

In a principles-based system, more responsibility for judgments and explaining judgments of preparers (CFOs) and auditors is necessary;

Resulting from differences in jurisdiction and different cultures around the world, convergence cannot be achieved if the basis is a rules-based approach, since this will be difficult ...