This has resulted in accounting for unanticipated transactions that is less transparent. A lack of precise guidelines could create inconsistencies in the application of standards across organizations. Principles-based accounting, on the other hand, avoids rules in favor of general guidelines.
In response, Congress passed the Sarbones-Oxley Act of to authorize the Securities and Exchange Commission to explore reforms to rules-based accounting systems. When there are strict rules that need to be followed, the possibility of lawsuits is diminished. Almost all companies are required to prepare their financial statements as set out by the Financial Accounting Standards Board FASBwhose standards are generally principles-based.
Conversely, there are potential drawbacks to a principles-based approach to standards setting. Although some rules are unavoidable, the guidelines or rules set are not meant to be used for every situation.
Rules-based accounting is basically a list of detailed rules that must be followed when preparing financial statements.
On the other hand, a contingent liability that is reasonably possible is only reported in the footnotes. Rules-based accounting generally does not have this weakness. The complexity of rules, however, can cause unnecessary complexity in the preparation of financial statements.
It is therefore very specific but also very complicated because many rules are needed to cover the numerous situations accountants face when preparing financial statements. Some accountants point out that, in the absence of specific rules, defending accounting practices in legal cases is difficult.
Rules Rule However, one problem with principles-based accounting is that financial statements for different businesses may not be comparable because accountants base transaction treatments on the given situation and on professional judgment.
If financial statements conform with accepted rules, the bases for a lawsuit are diminished. The problem with principles-based guidelines is that lack of guidelines can produce unreliable and inconsistent information that makes it difficult to compare one organization to another.
Others prefer a rules-based approach because they believe that accuracy in principles-based accounting depends on the ethical intent of the accountant -- essentially the same weakness in rules-based accounting that principles-based accounting is intended to address.
Recently, there has been much debate on whether principle-based accounting would be more efficient than the popular rules-based accounting - especially in response to accounting scandals, such as Enron and Worldcomthe current way of accounting has been under a great deal of criticism.
Instead of having to comply with hard-and-fast dictates, the accountant uses general principles to guide her professional judgment. This is essentially a principles-based system. Increased discussion has pushed accountants towards principle-based accounting, but it is recognized that the method needs to be modified to make it more effective and efficient.
A simple set of key objectives are set out to ensure good reporting.
Principle Reasons The Enron and WorldCom cases showed rigid rules could be manipulated and transactions structured in ways that concealed unfavorable information. In addition, forcing accountants to follow arbitrary rules can lead to practices that focus on compliance rather than providing the best information.
The fundamental advantage of principles-based accounting is that its broad guidelines can be practical for a variety of circumstances. Principles would be easier to comprehend and apply to a broad range of transactions. When contemplating which accounting method is best, it must be made certain that the information provided in the financial statements is relevant, reliable and comparable across reporting periods and entities.
Common examples are provided as guidance and explain the objectives. Principles-based accounting also has the virtue of being simpler: Having a set of rules can increase accuracy and reduce the ambiguity that can trigger aggressive reporting decisions by management.
In addition, principles-based accounting standards allow accountants to apply professional judgment in assessing the substance of a transaction. Relying on broad, flexible guidelines that can be applied to a range of situations, like those used in principles-based accounting, makes that sort of manipulation more difficult.
Their accountants must have a set of standards to follow when creating them. One option is a hybrid objectives-based system. Another advantage of a principles-based system is that it would result in simpler standards.
Precise requirements can sometimes compel managers to manipulate the statements to fit what is compulsory.With the principles-based accounting standards, prepares fear uncertainties brought by the flexibility of judgment and are more likely to report using a method that best reflect the value of the firm.
Principal vs Rule Based Accounting Essay adoption on. Almost all companies are required to prepare their financial statements as set out by the Financial Accounting Standards Board (FASB), whose standards are generally principles-based.
Recently. (A) Rules-based accounting standardRule-based systems are fairly simplistic, consisting of little more than a set of if-then statements, but provide the basis for so-called "expert systems" which are widely used in many fields.
The concept of an expert 3/5(2). Advantages and Disadvantages of Principles-Based Accounting Essay. This approach is substantially different from the underlying “box-ticking” approach common in rules-based accounting standards. FASB Chair Robert Herz has stated that he believes the professionalism of financial statements would be enhanced if accountants are.
This essay discusses the principle based approach and rules based approach for accounting and critically examine the more appropriate standard of accounting. According to Bennet et al () the difference between rules-based and principles-based standards is not clear and is subject to a variety of interpretations.
Rules - based approach says that accounting principles and standards should change with the environment, financial conditions, and as new issues arises in the field of accounting.
On the other hand, Principles - based approach says that accounting.Download