Pros And Cons Of Principles-Based Accounting

“We must rise above a rules-based mindset that asks, ‘Is this legal?’ and adopt a more principles-based approach that asks, ‘Is this right?” says former U.S Secretary of treasury, Henry Paulson at a conference on the implications of Sarbanes-Oxley in 2007. Unethical accounting practices by companies like Enron and WorldCom have caused Congress to pass the Sarbanes-Oxley Act of 2002 which authorized the Security and Exchange Commission (SEC) to explore reforms to rule-based accounting systems. The idea of the U.S. Generally Accepted Accounting Principles, or GAAP shifting to Principle based accounting has been heavily debated. The international Financial Reporting Standards, or IFRS, employ more principle-based accounting, while the U.S. GAAP

Principle based accounting, on the other hand, avoids rules and instead uses general guidelines that can be applied to numerous situations. Also, it requires professional and managerial judgement to have a better understanding of how to record a transaction. Advantages of Principle based accounting

• Flexibility

• Encourages professional judgement

Principle based accounting is more flexible than rule based accounting. The institute of Chartered Accountants of New England and wales (ICAEW) points out that principles are better suited to help accountants respond to rapid changes in a business environment. It can take the FASB years or even decades to amend accounting rules. In contrast, an accounting principle or idea can be applied to new types of transactions or financial instruments immediately. (Garcia, 2017).

ICAEW notes that rules based accounting is mechanical and only encourages accountants to look at the letter of the law. Accounting principles require accountants to look deeper into the substance of the transaction. This promotes sound professional judgment in the profession and instills more of a sense of responsibility in the accountant.

Disadvantages of Principle based accounting

• Decreased

Raymond Thompson, Ph.D., a certified management accountant, points out that it is possible for two accountants to look at the same data and come to completely different conclusions about what the data mean. Two companies with the same assets, in this case, could present them differently on the balance sheet.

Complying with accounting principles is more complex, expensive and time-consuming. If companies are required to constantly interpret principles, they need accounting staff with vast experience and an expert understanding of accounting frameworks. Work that was previously done by a lower-level accountant has to be handled by a higher-level accountant, and more time may be needed to come to a conclusion.

Companies and accounting firms are constantly accused of misstating financial information, but asking judges and juries with no financial experience to interpret accounting principles during enforcement cases may be a bad idea. Sue Anderson, program director for CPE link, points out that it’s hard enough for courts to come to a conclusion based on explicit accounting rules and it would be even worse with accounting