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Accounting generally been regarded as the language of business, and this language has been spoken in every aspect of people's daily lives. As a good language should easy for people to learn and have clear understanding, accounting information focus on greater accountability and comparability. The key factor that control these characteristics is the "grammar" of accounting, the regulation principles. With regards to the speech by Hans Hoogervorst, Chairman of IASB, this report will discuss advantages of using principle-based accounting standards rather than rule-based accounting standards and at the same time give some comments to its drawbacks which should be developed in the future.
"For the very reason that accounting is not an exact science, 'principle-based' or 'substance-over-form' approach for standard setting remains the right way forward"(Hans Hoogervorst, 2012). "Exact science" in this speech means if calculate procedure precise enough, you can count on the outcomes. From this point of view accounting indeed out the border of an exact science because the range of accounting is much larger than give a exact result, some other aspects like reliability of accounting information disclosure methods, considering public interest, and preventing fraud should also be took into consideration by accountants. Hence, accounting need a efficient regulation standards system to cope with different questions found in accounting practices which can also enhance companies' competence and comparability in the market. However whether using principle-based accounting system or rule-based accounting standard has already aroused a lot of debate. This research argument is to explain the reasons of why principle-based is better by discuss its advantages and disadvantages. As words limits, it will focus on the most currently topics in this area which are closely linked to accounting practice and nowadays economic environment.
Generally speaking, principle-based accounting standards provide a conceptual based guidance to accounts rather than lump of detailed rules. As consider the major objective of accounting is to provide a relevant, reliable, and comparable accounting statement across reporting periods, the principle base would be more appropriate to reach this object because it has these advantages as follows.
First of all principle-based accounting standards can provide more accurate accounting statements because this method focus on the real world economic environment in order to reflect a company's financial position more correctly. For example, Hans Hoogervorst(2012) has figured out, under rule-based standard intangible assets usually be record on their historical cost rather than fair value which may not correctly reflect their true value . On the contrast, principle-based accounting prefer using fair value to record these assets because some intangible assets obsolete extremely fast especially after the dot.com bubble. Take the film strip as an example, the patent holder, Kodak, who was continue valuing its vale on its historical cost for more than ten years even after the digital camera populated, this cause the management misunderstand their financial positon and at last this famous firm has to go bankrupt. From this case it can be known that principle-based accounting system has more flexibility than rule-based system.
Secondly, when facing an actual accounting fact, principle-based accounting standard usually provide a conceptual guidance to accountants instead of a list of rules. This method can avoid people manipulate rules for their self interests. A study relevant to leasing accounting can support this. In 1980s, USA, under the accounting standard (GAAP) using at that time, leasing was treated as a off-balance sheet-financing, so lots of companies would buy one asset, quickly sell it to third party, and lease it back to avoid record liability on the balance sheet. In order to regulate market, GAAP award new rules which stated that If a contract satisfies any of a four criteria, it must be recognized as a capital lease in the financial statements(GAAP 2002). However, companies manipulated items on lease contracts carefully to avoid these four criteria and cause this time regulation equals to noting. If similar situation happened on principle-based standards, those companies would loose their case because principle-based accounting provide a guideline that required company should disclosure their financial positon on true and fair value bases.
Another advantage of using principle-based accounting standards is that it could simplify standards to make it easy reading and understanding. Herz(2002) has pointed out that "a principles-based system usually less than 12 pages long, but rule-based system generally more than 100 pages". For company, time equals money, a standard with good communication skills and clear structure can save company a great amount of money especially on new employee training and subsidiary building. As in the trend of globalization, an increasingly number of firms choose to board their business to oversea market, a simper standard can greatly reduce company's cost in this area and increase its future competence. At the same time, Public investors usually trend to invest on those companies using a easy understanding standards such as IASB, hence if a company what to draw investor's attention it should join the big family of principle-based accounting system.
Last but not the least, the principle-based system allow accountants make their own judgment during the practices while under rule-based system accountants have to check the rules over and over again or do some "box-ticking" works to ensure there is no mistakes(Rebecca 2004). Form this point, rule-based system actually disregards the value of accountant's working experience which can save the company a great number of resources, and for some situation human's judgment may have better performance than rigid rules. For example, some accountants with experience can easy make a judgment by looking some key figures in the statement, there is no need to check each number. As principle-based system allow accountants do this way it can hugely enhance the efficiency of the company.
However, noting is perfect, principle-based standards also have some drawbacks. Firstly as this method stand on the broad view of accounting, sometimes it maybe too board to deal with detailed question. For example, FASB states the qualities of relevance and reliability, it does not provide any guidance for trading one for the other (FASB 2002). Second drawback is ambiguous description. For instance, under IASB a debt security has to be measured at market value when it is held for trading purposes, but it is reported at historic cost if it is held to maturity(IFRS 2012). But counterintuitively, a government bond which is a investment product held to maturity usually record on the market value base on discount method. It is hard to decide what kind of situation can treat a debt security like this way. These two shortages can be categorized as incomplete content and ambiguous descriptions which need to be focus by standard setter in the future.
To sum up, this argument compared principle-based accounting system with rule-based accounting system and point out the former is better because it is more flexible reliable and simpler than later. However it also has some drawback which stands on incomplete content and ambiguous descriptions. As Hans said "principle-based standard setting remains the right way forward". There is no doubt about that future economic environment will bring new challenges to the standard setters, to cope with this they should continuously adjust standards to fit the requirement of its users. While "competitive condition trend to make survival difficult for those who are continually taking the long end of the 'take and give' of everyday business"(Harry D. Kerrigan) it is necessary for those mangers apply a set of principle-based accounting standards on their entities to let them work effectively and efficiency.