Principles- versus rules-based accounting standards: the FASB's standard setting strategy

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Abstract:

In response to criticism of rules-based accounting standards and Section 108(d) of the Sarbanes-Oxley Act of 2002, the SEC proposed principles-based (or ‘objectives-oriented’) standards. We identify several shortcomings with this approach and focus on two of them. First, the format (type) of a standard is dependent on the contents of what the standard regulates. Given the asset/liability approach combined with fair values, we argue that the combination of this measurement concept with principles-based standards is inconsistent because it requires significant guidance for management judgment. Second, we propose the inclusion of a true-and-fair override as a necessary requirement for any format that is more than ‘principles-only’ to deal with inconsistencies between principles and guidance. We discuss the benefits of this override and present evidence from the United Kingdom's experience.

Keywords: Accounting standards; FASB; Principles; Rules; Rules-based

Document Type: Research Article

DOI: http://dx.doi.org/10.1111/j.1467-6281.2006.00196.x

Affiliations: 1: Goizueta Business School, Emory University 2: London School of Economics 3: University of Graz

Publication date: June 1, 2006

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