Exploring Corporate Governance Around the World

By Allison Garrett, Senior Vice President for Academic Affairs at Oklahoma Christian University





Wednesday, April 18, 2007

Principles-Based Accounting

James Kroeker, the SEC's Deputy Chief Accountant, recently spoke on the topic of principles-based accounting. The text of the speech is here.

He noted that principles-based accounting sounds odd in view of the fact that accountants in the U.S. are governed by Generally Accepted Accounting Principles -- not Rules. Although GAAP includes the word "Principles," it is very much a rules-based approach to accounting.

The Sarbanes-Oxley Act (section 108(d)) required the SEC to study adoption of a principles-based accounting system. That study, released in 2003, is available here. The SEC staff coined the phrase "objectives-oriented" to distinguish GAAP from pure rules-based or principles-based standards. The use of the terminology focuses on the fact that bright-line tests must be used in some areas, while subjective judgment may be called for in other areas.

In the international arena, comparability will be difficult to achieve even where a rules-based approach is used. Kroeker notes that transactions will be structured in a very deliberate manner to fall on one side of the line to achieve a desired accounting treatment. Objectives-based standards, on the other hand, can be written to get at the economic substance of transactions. A focus on substance rather than legal form, will better educate investors regarding the company's transactions.

The task faced by the FASB and IASB to draft guidance that gets to economic substance of transactions will be difficult. In particular, where the guidance requires the application of professional judgement, comparability may be lost. I am skeptical about whether guidance can be drafted that will achieve the objectives of comparability and accounting treatment based on economic substance.

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Principles based accounting is the base of accounting all around the world and it should be kept that way. Look at what is happening to the UK accounting system because of EU standardisation efforts. I really wonder why they would not take one of the most ethical accounting system from Britain instead of forcing rigid EU rules.

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Taxation by its nature is a burden on somebody and nobody wants this load. Of course this burden is necessary and individuals and business owners do what they can to limit their exposure. It's tough to find a tax system that is fair to everyone.