Rules-Based Accounting Analysis

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This paper seeks to critically analyze the statement that rules-based accounting adds unnecessary complexity, encourages financial engineering and does not necessarily lead to a ‘true and fair view’ or a ‘fair presentation’. This paper takes the position that the International Accounting Standard (IAS) which basically adopts a principles-based approach in setting accounting standards will help attain the objective of making a true and fair view or ‘fair presentation’.

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The present US GAAP rules are said to be rules-based rather than principles-based and that the practice of using the same has not resulted in producing a ‘true and fair view’ or a ‘fair presentation’. This is despite the statements made in the standard independent auditor’s report that the financial statements presents fairly the result of operation and financial of the audited company.1 It is therefore argued here that an alternative by using the International Accounting Standard, which is principle based, should be adopted instead to attain the desired objective in financial reporting. In fact the Sarbanes Oxley Act of 2002 recognized the need to adopt principles-based accounting standards.2

The proof that the international accounting standard has adopted a principles-based standard and not a rules-based standard may be seen in the report by The Institute of Chartered Accountants of Scotland (ICAS) on its Report on Proceedings of Financial Instrument Workshops in 2006 about the group examination of IAS 39 which refers to financial instruments: recognition and measurement.3 The group particularly focused on attempting to set standards about cash and contracts for cash.

The group has also discussed the difference between a principle and a rule, where they found that nomenclature was not important and what was required was a clear hierarchy of overarching principles as in the case of a conceptual framework and then guidance to support these principles.4 Although the group did not categorically define what is a principle and what is a rule, it can be deciphered from the work that they had acknowledged the need to use principles and guidance supporting the principles. This researcher takes the meaning of guidance to be equated with rules. Thus the use of rules can not be dispensed with completely in the preparation of the standard.

There is a difference however between making standard-setting as principles-based from rules-based. To use a rules-based approach would mean stating first the standards in terms of rules and maybe qualifying the same with principles which is rather an inverted way of trying to have a standard that must be conceptually broad to cover every transaction while allowing certain exceptions by the use of the rules.

The group from ICAS asserted the requirement to have a standard written to satisfy the high-level concepts that can be found in the relevant Framework or Concept Statement. It is easier to agree that a concept is written in principle as a matter of general statement rather than stating it as a particular statement that could be equated to a rule and which may be applicable only in certain cases. In logic, it is more convincing to present an argument deductively rather than inductively.5 Such deductive presentation when applied to standard making would be akin to making use of general statements or concept statements as the basis of providing possible exceptions in terms of rules when justified under the circumstances.

The ICAS working group aimed to find a resolution to the Principles versus Rules debate within international accounting standard-setting and their report came out favoring the use of principles-based rather than rules-based. In asserting the significance of the findings, the report of the working group concluded about the desirability of a principles-based approach to standard-setting, and the same was indeed considered necessary in serving the needs of business and the public interest. Moreover, the group further concluded that that the global convergence of accounting standards is impossible under a detailed rules-driven approach.6 The latter conclusion may be argued on the simple ground of the difference in culture among different countries.

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It was indeed the working group who asserted that “rules-based accounting adds unnecessary complexity, encourages financial engineering and does not necessarily lead to a true and fair view or fair presentation.” The group has proved the same when it explored an alternative model for financial instruments if the same is started from scratch. This researcher could only agree since rules-based accounting standards would be focused on mere compliance with the “letter” of the rules but not the “spirit” or principles of the standard that should give life to its broad implementation and applications regardless of differences in culture. It is said that the letter of the law kills but the spirit gives life.7 The same could be made applicable in standard settings.

It can be concluded that rules-based accounting would add necessary complexity since accounting practitioners or persons who will prepare the financial statements would always use the contention that they have complied with the rules of accounting which would cause them to believe that they have complied with the requirement of ‘fair presentation’. However, there is the basis to subscribe that the same would be mere acts of financial engineering which are merely designed to have complied with the “letter” of the standard but not a principle or “spirit’ of the standard. It can be further concluded that it is only by the use and application of IAS that a principles-based accounting standard could be made applicable.

Works Cited

Close, Francis. Eighty Sketches of Sermons: Together with an Introductory Essay, 1861, Original from Oxford University, Digitized, 2006.

Terrell, Dailey Burnham, Logic: A Modern Introduction to Deductive Reasoning, Holt, Rinehart, and Winston, 1967.

The Institute of Chartered Accountants of Scotland, Principles not Rules: Report on Proceedings of Financial Instrument Workshops, (2006a). Web.

The Institute of Chartered Accountants of Scotland, Principles-Based or Rules-Based Accounting Standards? A Question of Judgment, (2006b). Web.

Whittington & Pany, Principles of Auditing, IRWIN, London, UK, USA, 1995.

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Footnotes

  1. Whittington & Pany, Principles of Auditing , IRWIN, London, UK, USA, 1995.
  2. The Institute of Chartered Accountants of Scotland, Principles-Based or Rules-Based Accounting Standards? A Question of Judgment, (2006b). Web.
  3. The Institute of Chartered Accountants of Scotland, Principles not Rules: Report on Proceedings of Financial Instrument Workshops, (2006a). Web.
  4. Ibid.
  5. Terrell, Dailey Burnham, Logic: A Modern Introduction to Deductive Reasoning, Holt, Rinehart and Winston, 1967.
  6. The Institute of Chartered Accountants of Scotland, Principles not Rules: Report on Proceedings of Financial Instrument Workshops, (2006a).
  7. Close, Francis. Eighty Sketches of Sermons: Together with an Introductory Essay, 1861, Original from Oxford University, Digitized 2006.

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BusinessEssay. (2022, February 16). Rules-Based Accounting Analysis. Retrieved from https://business-essay.com/rules-based-accounting-analysis/

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BusinessEssay. (2022) 'Rules-Based Accounting Analysis'. 16 February.

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BusinessEssay. 2022. "Rules-Based Accounting Analysis." February 16, 2022. https://business-essay.com/rules-based-accounting-analysis/.

1. BusinessEssay. "Rules-Based Accounting Analysis." February 16, 2022. https://business-essay.com/rules-based-accounting-analysis/.


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