Rules, principles and judgments in accounting standards

Michael Eric Bradbury · Helen Prangnell

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Accounting Theory and Financial Reporting Auditing, Earnings Management, Governance Accounting Education and Careers

Abstract

The distinction between rules‐based and principles‐based standards is not well defined and is subject to a variety of interpretations ( SEC, 2003 , p. 5). Yet there is a commonly held view that the FASB's standards are rules‐based and the IASB's standards are principles‐based. This article identifies the basis of this distinction. For research and development, the article compares the FASB standard with two principles‐based standards. For each standard we identify and classify rules and judgments, and observe the level of justifications for the rules and assistance to support the judgments. The three standards have rules, are based on principles, and require the exercise of professional judgment; the less conservative standard requires more judgments and, unexpectedly, more rules. The results suggest that the rules‐based versus principles‐based distinction is not meaningful, except in relative terms. We conclude that a relatively more principles‐based standards regime requires professional judgment at both the transaction level (substance over form) and at the financial statement level (‘true and fair view’ override). Furthermore, it is suggested that any FASB and IASB convergence will require agreement on the weightings given to the qualitative characteristics.

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References

2002Evidence from Auditors about Managers' and Auditors' Earnings Management Decisions 1992Rules versus Standards: An Economic Analysis 2003Principles-Based Accounting Standards 2003Behavioral Evidence on the Effects of Principles- and Rules-Based Standards 1991Accounting theory: A conceptual and institutional approach 1995The Ability of Professional Standards to Mitigate Aggressive Reporting.2003Professionalism and Accounting Rules 2005Rules-Based Standards and the Lack of Principles in Accounting

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