The capital markets as of this time rely mostly on trust. Wherein the accuracy are imagined to be true based on the financial information and wherein the reality in economy is reflected. These financial information or statements are then examined by the company whether it is reasonable or not reasonable, and the assurance of the statements to be true and fair or the other side. The evaluation of these will stick on to Generally Accepted Accounting Principles (GAAP). This opens the door for what would be the appropriate accounting system of the companies in America; the Rules-Based or the Principle-Based Accounting Principles.
Rules-Based Accounting Principle Rules-Based Accounting Principle was established with the goal to provide the particular transaction or class of transactions a very specific accounting treatment (Paulson). In this principle of accounting, there are rules that serve as standards. The rules are very specific that often make large number of exceptions. However, the standards are very detailed that needs greater amount of guidance in the implementation of this principle.
This very detailed standard in this rules-based accounting principle pointed out as many contingencies as possible, finding the best accounting method to be used.Also so-called the “expert systems”, these very detailed standard are widely use in many fields. The knowledge of an expert is encoded as a rule and in the set was the concept of this so-called expert system. Usually written in the if-then format, the rules-based principle of accounting is relatively simple and can be used for many problems. In the concerns of many accountants of the litigation over the exercise of their judgment, and with the absence of bright-line rules, many accountants prefer the rules-based standards.Principles-Based accounting principle offers more comprehensive basis for the preparation of the financial statements.
The principle-based has the flexibility to handle the new and different economic situations. Setting an objective had been an integral part of the principle-based accounting principle. In this principle-based principle, there is only few or almost no exceptions are involved. An appropriate amount of guidance in implementing the said principle would be needed with regards to the nature of the transactions that will be done and will be dependent on the class of events the corporate would have.The principle-based accounting principle is a consistent and has a conceptual basis on reporting financial statements. With regards to the reporting periods, the financial statements in the principles-based standards must be relevant, reliable and comparable.
This implies that the principles-based accounting would best reflect the reality in economy of the corporate in the finance statements reporting. Differences (Advantages and Disadvatages) The rules-based principle follows a list of detailed rules while the principles-based accounting makes use of a conceptual basis as standard.Making a key objective in an entity has been the focus of the principles-based standards for reporting purposes. Guidance would be needed to explain these objectives and for the implementation of the principle. While rules-based are more on the possible contingencies.
The principles-based accounting has been focusing on the reliability and the relevance and comparability of the financial information for the reporting periods and entities. The usefulness of this information to the decision makers has been overriding the financial accounting concepts.But then this information made the comparisons even with the reporting periods impossible for the investors. The rules-based principle, with the precise and detailed rules, the consistency of the standards can be applied and the elimination of individual judgment is possible. This rules or standards make way for the off-balance-sheet financing to persist. In addition to this, justifications for the methods used were provided by these standards.
The United States Generally Accepted Accounting Principle (GAAP) is one example who uses the rules-based accounting principle.In order to comply with GAAP, one must follow the rules and standards that the corporate had set. An example of the transactions of GAAP with their rules-based principle is the lease of an airplane. To determine if the transaction made by the company and GAAP to be an operating lease or a capital lease, the lessee must follow the specific rules or standards the GAAP had set. Based on how the lessee would follow the leasing rules set by GAAP would make it easier to classify differently the two identical lease transactions (Hines).For a lease, whether it may be an operating or a capital lease, the International Accounting Standards must provide a large guidance in order to classify those two.
The International Accounting Standards, on its principles-based accounting, classifies a lease as a capital lease if all the risks and rewards are transferred to the lessee on the event of ownership. The lessee must then write the property as an asset and liability of their company if it is a capital lease (Myring). Conclusion The principles-based accounting is an alternative for the rules-based accounting.The failure of Enron gives way to find alternatives on the accounting principle to be used.
Thus the principle-based accounting was given attention. Thus, may be beneficial for the US corporate. What the rules-based principle has to do is to add more complexity on the accounting system due to vast amount of detailed rules and also these standards had encouraged financial engineering thus leading the US corporate into an “unfair presentation”. As what had happened on the Enron, because of the unwritten contracts, the company had hid some of their debts which are an implication of an unfair presentation.At this time, the need for an outcome-based judgment is important.
That is what the principles-based accounting got to do. Setting an objective and not rules for the evaluation of the corporate of the financial information or statements would be the right way to judge. In addition to this, more accurate financial statements and information are then provided by using the principles-based accounting principle. This is because of the reduced manipulation of the rules due to an increase in principles-based accounting standards.By using the principles-based accounting standards, the management is forced to ensure the company’s transactions and financial statements not abstractly but to define specifically the events and to structure their reports based on the objectives of the accounting standards.
This gives more responsibility for the auditors and to the management compared to the rules-based accounting, but makes lesser use of their judgment; because the company’s objective would be the focus of their judgment and not the many detailed rules of the rules-based accounting standards.And then to comply with the standards, this responsibility may serve as a facilitator for the auditor or the management. A sufficiently detailed framework and an established objective, and an appropriate model for accounting can be derived based on the principles of the principles-based accounting standards. And together with these, appropriate and sufficient details for the reports on financial statements and information will be provided to the regulators of the company, thus making a fair presentation of the financial statements.This takes away the place for financial engineering that can be oversee by the rules in the rules-based accounting standard.
The sufficient structure of the standards serves as barriers for those who may act badly in reporting the financial statements. In addition to these, with the objectives set forth, the evaluation would be if the accounting had reached the said objective rather than be under the rule masking up the true goal of the company. The other concern of the principles-based accounting standard is the preparation of more informative financial statements or information.This will add to the comparability in accounting statements for the investors to see in contrast to what the critique say about the principles-based standard to be incomparable.
This is due to the purpose of the principles-based standard to reflect the economic reality of the corporate wherein the events and transactions are on the record compared to the rules-based principle.To summarize the benefits that we can get from adopting the principles-based accounting standards; - improved conceptual framework - accounting objectives are clearly stated - clarification is easier due to this basis (accounting objectives) providing sufficient details on the financial reports/transactions - minimizing the exceptions from the standards due to the overriding of the rules - increased in comparability for the investors - the use of percentage tests is eliminatedFinancial statements must be of high quality and must be transparent in order to show a true and fair presentation and to reflect the economic reality. The principles-based accounting is a law that everyone must adhere to it, whether it would be a large, average or small company. It has been a law since the 1969 criminal court or the Continental Vending had happened.