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Accounting Theory

Rules-based approach to principles-based approach


of accounting standards development

By:
Halimah Tusya Diah
1410531056

International Accounting
Andalas University
1. Introduction

Before the great depression in 1929 there is no authoritative accounting standard


that can help investor to make a proper decision whether to invest or not and after the
great depression happen it makes the stock market collapse that really shook investor
confidence and they lost trust on financial report. The Enron case, probably as one of
the biggest case that shook the investor. By manipulating their financial statement to
maintain and get many investors. The development of technology and market
environment are affected to the capital market, from the model of financial accounting
standard, relativism of capital movement and the availability of information. The
scandal of Enron becoming one of the reasons of increasing the demand of accounting
standards. Because of changing in social and business environment it make the
accounting standard is also keep changing.
Currently, there are two major strength in the fields of accounting standards,
Financial Accounting standard boead (FASB) and International Accouting Standard
Board (IASB). FASB is the major standard in US and responsible for developing US
Generally Accepted Accounting Principle or well-know as GAAP. Principal based
accounting such the generally accepted accounting principle (GAAP) is used as
conceptual basis for the accountants. While the major setter in Europe is International
Accounting Standard Board which is responsible for International Financial Reporting
Standard (IASB) and considered to be the Principles-based. Since United States also a
part of Anglo Saxon, so US GAAP is considered become the rule-based standard.
While in Indonesia, before committed to use the IFRS use the financial accounting
standard that refer to the US GAAP which is rule base. And with this implication
form principle base, the accountants should be more attention to their professional
judgment.

2. Definition of Rules-based and Principle-based

The debate over principal based and rules-based has been going on for more than
a decade. The IASB convergence process with the FASB continues to eliminate the
fundamental differences of the two world accounting standards. Currently there is still
a difference between IASB and FASB output standards. However, the influence of the
Rule Based FASB within the IASB output standards is exist. The influence of US
GAAP is strongly felt in the standards of financial instruments (IAS 32, IAS 39)
where US GAAP does have a standard on financial instruments in advance so that the
standard in this case is more mature. Differences of rules-based systems and principal
base are the rules-based system accountants can get detailed implementation
instructions thereby reducing uncertainty and generating application of specific rules
in the standard mechanically.

Bullen and Crook (2005, p.1) define principes-based standard as follows :


“ to be principles-based,standard can not be a collection of conventions but rather
must be rooted in fundamental concepts”. Generally Accepted Accounting Principle
(GAAP) as including in Principles-based Accounting is used as a conceptual basis for
accountants. Where a simple set of key are set out to ensure good reporting.

Principle Based Standard has several advantages over Rule Based standard, among
others:
i. The vocabulary used "standard" means the word used in the Principle Based
Standard is the chosen principles.
ii. The principle-based standard is easier to understand.
iii. The relationship between one principle and another becomes clearer.
iv. Consistency between principles and individual standards can be guaranteed
v. The contradiction of principle is more easily perceived and perfected by the
standard compilers.

The principle-based standard provides an advantage in terms of allowing


managers to choose accounting treatment that reflects the transaction or underlying
economic event, although the opposite may happen. The principle-based standard
enables managers, audit committee members, and auditors to apply their professional
judgment to focus more on reflecting economic events or transactions substantially,
not just reporting transactions or economic events according to standards.

The disadvantages of Principle-based :


i. It decreased the comparability, because if principles are used rather than rules,
accounting information may start to become less consistent
ii. The compliance is more difficult, when complying with the principles of
accounting is more complex, time consuming and very expensive
iii. Enforcement is more difficult

A rules-based accounting standard adds excessive complexity, which facilitates


financial engineering and does not reflect a ‘true and fair view accounting (ICAS,
2006b). The fundamental flaw of the standard is due to having unnecessary
complexity surrounding each specific elements of the standard.
Some Advantages of Rules-based approach :
i. Rule-based standards are generally considered easier to audit for compliance
purposes, and may produce more consistent and comparable financial reports
across entities.
ii. Requirements are set out in detail and compliance with the rules can be more
easily monitored and enforced.

Some of the disadvantages of rule-based standards include:


i. Rule-based standards are always considered incomplete.
ii. Due to explesiveness, rule-based accounting standards are at risk of short-lived
iii. due to turbulence changes in the accounting environment.
iv. Feels over-regulated or overloaded by standard users.

Indonesia since 2011 began to implement accounting standards converging with


International Financial Accounting Standard (IFRS) or accounting standards called
principle-based. However, the principle-based accounting standards provide only
measurement and recognition guidelines that affect the financial position in general.
The principle-based accounting standards do not provide detailed guidance on the
measurement and recognition of financial statement items such as the bright-line
threshold as found in the United States' Generally Accepted Accounting Principles
(US GAAP). principle-based accounting standards that only provide general
guidelines coupled with professional products used by various parties increasing the
perception of the need for the accountability of a decision.
There is also the view where the principles-only standards may present
enforcement difficulties because that they provide insufficient structure as a basis for
ensuring ‘compliance’ so far. lecturer of Accounting Department of Economics
Faculty Sriwijaya University in his dissertation said the incremental influence of
accounting standards based on the principle of accountant's sense of accountability is
a major concern
Recent research has revealed the role of accountability for reducing various
decision-making biases, while no research has revealed the factors affecting
accountability itself in the audit profession

3. Conclusion

Both rules-based and principle-based accounting systems are meant to provide


the best possible financial statements to investors. IFRS convergence resulted in
changes in accounting standards being principle based rather than rule-based. This
principle-based arrangement aims to meet IFRS objectives of enhancing transparency,
accountability and comparability of financial statements among entities globally.
Because the current principle of accounting is based on principles, it is expected
that both practitioners and academics in the field of accounting to truly master the
accounting principles to perform judgment on recording transactions. Rule-based
standards result in the emergence of accounting standards for specific industries. rule
based approach tends to be redundant and can create many loopholes. It may even be
that this arrangement conflicts with the general rule.