Principle-based Standards versus Rule-based Standards - Essay Example

? Principle-based Standards versus Rule-based Standards Tile] Principle-Based Standards versus Rule-Based Standards Introduction Accounting is a discipline that deals with the reporting of financial activities of the organization to its shareholders. Accounting policy makers design accounting standards to provide faithful reporting, therefore transparency of financial statement is the main emphasis of accounting standards. Every organization prepares its financial statements following a certain set of accounting principles, these standards are generally principle (McGregor & Street 2007). Accounting policy makers are now emphasizing on the effectiveness of principle based accounting and rule based accounting. The argument of these debates has different perceptions (Bennett, Bradbury & Prangnell 2006). However, accounting is a precise subject based on mathematics and does not have any place for judgments. This paper discusses the statement with respect to arguments on these accounting principles referring conceptual framework. Rule-Based vs. Principle-Based Standards Rule based Accounting emphasizes on the detailed rules that shall be followed by accounting while preparing financial statements (Benston, Bromwich & Wagenhofer 2006). It states that the absence of rules may not provide accurate reporting of financial results. When strict rules are followed the accuracy increases and the possibility of ambiguity decreases. On the other hand, principle based accounting as known as Generally Accepted Accounting Principles is more focused on the conceptual basis for accountants (Bennett, Bradbury & Prangnell 2006). It is more concerned to ensure good reporting through a set of guidance. Principle-based accounting provides a broad range of guidelines that may be practiced for a variety of circumstances (Collins, Pasewark & Riley 2012). Accountants debate that the application of rule-based and principle-based accounting is as complicated as issues of economics; the dynamic economical conditions are triggering point for accounting circumstances to transform (Benston, Bromwich & Wagenhofer 2006). Therefore, the effectiveness of the application of these rules and principle may remain controversial. Considering the conceptual framework both accounting standards are based on simple mathematics. Treatment of Elements The treatment of the accounting elements is evidenced that the accounting principles are based on simple mathematics (Jones 2011). The treatment of assets, equities, liabilities, revenue and expenditures in both rule based and principle based accounting standards is alike. According to the conceptual framework, the objectives and elements of accounting principles are similar (Bennett, Bradbury & Prangnell 2006). Principle-based accounting and Rule-Based accounting have largely same objectives. The qualitative characteristics of both standards are also similar; according to the recent research it has been concluded that GAAP and IFRS follow basic agreements on the qualitative characteristic, that is, Relevance, Understandability, Reliability and Comparability (Collins, Pasewark & Riley 2012). Qualitative Agreement The concept of understandability is also similar in both standards. Principle based accounting and rule based accounting standards emphases that the financial information shall be understandable for users of financial statements (Ampofo & Sellani 2010). Another qualitative agreement, that is relevance, both the standards provide basic agreements on that the financial information should be relevant. If we focus on the treatment of elements in Principle-based accounting and rules based accounting is similar (Agoglia, Timothy & Tsakumis 2011). Consider the treatment of revenue in the both principles is similar (Whittington 2008). The foundation of accounting is based on a formula that is assets are equal to a sum of liabilities and equities (McGregor & Street 2007). No major differences in the treatment of assets, liabilities or equities have been observed over the period (Benston, Bromwich & Wagenhofer 2006). According to IFRS, Expenses are considered as decrease in the economic benefits during the accounting period which decrease the outflows or depletion or assets (Stolowy & Breton 2011). On the other hand, GAAP incorporates the definition of expenses and losses. These similarities in the two different types of accounting frameworks are reflective of the fact that there is no judgment involved in the accounting and its largely mathematics. However, it is often argued and observed that principle based accounting, as for instance, GAAP, also makes use of judgment in determining appropriate accounting treatment and policies. According to Collin, Pasewark and Riley (2012), Principle-based accounting standards provide more clear statement but lacks implementation of guidance, while rule-based accounting provide rigid details regarding implementation and compliance (Collins, Pasewark & Riley 2012). Analyzing conceptual framework of both accounting standards (GAAP or IFRS), it can be determined that the treatment of entities in both standards is based on , rules for entities. However, the variation in the implementation is based on the “bright lines” (Lamberton 2005). Comparing conceptual framework of GAAP and IFRS, it can be determined concepts of GAAP and IFRS are similar. According to Agoglia (2011), rule based standards are more specific and principle based standards are considered to be less specific. This is because of the reason that the principle based accounting is more dependent on the judgments, which are more dynamic (Schipper 2003). Whereas, the rule-based standards have a strict rule to follow, the treatment does not change with the variance in the business or economical circumstance. The research study describes, Principle based accounting GAAP has ASC 840 for lease accounting standards while ruled based accounting IFRS has IAS 17 that has less bright line guidance as compared to GAAP (Bennett, Bradbury & Prangnell 2006). Comparing application of guidance of the standards it can be determined that the rule based standard compel organization to a strict reading of rules while reporting financial statements (Benston, Bromwich & Wagenhofer 2006). On the contrary, the Principle-based standards have diverse application, as the guidance is more depended on the good judgments of circumstances. Analyzing the conceptual framework of IFRS and GAAP, it can be determined that the both standards are principle based. According to Schipper (2003), GAAP is “a recognized set of principle derived from the FASB’s Conceptual Framework”. According to the research, it has been determined that the conceptual framework is based on the concepts of IFRS (Ampofo & Sellani 2010). According to the study Christopher (2005), it can be determined that the framework of rule based accounting states the clear treatment of the elements and objective is also followed by principle-based accounting (Christopher 2005). This proves that the claim of the judgments in accounting is less effective as compared to rule based accounting (Benston, Bromwich & Wagenhofer 2006). The main objective is the transparency of the financial information, while the accounting shall not be concerned with the interpretation or judgments (Agoglia, Timothy & Tsakumis 2011). This shows that the accounting shall be more concerned with providing accurate financial information rather than transforming the treatments with respect to dynamic economic or business circumstances (Ampofo & Sellani 2010). Considering UK’s corporate sector, business entities make use of IFRS as their preferred financial reporting framework. Based on this understanding, it can be noted here that companies operating in the UK make more judgments rather than focusing on a mathematical and precise approach towards accounting. It is largely because IFRSs are considered by many as largely based on judgment as compared to the U.S. GAAP, for instance. As a consequence to this, it can be further stated that at one hand corporate entities in the UK are able to sort out complex financial reporting matters on the basis of mutual understanding and room provided for judgmental assessment and reporting by the financial reporting framework followed by them. While on the other hand, it sometimes result in a situation where judgments may not be agreeable for everyone and the conflict of interests and agency theory related issues may be raised by stakeholders. Conclusion Analyzing the conceptual framework of Principle based accounting and Rule Based accounting it can be determined that the accounting is precise subject and is based on simple mathematic formula. No major difference in the treatment of the accounting elements and objective has been observed under the conceptual framework of both accounting principle (Nelson 2003). Analyzing the basic treatment of accounting elements in both accounting framework are alike. Thought the circumstance may vary, but the reporting and treatment of the financial elements shall be done with a strict rule. If accounting is more concerned to deal and provide judgments, this may cause ambiguity and confusion in reporting financial information (Agoglia, Timothy & Tsakumis 2011). Due to this, interpretation and understanding financial information for the user may get difficult. Therefore, it can be concluded accounting is a precise subject, where as its interpretation may be broader. Accounting should have strict rule for reporting in order to attain its objective, if the judgments are incorporated with the financial reporting this may create variation in reporting financial information. List of References Agoglia, CP, Timothy, D & Tsakumis, G 2011, 'Principles-based versus rules-based accounting standards: The influence of standard precision and audit committee strength on financial reporting decisions', The Accounting Review, vol 86, no. III, pp. 747-767. Ampofo, AA & Sellani, RJ 2010, 'Examining the differences between United States Generally Accepted Accounting Principles (US GAAP) and International Accounting Standards (IAS): implications for the harmonization of accounting standards', Accounting Forum, vol 29, no. 2, pp. 109-126. Bennett, B, Bradbury, M & Prangnell, H 2006, 'Rules, principles and judgments in accounting standards', Abascus, vol 42, no. 2, pp. 189-204. Benston, G, Bromwich, M & Wagenhofer, A 2006, 'Principle versus Rule-based Accounting Standards', Absacus, vol 42, no. 2, pp. 165-188. Christopher, WN 2005, 'Rules?Based Standards and the Lack of Principles in Accounting', Accounting Horizons, vol 19, pp. 25-34. Collins, DL, Pasewark, WR & Riley, MR 2012, 'Financial Reporting Outcomes under Rule-Based and Principle-Based Accounting Standards', Accounting Horizon, vol 26, no. 4, pp. 681-705. Jones, R 2011, 'The Conceptual Framework of Resource Accounting', Public Money and Management, vol 18, no. 2, pp. 11-16. Lamberton, G 2005, 'Sustainabiltiy accounting - A breif History and Conceptual Framework', Accounting Forum, vol 29, no. 1, pp. 87-90. 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