Accounting standards are a common set of standards and procedures that act as a guide in financial accounting policies and rules. Principles-based accounting provides a set of guidelines that accountants follow in laying out fiscal statements. This standard is used globally other than in the United States. Rules-based accounting simple but specific accounting rules that are detailed and are to be used by company accountants must follow when preparing financial statements and is mostly used in the U.S. This article looks into the differences between principle-based and the rules-based accounting. It also discusses the evidence indicating that the U.S. generally accepted accounting principles are rule-based. These accounting principles are put in place to improve the transparency of financial reporting internationally.
One of the differences is principle-base offer guidelines that are understandable, readable, comparable and relevant to current financial transactions. It is preferred by most countries because it would be easier to adjust company’s accounting principles rather than its operations to fit accounting requirements ( Hoyle, 2015 ). Internationally, these guidelines are mostly developed by the International Financial Reporting Standard. In the contrary, rules-based accounting involves a detailed list of rules that must be followed to the letter during preparation of financial statements. One major example is Generally Accepted Accounting Principles that is majorly used in U.S. These rules do not give room for deviation from them and accountants must apply them.
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Secondly, the rules-based establishes a specific and verifiable procedure followed when creating financial statement. These procedures are helpful in instances where the statements are a subject of a court, they are able to point to specific rules that were followed. Even though this is a positive issue, sometime it can lead to needless complexities in preparing these statements. On the other hand, a principles-based system gives just guidelines. This system offers room for flexibility. This can sometime be a negative because the information cannot be dependable and lacks consistency. It makes it difficult to compare one company’s financial statements to another. This can lead to a biased economic decision when there is comparison between two companies’ financial statements.
Thirdly, the rules-based accounting is based on a bright line set of rules that gives a loophole to those who prepare financial reports to play the system with disregard to the relevant principles. The very many rules do not allow the accountants to use their professional judgement. In principles-based system, the questionable areas can be interpreted by the standard setting board.
Finally, the rules-based accounting requires more details in order to keep themselves in a minimal risk of being prosecuted. The accountants are made to believe that following the rules to the letter exempts them from facing a lawsuit. As for the principles-based standard, the accountants are given an opportunity to use their professional judgement in assessing the substance of the transactions them later prepare the financial documents. This can raise issues as it can lead to multiple interpretations on the same transaction.
On the evidence indicating that GAAP are rules-based, the GAAP requires the compliant companies to follow strict rules and regulations. In GAAP, a constant set of rules are applied throughout the financial reporting process ( Dunn, 2018 ). It also requires complaints to be accurate and be impartial. The accountants are not allowed to make assumptions when creating financial statements. These are clear indications that the GAAP follows the rules-based accounting standards.
Conclusively, these standards have a principle purpose of creating reports that used by investors in assessing the financial status of a given organization. They improve on the required transparency in financial reporting by setting up a threshold for all companies. Even though these companies employ different principles, they help in getting the job done.
References
Dunn, L. N. (2018). The Fundamentals of GAAP: Case Studies of Accounting Principles (Doctoral dissertation, The University of Mississippi).
Hoyle, J. B., Schaefer, T., & Doupnik, T. (2015). Advanced accounting . McGraw Hill.
