Accounting & Tax

Accounting Standards

A matter of principles.
Joseph McCaffertyDecember 1, 2002

The Financial Accounting Standards Board announced in October that it is considering a shift from rule-based toward principles-based accounting standards. The move would bring U.S. accounting closer to international standards, which some argue could have helped prevent the recent accounting scandals.

“We’re looking at whether a more principles-based approach would help reduce the level of detail and complexity in U.S. standards,” FASB chairman Robert H. Herz said in November at a Financial Executives International conference.

Proponents argue that shifting the emphasis to principles could reduce the temptation for accountants to comply with the letter but not the spirit of a rule. “Manipulators love detail-based systems because they like to find ways to get around the rules,” says Vincent O’Reilly, a professor at the Carroll School of Management at Boston College. “Look at Enron. It’s hard to look quickly at what they were doing and say it doesn’t conform to the rules of GAAP. But anybody can see that what they were doing wasn’t a fair representation of the company.”

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Critics, on the other hand, caution that a principles-based system could increase litigation. “I’m doubtful that it would work,” says Chuck Hill, director of research at Thomson Financial First Call. “It’s difficult to rely on companies to follow the spirit of the law. I think a lot of CEOs figure that as long as the lawyers tell them it’s OK, it’s not only legally OK, it’s also morally OK.”

Even Herz expressed some hesitation about moving to principles-based accounting. “Some are concerned that a principles-based approach could reduce the comparability of financial information and leave too much room for judgment by companies and auditors,” he said.

O’Reilly says it is unlikely that FASB would move completely to a principles-based model, but that some combination of the two would be ideal. FASB will hold a roundtable meeting this month, and has requested comment letters on the proposal by January 3.