The principle-based approach and ethics

Principles-based accounting seems to be the most popular accounting method around the globe. Most countries opt for a principles-based system, as it is often better to adjust accounting principles to a company’s transactions rather than adjusting a company’s operations to accounting rules.

The international financial reporting standards (IFRS) system the most common international accounting standard is not a rules-based system. The IFRS states that a company’s financial statements must be understandable, readable, comparable, and relevant to current financial transactions.

Encourages Professional Judgment

ICAEW notes that rules-based accounting is mechanical and only encourages accountants to look at the letter of the law. Accounting principles require accountants to look deeper into the substance of the transaction. This promotes sound professional judgment in the profession and instills more of a sense of responsibility in the accountant.

Flexibility

Principles-based accounting is more flexible than rule-based accounting. The Institute of Chartered Accountants of New England and Wales ICAEW for short  points out that principles are better suited to help accountants respond to rapid changes in a business environment. It can take the FASB years or even decades to amend accounting rules. In contrast, an accounting principle or idea can be applied to new types of transactions or financial instruments immediately.

Disadvantages

Compliance Is More Difficult

Complying with accounting principles is more complex, expensive and time-consuming. If companies are required to constantly interpret principles, they need accounting staff with vast experience and an expert understanding of accounting frameworks. Work that was previously done by a lower-level accountant has to be handled by a higher-level accountant, and more time may be needed to come to a conclusion.

Decreased Comparability

If principles are used rather than rules, accounting information may start to become less consistent. Raymond Thompson, Ph.D., a certified management accountant, points out that it’s possible for two accountants to look at the same data and come to completely different conclusions about what the data mean. Two companies with the same assets, in this case, could present them differently on the balance sheet.

Enforcement Is More Difficult

Companies and accounting firms are constantly accused of misstating financial information, but asking judges and juries with no financial experience to interpret accounting principles during enforcement cases may be a bad idea. Sue Anderson, program director for CPE Link, points out that it’s hard enough for courts to come to a conclusion based on explicit accounting rules and it would be even worse with accounting principles.