Rules, principles and judgments in accounting standards

The distinction between rules-based and principles-based standards is not well defined and is subject to a variety of interpretations ( SEC, 2003 , p. 5). Yet there is a commonly held view that the FASB's standards are rules-based and the IASB's standards are principles-based. This article identifies the basis of this distinction. For research and development, the article compares the FASB standard with two principles-based standards. For each standard we identify and classify rules and judgments, and observe the level of justifications for the rules and assistance to support the judgments. The three standards have rules, are based on principles, and require the exercise of professional judgment; the less conservative standard requires more judgments and, unexpectedly, more rules. The results suggest that the rules-based versus principles-based distinction is not meaningful, except in relative terms. We conclude that a relatively more principles-based standards regime requires professional judgment at both the transaction level (substance over form) and at the financial statement level ('true and fair view' override). Furthermore, it is suggested that any FASB and IASB convergence will require agreement on the weightings given to the qualitative characteristics.     

Interpretation and application of “new” and “complex” international financial reporting standards in Fiji: Implications for convergence of accounting standards

This study extends prior research on accounting judgment and decision making research by examining the effects of ‘new’ and ‘complex’ accounting standards on judgments of professional accountants. It examines whether there are differences in judgments of professional accountants in Fiji when interpreting and applying selected International Financial Reporting Standards (IFRSs). A significant within-country difference in judgments of professional accountants has serious implications for convergence of accounting standards. The results show that interpretation and application of accounting standards are affected by complexity of the accounting standard and professional accountant's familiarity with the standard. The study also finds strong support for an interactive effect of familiarity with the accounting standards and complexity in accounting standards on judgments of professional accountants. Furthermore, the results show that differences in judgments exist between the Big 4 and non-Big 4 professional accountants when provided with new accounting standards that require complex judgments. The results of this study are of interest to stakeholders at a time when IFRSs are increasingly being adopted throughout the world and standard setters are struggling to promote compliance with those standards.     

An examination of the perceptions of auditors and chief financial officers regarding principles versus rules based accounting standards

The debate over the adoption of International Financial Reporting Standards (IFRS) by United States issuers, or its convergence with U.S. Generally Accepted Accounting Principles (U.S. GAAP) has been going on for several years now. However, as of this writing, the Securities and Exchange Commission (SEC) has still not taken a definitive position on the issue. This is in part due to issues involving the cost of adoption, independence concerns relating to the IFRS promulgation body, the International Accounting Standards Board (IASB), and the debate over which type of accounting standards is superior for financial reporting: IFRS, which are said to be “principles-based,” or U.S. GAAP, which are said to be “rules-based.” In this paper we examined the views of two stakeholders in the U.S. financial reporting system, auditors in large public accounting firms and Chief Financial Officers in the Fortune 1000. We elicited their perceptions involving ten situations where specific rules are incorporated in U.S. GAAP. We asked if the elimination of the specific rule would be likely to better achieve the “qualitative characteristics of useful financial information” as defined by the Conceptual Framework for Financial Reporting adopted by the Financial Accounting Standards Board (FASB) in 2010 (FASB 2010) and the similar document adopted by the IASB at the same time (IASB 2010). We found that in eight of the ten situations both groups preferred the rules-based accounting regime (the current U.S. GAAP rules) over a principles-based approach.     

A Study of Accountants' Judgments With Respect to the Provision of Consolidated Financial Statements

The release of the Australian Accounting Standards Board AASB 1024. Consolidated Accounts. in September 1991 represents a fundamental shift in concept, criteria and approach. The Standard is based on the entity concept and adopts 'capacity to control' as the sole criterion for identifying related entities for the purpose of preparing consolidated financial statements. A conceptual (substance-over-form) approach is used to implement the control criterion. In essence, this approach requires accountants to make professional judgments about the existence of control based on the substance of group structures and arrangements rather than their legal form. Concerns about the subjectivity and possible variability of accountants' judgments cast some doubt on the operational effectiveness of the conceptual approach. In response to these concerns, this paper reports the results of an experiment that examines the consolidation judgments accountants make in response to a number of hypothetical scenarios. The purpose of this paper, therefore, is to provide some insights into the likely quality and reliability of consolidation judgments under the conceptual approach adopted by AASB 1024. The results indicate that accountants can be expected to exhibit broad consensus in their consolidation judgments. In addition, an analysis of the variables suggests that the degree of share ownership is the most significant factor in making such judgments. Nevertheless, other factors including the composition of the board of directors, the existence of a special arrangement, and interactions with the other variables also proved to be significant. Overall, the study provides tentative support for the conceptual approach adopted in AASB 1024.     

The meaning of a defined accounting concept: regulatory changes and the effect on auditor decision making

Accounting standards exist in an attempt to “standardize” accounting practice. These standards contain definitions of accounting concepts whose function is to guide judgments made in practice. However, such judgments can have a major impact on a firm's externally reported accounting numbers, as their inherent subjectivity and discretion may be lent to the manipulation of earnings. This study provides empirical evidence of the effect of measured meaning on an accounting judgment, in the context of regulated changes to the definition of one key accounting concept used in measuring operating income. The extraordinary items classification decisions made by auditors were found to be systematically associated with differences in measured meaning of the extraordinary items definition. The study has important policy implications for accounting standard-setting.     

Bright Pharmaceuticals SE: Accounting for a Business Combination under IFRS 3

This instructional resource familiarizes students with the accounting for business combinations under IFRS 3 and illustrates the uncertainty and professional judgment involved in asset valuation and consolidation. First, students need to assess the quality of information generated under IFRS 3 and fair value accounting. Second, they are asked to account for a business combination by identifying possible input parameters to measure several intangible assets and a contingent liability. Based on their valuation results, they compute the amount of goodwill recognized on the acquisition and assess the effects of their parameter choices on the values of different assets and liabilities. As an optional third task, the case asks students to consolidate the financial statements and evaluate the impact of the acquisition on the financial position of the acquirer.     

Professional judgment and accounting standards

This essay explores relationships between accounting standards and people's inferences and judgments. Acknowledging that Demski's impossibility theorem implies that the standards will be “social-preference incomplete”, the paper shows that they are also “decision-procedure incomplete” on three levels. These levels correspond to three kinds of professional judgment: semantic, pragmatic and institutional. The investigation facilitates understanding of (1) how accountants exercise judgment and deduction in applying incomplete standards; (2) how financial statement readers use the incomplete standards to draw deductive inferences from financial reports which are based on accountants' judgments; (3) the special kinds of judgment required of standard setters; and (4) the meaning and extent of professional liability, given the relationships identified between accounting standards, inferences and judgments.     

The content of accounting standards: Principles versus rules

The Global Accounting Alliance has raised a call for different perspectives on principles-based accounting standards. Based on prior studies this paper identifies a number of characteristics of principles-based accounting standards. It uses content analysis to empirically test whether the asserted characteristics are consistent with the IASB and FASB standards on interest costs. We find that rules-based standards, relative to principles-based standards, have more rules, more justification, acknowledge less judgement is required, have more bright-line thresholds, have more scope exceptions, and are more verbose and complex. The main drafting difference between a rules-based or principles-based approach is whether extensional definitions or intensional definitions are used. Several policy implications are noted.     

合并会计报表问题研究

合并会计报表是会计理论和方法体系中的难点，本文论述了合并会计报表涉及到的合并范围的确定和变更、子公司净资产为负数情况下的合并会计报表及比例合并方法几个方面的内容。     

The role of a crisis in reshaping the role of accounting

Prior to 2001, international accounting standards (IAS) were insufficiently attractive to gain the support of US regulators. The potential role of IAS in the US gained prominence during a period of extreme financial reporting instability in 2001–2002. Emerging opinion increasingly upheld principles-based rather than rules-based accounting standards in the face of the financial reporting crisis. But to promote any active shift in the US position, an institutionally legitimate infrastructure for the international accounting standards setter had to be created. As this was taking shape, the globalisation of business activities grew with inter-organizational linkages and cross-national financial inter-dependencies and flows becoming increasingly complex. Given the extensively uncertain, uneven and constantly evolving nature of global business changes, the aptness of applying judgment in assessing financial performance and position rather than relying on the application of pre-defined rules continued to achieve wider acceptance. The argument is made in the paper that international financial reporting standards are today seen to fulfil a global risk mitigating role founded on a logic that had to first gain political and institutional legitimacy and that also had to be viewed as being responsive to perceived market imperatives.     

Accounting aggregation: User preferences and decision making

This experiment tests the effects of alternative aggregations of accounting data in a simulated portfolio task. Certain entropy-based aggregation criteria were used to prepare differentially aggregated financial statements for use in the task. Subjects made allocations of initial edowments between hypothetical firms, disclosed confidence in their allocation decisions and reported on specific characteristics of the financial statements. Differences in reported usefulness of statement sets furnished were found to be associated strongly with measured information content. The results also provide limited evidence that decisions and judgments of subjects were affected by the information content of the accounting aggregations provided.     

Do principles‐based accounting standards lead to biased financial reporting? An Australian experiment

International accounting standards are deliberately designed to be principles‐based (i.e. ‘substance over form’). With Australia's recent adoption of international accounting standards, a relevant question is, do principles‐based accounting standards lead to biased financial reporting? The present paper describes a study that analysed the consolidation judgements of senior accounting officials from Australian listed companies. Participants made consolidation judgements based on AASB 1024 Consolidated Accounts. Although AASB 1024 is not identical to IAS 27 Consolidated and Separate Financial Statements, there are many similarities and both follow a principles‐based approach. In aggregate, the present study finds that principles‐based accounting standards do not necessarily lead to biased financial reporting.     

Accounting Standards, Implementation Guidance, and Example-Based Reasoning

This paper examines interpretation of accounting standards that provide implementation guidance via affirmative or counter examples. Based on prior psychology research, we predict that practitioners engage in “example‐based reasoning” such that they are more likely to conclude that their case qualifies for the same treatment as the example. We test our predictions in two experiments in which participants judge the appropriateness of income‐statement recognition. Experiment 1 uses Masters of Business Administration (MBA) students and varies example type (affirmative, counter) and case (revenue recognition, expense recognition) in a 2 × 2 design. Experiment 1 supports our predictions. Experiment 2 uses more experienced practitioners, and varies example type (affirmative, counter, both) in a 1 × 3 design. Experiment 2 supports the use of example‐based reasoning, and indicates that practitioners in the “both” condition respond as if they had only received an affirmative example. These results have implications for understanding how guidance that accompanies accounting standards can result in aggressive or conservative application of standards.     

A note on the role of memory in commercial loan officers' use of accounting and character information

A concept called “the five C's of credit” is the basis of a theory about the role of memory in loan officers' credit analysis. It is predicted that recall of two related types of information, accounting and information about borrowers' character, is greater when facts are consistent with loan decisions and judgments than when they are inconsistent. Results of an experiment support the prediction when information consistency is denned relative to decisions whether to approve or deny loans, but not when it is related to judgments of the risk of nonpayment.     

Principles- versus rules-based accounting standards: the FASB's standard setting strategy

In response to criticism of rules-based accounting standards and Section 108(d) of the Sarbanes-Oxley Act of 2002, the SEC proposed principles-based (or 'objectives-oriented') standards. We identify several shortcomings with this approach and focus on two of them. First, the format (type) of a standard is dependent on the contents of what the standard regulates. Given the asset/liability approach combined with fair values, we argue that the combination of this measurement concept with principles-based standards is inconsistent because it requires significant guidance for management judgment. Second, we propose the inclusion of a true-and-fair override as a necessary requirement for any format that is more than 'principles-only' to deal with inconsistencies between principles and guidance. We discuss the benefits of this override and present evidence from the United Kingdom's experience.     

Mandatory Adoption of IASB Standards: Value Relevance and Country-Specific Factors

The objective of this study is to investigate if the value relevance of European-listed companies increased after the mandatory application of International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS) and how the value relevance of accounting information prepared under IAS/IFRS is shaped by the specific factors of the country in which companies are domiciled. Results show that the value relevance of financial information during the period companies applied mandatory IAS/IFRS is higher than for the period during which they applied local accounting standards. We also found that countries where accounting and tax are clearly separated show more relevant accounting information. Finally, we found that companies from countries with more legal and public enforcement mechanisms disclose less relevant accounting information under IAS/IFRS.     

The Many Challenges of Pension Accounting

Accounting for defined benefit pension plans has long been a major issue in accounting. Standard‐setters are grappling with revisions to pension accounting standards, and much change has already occurred in the United Kingdom. This paper identifies and discusses most of the major issues that standard‐setters must confront in developing new approaches to financial reporting for pensions. Key issues concern how to report the impact of changes in assumptions, how to recognize pension costs on the balance sheet and income statement, and how to reconcile the differences between accountants' and actuaries' approaches to pensions. Current standards assume that accounting estimates are independent of actuarial assumptions, and yet require a direct comparison of the accounting liability with the pension plan assets, when in fact they are incompatible measures based on differing assumptions and differing methodologies. As well, accounting has been complicit in managers' wishes to hide the volatility inherent in a pension plan investment strategy that focuses on higher‐risk equities to fund estimated monetary liabilities that have been discounted at low‐risk interest rates. Drawing on studies and research done largely in Europe, this paper attempts to consolidate some of the current thinking on the topic and to propose some preferred approaches to dealing with the problems of pension accounting.     

Self-insight into the cognitive processing of financial information

An experimental setting was formulated where individuals processed financial information and provided estimates of changes in security prices. The ability of subjects to express accurate subjective cue weights was assessed by comparing the subjective weights with objective (statistical) cue weights based on their judgments. The results indicate an encouraging degree of insight, especially when the results are compared with previous studies in psychology, since this group of users of accounting information were able to express indications of relative cue importance which reflected the way they were using the information.     

Cultural differences and judgment in financial reporting standards

This instructional resource provides you with the opportunity to explore how cultural differences can impact financial reporting outcomes through the judgments accountants make when interpreting and applying accounting standards. It is intended to draw your attention and awareness to culture’s impact on financial reporting judgments since financial reporting is becoming increasingly international in scope. The instructional resource begins by discussing financial reporting standards and cultural differences and then moves into presenting three accounting scenarios. The three scenarios (lease classification, contingent liability, and revenue recognition) examine how applying accounting standards requires judgment and how cultural differences can influence accountants’ judgments and the resulting financial reporting outcomes. In each scenario, you have the opportunity to identify and consider how different cultural dimensions could impact cross-cultural financial reporting outcomes. The instructional resource content allows you to consider the challenges in using and applying a uniform set of global accounting standards that require judgment across cultures.     

The impact of professional standards on accounting judgments: The role of availability and comparative information

Given scant research on the influence of the AICPA’s Code of Conduct, this study examines the effects of professional standards for advocacy and integrity on a financial reporting decision. Based on the availability and priming literature, we test whether the current wording of two AICPA professional standards influence financial reporting decisions. Prior accounting research has documented cases where professionals were inclined toward a conservative or skeptical bias (Francis & Krishnan, 1999; Jenkins & Lowe, 1999) while other studies have documented an inclination toward a client-confirming bias (Hackenbrack & Nelson, 1996; Roberts, 2010). Our study examines whether using AICPA ethical standards as primes results in a neutral, unbiased financial reporting decision in a context in which there is substantial, yet inconclusive, evidence. Roberts (2010) documents the tendency for professionals to view integrity and advocacy as segregated objectives: one for promoting unbiased reporting, associated frequently with accounting-related decisions, and the other condoning client advocacy, typically associated with tax-related judgments. Hence, we test for availability effects based on separately-stated standards. However, the literature on comparative analysis explains that a combined concept containing counterbalancing features allows the participant to form causal relationships between the distinguishing components. This type of mental process brings the causal knowledge into working memory. Hence, a joint presentation of countervailing standards should result in a more balanced judgment, reflecting neither a conservative nor pro-client tendency.The psychology literature suggests that heuristics, such as availability priming and comparative analysis, are more likely to affect novice decision makers (e.g., jurors, clients, new hires, students) than experts whose work experiences could drive the results. This study examines the responses of upper-level accounting majors, and the results show that the participants are inclined toward conservative decision making. Participants exposed to a separately-stated standard for integrity respond conservatively, just as they do in a control group without explicit access to the professional standard. Similarly, even when exposed to AICPA Rule 102-6 allowing client advocacy, they report conservatively. In contrast, when the prime is a joint presentation of the standards, participants respond with an unbiased decision, which differs significantly from the consistently conservative response by the control group as well as by the participants primed with an isolated standard. We conclude that two AICPA standards (as currently worded) are best understood when they are aggregated. Whether this finding holds for professionals is an empirical question for future research. The implication is that accountants’ decision making could be enhanced by a revised professional standard reminding them to jointly consider the goals of unbiased decision making and justifiable client advocacy.