Name: Reg#:

Musa Khan MM121014

Rule based vs Principle based Accounting Standards

Recently, there has been much debate on whether principle-based accounting would be more efficient than the popular rules-based accounting - especially in response to accounting scandals, such as Enron and Worldcom, the current way of accounting has been under a great deal of criticism.

RULE and Principle

A principle will tell you generally what is the right thing to do and then you must judge what to do in specific circumstances. A rule will tell you what to do in specific Circumstances.

Principle is like a compass (pointer) which shows you the direction, And Rules are like maps which show you exactly how to get there.
R. Hussey & A. Ong (Financial Reporting, Regulation & Governance, 2005)

The International Financial Reporting Standards (IFRS) - the accounting standard used in more than 110 countries - has some key differences from the U.S. Generally Accepted Accounting Principles (GAAP). At the conceptually level, IFRS is considered more of a "principles based" accounting standard in contrast to U.S. GAAP which is considered more "rules based."

RULE BASED STANDARDS

In

a rules-based system, lawmakers and regulators try to prescribe in great detail exactly what companies must and must not do to meet their obligations to shareholders and clients.
Rules-based

accounting is basically a list of detailed rules that must be followed when preparing financial statements.

Principles-based accounting

Principles-based accounting is used as a conceptual basis for accountants. A simple set of key objectives are set out to ensure good reporting. Common examples are provided as guidance and explain the objectives.

Difference b/t Rule based vs principle Based.

Intangibles
Acquired intangible assets under U.S. GAAP are recognized at fair value, while under IFRS, it is only recognized if the asset will have a future economic benefit and has measured reliability. Intangible assets are things like R&D and advertising costs.

Inventory Costs
Under IFRS, the last-in, first-out (LIFO) method for accounting for inventory costs is not allowed. Under U.S. GAAP, either LIFO or first-in, firstout (FIFO) inventory estimates can be used.

The fundamental advantage of principlesbased accounting is that its broad guidelines can be practical for a variety of circumstances. Precise requirements can sometimes compel managers to manipulate the statements to fit what is compulsory. When there are strict rules that need to be followed, the possibility of lawsuits is diminished. Having a set of rules can increase accuracy and reduce the ambiguity that can trigger aggressive reporting decisions by management.

The main theme of this debate is to focus on the substance over form in the financial reporting , and to present the fair value of in the financial reporting.