It is ten years since the Institute of Chartered Accountants of Scotland published the report Principles Not Rules: A Question of Judgement. It argued that the global convergence of accounting standards, essential to both the public interest and the needs of business worldwide, could not be achieved through a detailed rules-based approach. Only a principles-based approach could provide regulators, preparers, auditors and investors with a workable system which would inspire trust and engender integrity. This approach would emphasise judgement over a blind following of the rulebook. As the working group said a decade ago: ‘It is necessary to recognise that complete comparability is never possible in accounting. More emphasis needs to be placed on explaining the key judgements made by preparers of financial statements. This is critical to effective communication in financial reporting’.
Ten years on the philosophical battle is probably won. The means of putting it fully into place are complex and much argued about. And the whole process has created new opportunities for ways forward. This became clear at an event organised by ICAS and held at the Deloitte Academy in central London. As Veronica Poole, Deloitte’s Global IFRS Leader pointed out, it was always easier to defend judgements based on principles than a position based on compliance with the rules. The nature of a judgement was that people could disagree with it and therefore it had made explaining how you got to those judgements much more important. And as another participant, Jane Fuller of the Centre for the Study of Financial Innovation, put it there was a need for rational assessments of judgement, and the practice of documenting professional judgement had become just good practice. Though she also said there was ‘still too much of the “I obeyed the rules” arguments.
Ian Mackintosh, the outgoing deputy chairman of the IASB, emphasised the importance of the IASB’s new disclosure initiative which would focus minds on the objective of disclosure and underlying principle rather than providing people with a check-list. This, he said, would help fight any tendency to develop a check-list mentality. The chair of the event, non-executive director Mike McKeon, said that if we wanted to see how the introduction of an overriding principle could change practice all we needed to do was look at how the Financial Reporting Council’s introduction of the principle that annual reports had to provide a ‘fair, balanced, and understandable’ representation of a business had fundamentally changed UK practice. ‘All of this changed the landscape completely’, he said. And that had meant further changes in precisely what reports should be doing. ‘The dialogue is shifting from what is in the financial statements to what should be in the financial statements’, said Poole. And there was now a wider audience to satisfy. The growth of such concepts as integrated reporting, which brought many other drivers of a corporate strategy than simply the financial figures into play, was one example. Stewardship and prediction of future cash flows could no longer be viewed through one lens. ‘The dialogue is moving rapidly on from what should be in the financial reporting to how relevant is the financial reporting anymore? ’, she said. Backing up the view that the emphasis on principles had changed the thinking Paul Druckman, outgoing CEO of the International Integrated Reporting Council, said that in the UK the core principle of ‘fair, balanced and understandable’ underlined the view that the principle of balanced reporting now covers more than just the financial data. And he urged standard setters to think through the concepts of both hard and soft legislation and focus on the underlying principle.
Whether the world has changed because the principles not rules debate opened things up a decade ago or whether the debate simply caught the zeitgeist doesn’t really matter. The debate over the nature of corporate reporting is a much more fluid affair these days.