Principles versus rules

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31 Jan 2002

From IASPlus Americas Edition, January 2002

While the fallout from the Enron collapse continues to unfold, one issue that has come to light is the impact of rule-based standards on financial reporting.

Much of the complexity of U.S. GAAP, for example, arises because of detailed rules as opposed to broader concepts and principles. Prescriptive rules can encourage companies to concentrate on complying with the 'letter of the law'. Oftentimes this may result in financial statements that fail to capture the economic substance of a company's activities.

While all of the facts surrounding the accounting for certain off-balance sheet transactions at Enron have yet to surface, one fact is clear – U.S. rules governing the accounting for SPEs will be changed.

The FASB has indicated that it is likely to revise its rules relating to SPEs so as to take more account of wider issues of influence and control. However, the issue how standards are written is broader than just the accounting for SPEs.

With the IASB in place, no longer will accounting standards be developed in the vacuum of the domestic environment only. This also means that the standards will be written differently than in the past. Emphasis now will be on underlying concepts and principles versus a set of rules.

The movement toward more principle-based standards will be a significant change for many reporting environments, including those in the Americas region. The result of this movement will be more judgment in the application of accounting standards. Consequently, the focus will be on understanding a company's accounting policies and areas where judgment exists, including how underlying concepts and principles are applied.

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