Provide the key characteristics of rules-based standards and principles-based standards.

What are Principles-based Accounting Standards?

Principles-based Accounting Standards refers to a set of rules and guidelines that organizations must follow when making financial reports. Different states and countries have accounting principles that guide them when reporting their financial data, in the United States, for instance, companies must abide by the generally accepted accounting principles (GAAP) so as to remain listed on the stock exchange. Principle-based accounting standards are compiled by boards of states. In the United States, GAAP was set by the Financial Accounting Standards Board (FASB).

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How are Principles-Based Accounting Standards Used?

Companies make financial reports to regulatory bodies or tax agencies annually, semi-annually or monthly. When preparing financial reports, there are some set of principles they must comply with, these are known as accounting standards. Accounting standards are often set by private or non-profit organizations and these rules and guidelines vary across the globe. In the United States, the Financial Accounting Standards Board (FASB) has a responsibility set GAAP and ensure they are complied with by organizations in the U.S. Despite the variations of principles-based accounting standards across countries, they all have some qualities in common. FASB has 11 concepts which include consistency, accounting period, dual aspect, materiality, money measurement, realization and conservation. Accounting standards also vary from company form company, while medium and small businesses have simplified accounting standards they must follow, there are strict accounting standards public companies are expected to stick to when making financial disclosures and reporting. Vital elements of accounting standards include specification of monetary units, identification of the entity reporting, reporting time frames, among others.

Accounting Standards

In the United States, the FASB makes certain pronouncements known to be part of the generally accepted accounting principles. These serve as information and guidelines that companies must follow when making financial reports. The FASB pronouncements include Statements of Financial Accounting Concepts, Statements of Financial Accounting Standards, FASB Technical Bulletins, EITF Abstracts, and FASB Interpretations. Accounting standards vary across countries of the globe, most standards are set based on the financial data prevalent in the country. In the United States, the major standards of the Financial Accounting Standards Board (FASB) include Revenue recognition, derivative accounting, variable interest entities, credit losses, leases (balance sheet), stock options, pensions, and others. 

Major FASB Standards 

According to the history of principle-based accounting standards which were set and used mostly in the 21st century, there are some drawbacks on these accounting principles. Despite that, they present a set of guidelines that companies must follow when making financial reports, fraud was prevalent at this time, to the extent that they were unnoticed by external auditors. The major examples of accounting irregularities in the 21st century were those of Enron and Worldcom. Benefits of Accounting Standards: The major benefits of accounting standards are highlighted below;

  • Accounting standards increased transparency in the financial report of companies.
  • These standards created a formal guideline for accountability by businesses and organizations.
  • Accounting standards reduce fraud and covering of debts and losses mostly practiced by companies.
  • These are sets of regulations created to prevent financial crackdown in businesses.

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Abstract

Recent accounting scandals have resulted in regulatory initiatives designed to strengthen audit committee oversight of corporate financial reporting and have led to a concern that U.S. GAAP has become too rules-based. We examine issues related to these initiatives using two experiments. CFOs in our experiments exhibit more agreement and are less likely to report aggressively under a less precise (more principles-based) standard than under a more precise (more rules-based) standard. Our results also indicate that CFOs applying a more precise standard are less likely to report aggressively in the presence of a strong audit committee than a weak audit committee. We find no effect of audit committee strength when the standard is less precise. Finally, we find support for a three-path mediating model examining mechanisms driving the effect of standard precision on aggressive reporting decisions. These results should be of interest to U.S. policymakers as they continue to contemplate a shift to more principles-based accounting standards (e.g., IFRS).

Journal Information

The Accounting Review is the premier journal for publishing articles reporting the results of accounting research and explaining and illustrating related research methodology. The scope of acceptable articles embraces any research methodology and any accounting-related subject. The primary criterion for publication in The Accounting Review is the significance of the contribution an article makes to the literature.

Publisher Information

The American Accounting Association is the world's largest association of accounting and business educators, researchers, and interested practitioners. A worldwide organization, the AAA promotes education, research, service, and interaction between education and practice. Formed in 1916 as the American Association of University Instructors in Accounting, the association began publishing the first of its ten journals, The Accounting Review, in 1925. Ten years later, in 1935, the association changed its name to become the American Accounting Association. The AAA now extends far beyond accounting, with 14 Sections addressing such issues as Information Systems, Artificial Intelligence/Expert Systems, Public Interest, Auditing, taxation (the American Taxation Association is a Section of the AAA), International Accounting, and Teaching and Curriculum. About 30% of AAA members live and work outside the United States.

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Which of the following is a characteristic of rule based standards?

In these discussions four common characteristics of rules-based standards were identified, which are: (1) bright line thresholds, (2) scope and legacy exceptions, (3) large volumes of implementation guidance, and (4) higher levels of detail.

What are the characteristics of principles

A principles-based approach seeks to set principles that specify the intention of regulation, rather than set rules detailing requirements of a financial institution.

What is rule based and principle based?

A rules-based approach mandates the same benchmark for all projects, whereas a principles-based approach implies different benchmarks, based on judgment and contextual information.

What are principles

Principles-based Accounting Standards refers to a set of rules and guidelines that organizations must follow when making financial reports.