Investors are likely to benefit from more emphasis on principles-based standards, since rules-based standards may provide a method, such as through exceptions and bright-line tests, to avoid the accounting objectives underlying the standards. In other words, without the exercise of professional judgment, rules in the form of bright lines may result in a false consistency – that is, ostensibly uniform accounting for differing fact patterns. If properly implemented, principles-based standards should improve the information provided to investors while reducing investor concerns about “financial engineering” by companies using the rules to avoid accounting for the substance of a transaction.
While preparers appear supportive of a move to less prescriptive guidance, they have expressed concern regarding the perception that current practice by regulators in evaluating judgments does not provide an environment in which such judgments may be generally respected. This, in turn, can lead to repeated calls for more rules, so that the standards can be comfortably implemented.
Guidance on the exercise of professional judgment may help address the following issues:
(1) Investors’ lack of confidence in the use of judgment – Guidance may provide investors with greater comfort that there is an acceptable rigor that companies follow in exercising reasonable judgment. (2) Preparers’ concern regarding whether reasonable judgments are respected – In the current environment, preparers may be afraid to exercise professional judgment for fear of having their judgment overruled, after the fact, by regulators. (3) Lack of agreement in principle on the criteria for evaluating professional judgment – Identification of the criteria for evaluating reasonable judgments, including the appropriate role of hindsight in the evaluation, may not be clearly defined, which may lead to increased uncertainty. (4) Concern over increased use of principles-based standards – Companies may be less comfortable with their ability to implement more principles-based standards if they are concerned about how reasonable judgments are reached and how they will be assessed.
There are many different ways that potential guidance on professional judgment could be provided. To be successful, however, that guidance should not eliminate debate, nor be inflexible or mechanical in application. Rather, the guidance should encourage preparers to organize their analysis and focus preparers and others on areas to be addressed, thereby improving the quality of the judgment and likelihood that regulators will accept the judgment. Any guidance issued should be designed to stimulate a rigorous, thoughtful and deliberate process rather than a checklist-based approach for making and evaluating professional judgment.
