Principles not Rules: A Question of Judgement

The Institute of Chartered Accountants of Scotland (ICAS) published (in April 2006, updated July 2008) a research report called Principles not Rules: A Question of Judgement. The Introduction to this 27-page report was written by Hugh Shields, Chairman of the Working Group (Director and Head of Financial Reporting at Barclays Capital, a division of Barclays Bank). He states that: “The key to true and fair financial reporting is the balanced exercise of judgement. If standard setters, preparers, auditors and regulators could all exercise judgement on broadly equal terms, then this would provide the healthy tension which is needed for true and fair financial reporting and for communication with stakeholders.”

According to Shields, “Principles-based accounting standards are based on a conceptual framework, consist of a clear hierarchy of overriding principles and contain no ‘bright-line’ or anti-abuse provisions. Such an approach requires the use of judgement by preparers, auditors and regulators. ...With the safeguards afforded by such an approach, all parties should be more able to accept the consequences of exercising judgement in a principles-based accounting world.

“Against the above background, much greater simplicity in standard setting becomes possible. An interviewee in this project noted that: “Any accounting standard should be capable of being explained in one minute.” Yet some standards currently seem to defy any simple explanation at all. In the interests of all parties involved in financial reporting and, in particular, the broad range of users, such a situation should not be allowed to persist.”

Shields further notes that, “Einstein once said that ‘Everything should be made as simple as possible, but not simpler.’ This perfectly captures the Working Group's view that accounting standards should be firmly governed by high-level principles with only the absolute minimum additional guidance required to make the standard operational. Preparers and auditors would, therefore, need the courage to exercise and defend their judgements in this simplified accounting world. Users and regulators would need the wisdom to accept that there may be more than one answer and, over time, all parties would have to build the trust that this state of the world implies.”

A summary of 10 recommendations is presented in the report (page 3). A review of the professional, academic and regulatory literature on the principles versus rules debate in international accounting standard setting entitled Principles-Based or Rules-Based Accounting Standards? A Question of Judgement is available on the lCAS website. Also available is the output from the financial instrument workshop sessions Principles not Rules: Report on Proceedings of Financial Instrument Workshops.