Should Accounting Standards be Principles or Rules?

In a recently-published article, Sir David Tweedie notes that: “Forty-odd years ago, as a CA apprentice, I didn't have to study accounting standards because there weren’t any! There was one major standard – the true and fair view – augmented by accepted practice.” According to Tweedie, two disputed takeover bids soon changed that. The President of the Institute of Chartered Accountants in England and Wales (ICAEW), Sir Ronald Leach, senior partner of Peat Marwick & Co., and Professor Edward Stamp of Edinburgh University became embroiled in a public argument in the pages of The Times over the state of British financial reporting.

 

“Professor Stamp argued that for any major company, there would be a million ways which you could show a true and fair view, and that this was totally unacceptable. Sir Ronald reacted with alacrity, and together with the other Institutes (including a rather reluctant ICAS), agreed to form the Accounting Standards Steering Committee in 1969. Pressured by the Government, the Committee looked for a quick win and came upon a research paper of the ICAEW dealing with Associated Companies. This was rapidly turned into the Statement of Standard Accounting Practice 1. While to accountants such a topic would be a bizarre choice for the first standard, rather than what became SSAP2 – Accounting Policies – the profession needed to show it.”

 

“The argument continues over whether standards in financial reporting can best be governed by clear and detailed rules, or by principles and judgement could act quickly in a time of crisis. Since then, we have seen the SSAPs gradually replaced with Financial Reporting Standards and latterly by International Financial Reporting Standards (IFRS). These standards have become more and more complex.”

 

“Accounting is not rocket science. Writing a standard to deal with 80 per cent of the problems takes only a few pages, yet if our profession requires every avenue to be explored, then it can run into hundreds. ICAS is just completing a judgement framework to assist professionals who are unsure what exactly judgement involves. If you have been trained in what I term ‘search-engine’ accounting – looking up the answer in a massive book of rules –judgement can be scary.”

 

“The profession is at a crossroads, and the more we head down the rules route the harder it will be to pull back to simpler, more clearly expressed principle-based standards.” Read the article “Should Accounting Standards be Principles or Rules?” by Sir David Tweedie, President of the Institute of Chartered Accountants of Scotland (ICAS), as well as previous postings regarding the Principles versus Rules debate.

Are checklists killing the CA profession?

A recent article in CAmagazine notes that, when faced with the 570-plus requirements in the Canadian auditing and quality control standards, generic checklists may be a great way to start an audit, but they can lead to a lessened focus on judgment. It states that “...ours is a thinking profession, not one that relies on a mechanical approach to deliver a product. Every audit is unique so reliance on a common set of checklists is unlikely to be efficient, nor will it result in an effective audit.”

The relatively new Canadian auditing standards (CAS) clock in at 800-plus pages. Many experienced auditors rely on generic checklists developed in-house or by third parties to cope with the volume, with reliance on generic checklists appearing easier than crafting their own. However, “Research shows that reliance on systems designed to do your thinking for you can reduce your ability to make good judgments. Professional judgment is the crux of our profession. It is what the public expects and what clients pay for.”

“Systems with built-in decision-making capabilities may be easy to use, but they don’t encourage the thought required for difficult decision-making. A point-and-click operation is not the same as thinking through a process. In an effort to make application software easy, designers often bury the underlying logic in the application so users can focus on moving or clicking through the program to reach their goal quickly. While this is an admirable design goal for many computer applications, it is the antithesis of a quality audit process. Removing the decision-making process could impair a user’s ability to think deeply — and deep thinking is essential in making sound judgments.”

“This situation is more than relevant to the audit profession. Auditors must think their way through every aspect of an audit to decide what evidence needs to be obtained, evaluate the quality of that evidence and then use this information to make a myriad of professional judgments. Just because an auditor understands the individual steps suggested by the expert system does not mean he or she grasps the bigger picture of how the steps fit together. Bottom line: a successful audit is not built on a system that encourages superficial thought.”

“Generic checklists can lead to a lessened focus on professional judgment, which is the antithesis of the intent of CAS. However, customizing checklists for each audit can heighten professional judgment. Once customized, audit automation provides the ability to carry your unique approach forward annually — tailoring changes as appropriate, improving recoveries and reducing engagement risk.”

To learn more, read the article “Are checklists killing our profession?” by Phil Cowperthwaite, FCA in the September 2012 issue of CAmagazine online.

A professional judgment framework for financial reporting

The Institute of Chartered Accountants of Scotland (ICAS) has been pursuing a campaign in support of principles-based financial reporting standards since the publication of Principles not Rules: A Question of Judgement in 2006. According to the ICAS, principles-based standards provide a framework within which the economic substance of transactions can be faithfully presented and better serve the needs of business and markets, and the public interest.

 

 

The key to the effective functioning of a principles-based framework is the ability of preparers and auditors to exercise professional judgment in the application of principles to the circumstances of a particular transaction or accounting issue. The basis of such judgments needs to be properly documented, so that regulators (who also need to have the experience and expertise to consider and challenge such judgments) can assess the reasonableness of the judgments based on the facts and knowledge available at the time of the judgments.

 

In an effective principles-based environment, each party plays a key role in making their own judgments and challenging others’ judgments, building up trust that all the parties have sufficient experience and expertise and that they approach their different roles in a proportionate and sensible manner. In the light of comments received on earlier work and involvement in similar work undertaken by the Global Accounting Alliance (GAA), there is a need for guidance on how to make judgments, especially in jurisdictions which are first time adopters of International Financial Reporting Standards (IFRS) or which are used to operating in a prescriptive or rules-based environment.

 

The ICAS has therefore developed A Professional Judgement Framework for Financial Reporting: An international guide for preparers, auditors, regulators and standard setters which offers guidance that may be useful around the globe. Other postings regarding a “professional judgment framework” may also be useful.

Finding Integrity in the Auditor

 

A recent article by the Institute of Chartered Accountants of Scotland notes that “Amid global uncertainty, the search for professionalism and assurance has never been more important...” It also notes that the work the International Auditing and Assurance Standards Board (IAASB) is doing in relation to ongoing development of auditing standards and auditor reporting will be vital to providing assurance to investors, and clarity and confidence to a world sorely lacking both.

The article expresses the view that: “Confidence in an audit comes from confidence in the auditor; there's something wonderfully personal about the title ‘Auditor's Report’. It places an emphasis on the individual woman or man, on her or his expertise, evaluations and integrity. And where do you go for this integrity? Where do you go for men and women who have an innate understanding of what it means to be a professional? Where do you go for people who know their professional responsibilities and who act, not because of fear of regulators or because they’re blindly following rules, but because of who they are?”

According to the article, “It comes from the training they receive and the role models they look up. It comes from ethics declarations such as the one the newest CAs made at the recent Institute of Chartered Accountants in Scotland admissions ceremony in Edinburgh. And it comes from advice and discussion, between a community of peers and from senior to junior, about the professional issues of the days.”

Read the article “Finding Integrity in the Auditor” by Anton Colella in the August 2012 issue of GAA Accounting online (also available in the Digital Edition, page 53). To learn more, see other resources dealing with “integrity.”

Centre for Accounting Ethics: 2013 Symposium on “Tone at the Top”

The Centre for Accounting Ethics at the University of Waterloo was established in 1991 through a grant from the Auditing and Accounting Development Fund. In supporting projects designed to enhance the teaching of ethics to accounting students and the research of ethical issues in accounting, the Centre aims to help prepare future accountants and financial managers to exercise professional judgment within an ethical framework and to promote high ethical standards.

The Centre has announced its first biennial Symposium to be held on April 18–20, 2013 in Toronto, Canada. The theme is Accounting Ethics and Tone at the Top. Papers are invited from academe and practice addressing this theme. Possible questions include the role of boards of directors in shaping ethics policy, the audit committee’s oversight role in setting the ethical environment of an organization, the intersection of risk management, control systems and ethical practices and its impact on tone at the top. The papers from this Symposium will be considered for a Special Issue of the Journal of Business Ethics. Submission deadline is January 15, 2013. For more information, see the Call for papers and register online.

Additional resources are available at the Centre, including Members of the Centre, Ethics Teaching Cases, Published Articles,  Ethics Links and an Ethics Bibliography which can be searched by 59 subjects, such as “Ethical/Professional Values,” “Integrity” and “Professional Judgment.”