According to a 2013 Financial Reporting Commentary by Staff
of Canada’s
Accounting Standards Board, the debate over principles-based standards vs.
rules-based standards has gone on for many years. All standards should be based
on principles. There also needs to be some amount of guidance in the standards
on how to apply those principles. The question is how detailed or rules-like
should guidance be? What is the balance that provides enough guidance to apply
the standards in a consistent manner – but still leaves sufficient flexibility
for financial statements to provide information about the entity in a way that
is most helpful to users?
Detailed guidance makes it easier to determine the
accounting for specific transactions and events – just check the rules. It also
makes consistent application of the standards more likely. However, in some
circumstances rules may not result in financial statements that provide the
most relevant information. This is because those writing the standards often
cannot foresee all the different types of transactions and circumstances that
the rule will be applied to. In the extreme, detailed rules can become a
straightjacket that limits the ability of financial reporting to provide
information that meets user needs. Detailed rules can also make it easier to
structure transactions to achieve a certain accounting result that is contrary
to the underlying principles of the standard.
Professional judgment searches for the accounting that best
meets the objective of financial statements – communicating information to
financial statement users that helps them in making resource allocation
decisions and assessing management stewardship – and is consistent with primary
sources of GAAP. This is the test that must be met when applying professional
judgment. In many cases, it will be clear there is only one method of
accounting that meets this test for a specific transaction or event. However,
differences in key facts or circumstances may result in different accounting
being appropriate for similar transactions or events.
Read more about this Commentary
on Making Judgment Professional and the ongoing debate over principles-based
standards vs. rules-based standards.
