CPAs and CFOs PERCEPTIONS REGARDING PRINCIPLES BASES VERSUS RULES BASED ACCOUNTING STANDARDS Harvard Case Solution & Analysis

INTRODUCTION

Almost all of the companies of the world’s leading markets are required to prepare their financial statements in accordance with the relevant and reliable accounting standards. For the companies listed in the US market, they need to follow the Generally Accepted Accounting Principles (GAAP), which is based on the rules-based accounting system. However, the companies listed on the UK market are required to follow the International Financial Reporting Standards (IFRS).

The IFRS are based on the principles based accounting system. While the GAAP standards are based on the rule based accounting system. The difference between the principles based accounting system and the rules based accounting system is that under a rules based accounting system where specific regulations, rules and laws must be followed so that the financial statements of the company comply with comply with GAAP. These rules are strict to follow and they must be followed if the company prepares its financial statements on the rules based accounting system. This approach leaves no room for the financial statement preparers and for the management of the company for flexibility in preparing the financial statements and it increases rigidity.

The rules based accounting system is also a form of aggressive accounting under which if there is a certain accounting treatment then that treatment must be followed so that the financial statements of the company show a true and fair view. If the financial statements deviate from these rules than they are considered to be misleading and not prepared on the fair basis. In the US market, if a certified public accountant does work for a client and he fails to properly apply GAAP, then he could be held in violation of Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA).

The IFRS on the other hand are based on a principles based accounting system. Under this system, the underlying concepts of the standards are same but they provide few exceptions in the principles which are not the case with the rules based accounting system. This system favors principles and avoids rules. Therefore, while the companies are preparing their financial statements they have a lot of flexibility and they have many choices or exceptions to choose one method of accounting treatment over the other.

This article focuses on the perspectives of the certified public accountants and the chief financial officers regarding the principles based accounting system and the rules based accounting system. There has been a lot of discussion and analysis regarding these two approaches over the years, however the controversy over a principles based accounting system has globally been evolving since then. This is also seen by the fact that those companies that are basically non-US companies have freedom to adopt the international financial reporting standards and they are also permitted to list of the American stock exchanges without meeting the requirements of implementing a GAAP framework. However, this rule has not been extended for the US companies which is something that has made this thing controversial. This article focuses on certain attributes and on the basis of those attributes it compares the rules based and principles based accounting system from the perspective of the public accountants and the chief financial officers.

PROBLEM STATEMENT AND ISSUES

The initial collapses of large corporation such as the Enron and WorldCom led to the situations that confirmed that the current standards being followed left room for creative accounting and manipulating. It was then when a new accounting system needed to be developed. The rules based accounting system has failed previously and had not worked well. However, this system has its own advantages and disadvantages. Its advantages include clarity of reporting, consistency in the preparation of financial statements, reduction of risk and also the companies can be individually compared with other companies. However, the disadvantage of this approach is that the rules must be followed no matter if the financial statements gives misleading results and become non comparable.

On the other hand, however, under principles based accounting system there are no rigid rules. The management has to follow the standards and make their own guidelines. This helps the company to meet the requirements of preparing the financial statements with greater flexibility and also adopting different methods for different situations so that the results are reliable. There is also an advantage of greater comparability between firms in the industry. However, the disadvantages associated with this approach are that there is a lot of room for manipulation by the management. The management might use different transactional approaches for similar transactions for their personal benefits. This affects the reliability of the company and the financial statements are misleading for the investors...................

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