Do Principles- vs. Rules-Based Standards Have a Differential Impact on U.S. Auditors' Decisions?

Abstract

Multiple stakeholders in the financial reporting process have articulated concerns over the rules-based orientation that U.S. accounting standards have adopted. Many argue that a more principles-based approach to standards setting, typified by international accounting standards, would improve the quality of financial reporting and strengthen the auditor's position when dealing with client pressure, thereby enabling a focus on transparency and fairness of financial reports. In early 2009, the U.S. appeared poised to transition U.S. accounting standards to international accounting standards. The transition decision was made after the recommendations of the SEC Advisory Committee on Improvements to Financial Reporting (i.e. SEC Pozen Committee) publicly expressed strong support in its final report (U.S. SEC 2008a). The SEC in turn issued its Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers on November 14, 2008 (U.S. SEC 2008b) outlining the transition procedures. However, with Shapiro taking over as chairperson of the SEC, this move now appears less likely pending a stronger review of how principles-based international standards may impact the strength of financial regulatory oversight-a potential delay met with disdain by the pro principles-based European regulatory community (Doran 2009). While transition to international standards continues to progress, little research examining whether principles-based standards affect auditor decision-making has been conducted. The purpose of this study is to explore the impact of principles- vs. rules-based standards on auditors' willingness to allow preparers leeway in reporting practices and to consider how auditors' decision behavior is influenced by potential client pressure and/or opposing pressure from the SEC. Based on a sample of 114 experienced auditors, the results show that auditors are more willing to allow clients to manage earnings under rules-based standards; and, these results are persistent even under external pressure. Results also indicate that more experienced auditors are less willing to allow clients who exert high pressure to report earnings aggressively while SEC pressure has more affect on less experienced auditors. These results provide important insights to the FASB, SEC, and IASB as they weigh arguments underlying the principles- vs. rules-based debate.

JEL Classification: M41, M44, G38, M47, M49