Principles- Versus Rules-Based Accounting Standards: The Fasb's Standard Setting Strategy

Abstract

In response to criticism of rules-based accounting standards and Section 108(d) of the Sarbanes-Oxley Act of 2002, the SEC proposed principles-based (or objectives-oriented) standards. We identify several shortcomings with this approach and focus on two of them. First, the format (type) of a standard is dependent on the contents of what the standard regulates. Given the asset/liability approach combined with fair values, we argue that the combination of this measurement concept with principles-based standards is inconsistent because it requires significant guidance for management judgment. Second, we propose the inclusion of a true-and-fair override as a necessary requirement for any format that is more than principles-only to deal with inconsistencies between principles and guidance. We discuss the benefits of this override and present evidence from the United Kingdom's experience.