Can principles overule the rules?

In the words of Franklin D Roosevelt, “Rules are not necessarily sacred, principles are”.

During his reign this central figure in world events navigated a period of worldwide economic crisis, introduced the regulation of Wall Street by the Securities and Exchange Commission, and spearheaded a variety of reform programs.

Flash forward to today and President Roosevelt may have had a lot of influence over the current debate on principles-based accounting standards.

ICAS continued its five-year long campaign on principles-based standards with a recent joint event with BDO in London to debate what the future holds. Speakers at the event included Hugh Shields, Chair of ICAS Corporate Reporting Taskforce; Hans Hoogervorst, International Accounting Standards Board (IASB) Chairman; Bill Knight, Chairman of the UK Financial Reporting Review Panel and James Roberts a Partner with BDO.

The event coincided with the 5th anniversary of the ICAS publication ‘Principles not Rules: A Question of Judgement’; published to help find a resolution to the principles versus rules debate within international accounting standard setting.

The report at the time concluded that a principles-based approach to standard setting was essential to serve the needs of business and the public interest. Following the onset of the financial crisis, the need for well written principles-based accounting standards has gained further backing.

A recent member survey by ICAS determined strong support for a principles-based framework for financial reporting. Nearly 92 per cent of respondents expressed a preference for principles, supported by additional guidance or rules. However, 67 per cent expressed concerns that international financial reporting standards (IFRS) have become more and not less rules oriented over the last five years.

At the event, Hugh Shields warned of an overwhelming belief that the financial crisis will lead to more rules, when the aftermath clearly demonstrates the need for more principles. “There is a danger that we will breed accountants who like to tick boxes. We must not lose the ability to make judgements. If principles are well written, it is much more difficult to do things that would fail a ‘smell’ test”, he said.

He urged the profession “to come to the table with action and to be guided not dominated by technical accounting.”

Hans Hoogervorst spoke of the future direction of the IASB stating he is “a firm believer in principles- based regulation and standard setting. Too much prescription takes common sense out of the equation.”

However accountants may face challenges in implementing professional judgement. At the event, ICAS announced its plans to publish a professional judgement framework for financial reporting preparers, auditors and regulators, to help make and document judgements in a principles-based accounting environment.

The judgement framework evolved from China’s experience in implementing principles-based standards. Based on ICAS interviews with key stakeholders in China, it was clear that full convergence of financial reporting was unlikely to be achieved without the simplification of IFRS and a clearer framework to explain how principles-based judgements could be arrived at.

The ICAS professional judgement framework will be straightforward and concise and it will assist preparers of financial statements and auditors when faced with accounting for complex business transactions, and should be applicable internationally as well as in the UK.

These plans were welcomed by the audience of leading business figures at the conference. James Roberts speaking at the event stated that “what we really need is a culture where professional judgement is nurtured”.

Bill Knight stated that we “need principles and rules” and that “presentation, disclosure and enforcement are all part of the story”. Although a principles-based approach worked in the UK, he was sceptical as to whether this could be rolled out across all jurisdictions and cultures across the world, and feared that more rules could be necessary.

Views from speakers and the audience at the event were generally unified that rules-based accounting adds unnecessary complexity, encourages financial engineering and does not necessarily lead to a true and fair view or fair presentation. Principles-based accounting provides a more comprehensive basis for the preparation of financial statements.

However, principles-based standard setting will still require a change in the global profession, with preparers and auditors assuming more responsibility for their judgements; the documentation of key judgements in the financial statements; and regulators accepting a range of judgement-based outcomes.

The difficult challenge of “rolling back the tide of existing rules” was recognised by all.

David Wood is executive director of technical and member services at ICAS