Principles Based Accounting
There is increasing political pressure on the SEC and FASB to adopt global accounting standards.
Clearly, most large US companies derive a substantial part of their income and sales outside the US, and it is a significant issue. Generally, foreign accounting standards can be described as principles based accounting as compared to the US rules based accounting.In theory, principles based accounting focuses on reporting which yields the “correct” results without specifying how these results should be obtained.Another way to view this is the “end justifies the means” although the public agencies would not use this term.
On one hand, this is intellectually appealing as the myriad of rules promulgated by FASB et al. is virtually impossible to keep up with. Often the minutiae of the rules moves the focus from the goal or results.
The problem with this approach is psychological, not accounting. It requires confidence that corporations will have a common aim of fairly reporting results.
My 30+ years in corporate America has taught many valuable lessons. Perhaps the most consistent is that people will act in ways which is to their benefit (which they should), and will act in ways they are incented to do so.
Salespeople are often paid a commission based on sales volumes. Without the proper credit controls, we can reasonably expect them to sell to any customer, regardless of the ability to pay, because it is in their interest to do so.
Corporate executives are often paid with bonus and stock option calculations that reward successful performance. (Although recently the link is often tenuous at best). So it is in their best interest to report better results.
If we are to have confidence in principles based accounting, we need confidence that executives will report accurate results. Since this may not be in their best interests, we can reasonably conclude that faced with a choice between accuracy and personal reward, many will choose the latter. The same is true for accounting firms certifying results who are paid millions of dollars to do so.
This is a fundamental inconsistency in principles based accounting. Also, in many parts of the world truth is more relative than it is in the US. Prevarication and graft are woven into the fiber of many non-US cultures. This is not necessarily a criticism, as complex situations often have multiple explanations. It does not, however, lead to more accurate financial reporting.
A massive, significant change of this nature should have expected positive benefits. Other than potentially reducing costs, due to multiple reporting standards, it is difficult to see how this would be a positive change. It most likely would lead to more financial reporting irregularities.The current rules based system does not remove or eliminate the possibility of fraud as our recent experience clearly shows.
Unfortunately, principles based accounting is not a solution, since the problem is not caused by accounting, but by individuals, and this is not likely to ever change.
This entry was posted on 6. July 2008 at 19:11 and is filed under Servicing Valuation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or trackback from your own site.