Samuel J. Ochieng
DQ Week 2
Discussion on whether to use rules or principles based accounting standards
Stakeholders in accounting include and are not limited to shareholders/investors in the company, regulators, lenders, customers and the accounting profession, just to mention a few. All the stakeholders have interest in high quality accounting reports that enable them to make a fair judgment whenever they need to make a decision on regarding a company.
Rules-based and principle-based accounting standards both have advantages and disadvantages. Advantages of rule-based accounting standards include clarity in application, reduction of risks when the rules are followed to the letter and the ease of comparing companies with the same industry using the same rules. Disadvantages of rule-based accounting standard include rigidity since a transaction must be accounted for under specified rule(s), inability to compare companies when the rules are different even if the transactions are similar and increased risks when the prescribed rules are not adhered to. Advantages of principle-based accounting standards include the option(s) left to those preparing the accounting statements to consider how to account for and report a transaction, ease of comparison of companies with similar transactions and the room to for accountants to defend their positions based on the principles followed. Disadvantages of the principle-based approach include the proliferation of too many accounting approaches with different principles, room to manipulate accounting statements and lack of precise rules on how to account for transactions.
Discussion on the accounting standard, whether rules-based or principle-based accounting, that best serves the needs of stakeholders have focused on the experiences with either of the approaches, lessons learnt and the evolving needs on the stakeholders.
Smith and Hogan (2004) argue that Enron and other high profiled corporate scandals have intensified scrutiny of accounting standards-setting processes and regulatory systems that are being established to prevent the recurrence of such scandals. In their view, many stakeholders prefer principle-based compared to rule-based accounting standards. In his testimony on legislative solutions to problems raised by events relating to Enron submitted to a sub-committee of the US House of Representatives, the Chairman of the US Securities and Exchange Commission (SEC), Harvey Pitt, pointed out that companies should be required to point out the most critical accounting principles upon which the company’s financial status depends and that investors needed to be informed on how the principles have been applied and the possible effects in differing application of these principles.
Accounting approach used in Kenya
Kenya adopted the IFRS system, which is regarded as principles-based in 1999 through a resolution of the Institute of Certified Public Accountants of Kenya (ICPAK). Outa (2011) in a study on the...