Principle-based:
Accounting standards may take the form of general principles, relying on interpretation and judgment by the financial statement preparers before they can be implemented.
Whereas:
Rule-based:
Alternatively, standards may take the form of a series of rules, limiting the flexibility and use of judgment allowed in their implementation.
A Comparison of the Principle-based versus Rule-based:
Principal-based:
Advantages :
- potentially very flexible with regard to new and changing products and environments. As such, they should also require less maintenance.
Disadvantages:
- more difficult to audit relative to compliance, and concern over consistent and reliable interpretations across entities.
- To the extent that they rely on individual judgment to interpret and implement the standards, there is a danger that they can be used to manipulate financial results.
Rule-based:
Advantages:
- Rule-based standards are generally considered easier to audit for compliance purposes, and may produce more consistent and comparable financial reports across entities.
Disadvantages:
- may include a lack of flexibility with regard to changing conditions and new products, hence requiring almost continual maintenance at times.
- frequently easier to “gameâ€, as entities may search for loopholes that meet the literal wording of the standard but violate the intent of the standard.
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