Accounting standards may take the form of general principles, relying on interpretation and judgment by the financial statement preparers before they can be implemented.
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:
- potentially very flexible with regard to new and changing products and environments. As such, they should also require less maintenance.
- 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 standards are generally considered easier to audit for compliance purposes, and may produce more consistent and comparable financial reports across entities.
- may include a lack of flexibility with regard to changing conditions and new products, hence requiring almost continual maintenance at times.
- frequently easier to â€œgameâ€, as entities may search for loopholes that meet the literal wording of the standard but violate the intent of the standard.