Understand The Difference Between Principle-based Versus Rule-based Accounting Standards

Difference Between Principle-based Versus Rule-based

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 “game”, as entities may search for loopholes that meet the literal wording of the standard but violate the intent of the standard.