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What are the advantages and disadvantages of principles-based accounting? Perhaps the
primary benefit of principles-based accounting rests in its broad guidelines that can be
applied to numerous situations. Broad principles avoid the pitfalls associated with precise
requirements that allow contracts to be written specifically to manipulate their intent. A
1981 study sponsored by FASB found evidence that managers purposefully try to structure
leases as operating leases to avoid incurring additional liabilities. Providing broad
guidelines may improve the representational faithfulness of financial statements.
In addition, principles-based accounting standards allow accountants to apply professional
judgment in assessing the substance of a transaction. This approach is substantially
different from the underlying "box-ticking"“ approach common in rules-based accounting
standards. FASB Chair Robert Herz has stated that he believes the professionalism of
financial statements would be enhanced if accountants are required to utilize their
judgment instead of relying on detailed rules.
Another advantage of a principles-based system is that it would result in simpler standards.
Herz has claimed that a principles-based system would lead to standards that would be less
than 12 pages long, instead of over 100 pages (BusinessWeek online, 2002). Principles
would be easier to comprehend and apply to a broad range of transactions. Harvey Pitt,
former SEC chairman, explained this as follows: "Because standards are developed based
on rules ... they are insufficiently flexible to accommodate future developments in the
marketplace. This has resulted in accounting for unanticipated transactions that is less
transparent."“
Finally, the use of principles-based accounting standards may provide accounting
