Accounting with Principles!!

Accounting with Principles!!

Today we would like to talk about one of the most important aspects of accounting today, the Principle based accounting. For people who are not from ACCA or are from ACCA but haven’t studied the Financial Accounting, Financial Reporting and Strategic Business Reporting papers may not be aware that the IFRS standards are purely based on principles.

But why Principles? So let’s look at what happens if we do not follow the principle based accounting, i.e. we follow the rule based accounting like the US GAAP. The rule based accounting are actually very straight forward, there’s either black or white, there’s either right or wrong, there’s no grey area per se. Like in the Rule based LAW system, if you steal, then you are a criminal. There won’t be a difference between someone who has a hungry family that hasn’t eaten for last few days and that person steals Rs. 30 worth bread, or someone who is out and about cheating people of their money and going on international holidays living a life people can only dream of. Obviously by now you would have understood where we are taking you, the rules are straight forward however can be crude at times and may not even relay the right judgment.

Similarly the rule based accounting can be used to cook the books as people (accountants) may sometimes want to play with the numbers aka window dressing and therefore would be able to circumvent the rules in place. Therefore it’s about bending the rules without breaking them; this ensures you still are not on the wrong side of the accounting standards requirements. Enron failure is a prime example of window dressing where the shareholders lost over $75 billion after the company's senior executives used fraudulent accounting practices to overstate revenue while hiding debt in its subsidiaries. This was possible because the executives were able to circumvent the rules.

Let’s take an example that the rules allow any expense that have been incurred towards making an asset can be capitalised. Therefore anything and everything instead of going to P&L will be added to the value of the asset. However the principles state that these can be only be capitalised if the management does think that the asset eventually will result in probable benefits, the company has the intention and the resources to complete the asset and that the expenses incurred can be reliably measured. Now with these principles it will become difficult for a company to capitalise any expenses where they know the end Asset may not ever complete because of lack of resources, capabilities etc. So here, it’s difficult for someone to con the investors by just using the rule book and do window dressing.

It is for these reasons most countries have started to use the principles-based system, as it easier to adjust accounting principles to the company’s transactions, rather than adjusting a company’s operations to accounting rules.There are currently more than 110 countries that use IFRS as their accounting standards which are a principle based accounting, while the U.S. continues to use the rules-based GAAP method. As a result, investments, acquisitions, and mergers may require a different lens when comparing international competitors such as Amazon and Flipkart, which use different accounting methods.

 

About Author

Zaheer Sayed, is one of the oldest ACCA members in India having passed out ACCA exams in December 2007 from London. Has vast work experience of over 14 years, having worked with Ernst and Young in Stat Audits to working as Associate Director at the UBS Bank, has in-depth knowledge of finance and accounting world. On academics side, has been teaching for almost 10 years, with ACCA teaching experience of over 6 years specialising in Reporting, Tax and Audits. Has also co-authored over 20 titles for a leading publication house in Pune on varied topics like Economics, Audit, Accounting, etc.