In particular, the staff is consumed with contrasting a rules-based system with what it calls an objectives-oriented principles-based accounting system. Unfortunately, the staff never defines its terms. Without some idea of what the staff members actually think constitutes these three constructs, one finds it difficult to perceive exactly what it is staff members are talking about.
I can understand this lack of definitions of terms. Many, many people wrote essays in the 1960s and the 1970s that attempted to bash rulemaking in support of the promulgation of principles. Unfortunately, nobody ever succeeded completely. Not achieving this differentiation emerges because accounting is a human invention that exists for utilitarian reasons. There is no clear dividing point between what is a rule and what is a principle, and different individuals will evaluate a statement as a rule or as a principle differently.
The staff punts this lexical issue by providing lists on pages five and 11 of the document. One list deals with characteristics of an objectives-oriented principles-based accounting system, while the other enumerates the shortcomings of a rules-based system. Combining the lists, we have:
The first criterion provides a noble goal, but standards setters can apply it under a rules-based, principles-based, or objectives-oriented system. A perfectly consistent conceptual framework might be constructed in some utopia, but on earth this goal will always remain an ideal. As such, it's unfair to criticize the current process by the Financial Accounting Standards Board for formulating new statements.
The second attribute is curious. While laudable, this too can be applied under any of the approaches to standards setting. Additionally, it might not be that critical, given an existing conceptual framework.
Let's look at the staff's example in which the objective might be to improve the accounting for business combinations. Regrettably, that example doesn't help much, since this was a goal of both APB Opinion 16 and SFAS 141 by the FASB. Given that the staff alleges that Opinion 16 exemplifies rules-based standards and that Statement 141 illustrates principles-based accounting, it is not clear that this criterion helps much.
The third condition is applicable to all three systems. Of course!
The fourth trait is important and starts to explain the features that distinguish the systems. But, the staff does not tell us how many exceptions to allow, so we have not advanced very far. (If it creates a bright line to tell them apart, then the staff will violate the next feature.)
The fifth characteristic perhaps comes the closest to differentiating rules-based and principles-based systems. But, how can a regulatory body avoid use of percentage tests (i.e., bright lines) unless it eliminates all alternatives? Returning to the example of business combination accounting, we find that the staff criticizes the twelve criteria in APB Opinion 16 for telling whether to apply purchase or pooling accounting. The basis of this censure rests mostly on these bright lines. Turning to FASB's Statement 141, we find that the board eliminates all but the purchase method, so no bright lines are needed. It isn't the bright lines so much as it is the existence of several options that causes the problems. On the other hand, maybe the staff could examine the accounting for investments and illustrate how to create a principles-based rule that indicates when to employ the equity method and when not to. A better example might clarify the issue.
Last, I have mixed feelings about issuing implementation guidance. Perhaps the rules should not contain too many implementation thoughts; we could leave those concerns with another board. But let's not kid ourselves -- given our litigious society, much implementation will be desired and accounting regulators would drop the ball by not furnishing this advice.
Let's bring this essay to closure by pointing out that the staff did not address the perplexing issues of the day. I suggest that the SEC staff perform another study and publish the results as an addendum to this report. Specifically, I would like the staff to research two complex issues and provide something more concrete in how to address the accounting. Given that at least a trillion dollars of SPE liabilities and pension liabilities do not reach corporate balance sheets, I request the staff to inform us why the SEC allows these debts to stay off the balance sheets.
Help us to create some meaningful rules or principles -- in the end I don't care what you call them -- but don't keep hiding these liabilities.
J. EDWARD KETZ is the MBA Faculty Director at the Smeal College of Business at The Pennsylvania State University. Dr. Ketz's teaching and research interests focus on financial accounting, accounting information systems, and accounting ethics. He is the author of Hidden Financial Risk, which explores the causes of recent accounting scandals.2003 SmartPros Ltd. All Rights Reserved. Editorial content does not necessarily represent the opinions or beliefs of SmartPros Ltd.