Recently I re-read the comment letters to the Financial Accounting Standards Board about principles-based accounting. I was happy to see that in this reality show not everybody who was a contestant compromised ethics and good sense.

Recall that Section 108 (d) of the Sarbanes-Oxley Act mandated a study of principles-based accounting. FASB entered this public forum soon after, perhaps to influence the tenor of the debate. FASB began with its mantra, "Recently, many have expressed concerns about the quality and transparency of U.S. financial accounting and reporting. A principal concern is that accounting standards, while based on the conceptual framework, have become increasingly detailed and complex." The board erroneously claimed that complex rules was behind the likes of Enron, WorldCom, and the thousands of accounting restatements -- when in reality the main culprit was the lying thieves otherwise known as managers and, in some cases, their professional advisers.

FASB received 135 written comments, and most of the responders support a principles-based approach. But, let's consider the voice of sanity raised by some of these responders.

BDO Siedman begins by observing that FASB does not define its terms, so the difference between principles-based and rules-based accounting is unclear. BDO Seidman claims that the dichotomy is artificial because accounting standards-setting in the real world is a blend of principles and rules. If the board proceeds on this path and reduces guidance, it will lead to significant lack of comparability among financial reports. Additionally, the board did not sufficiently analyze the causes of complexity, which also include inconsistent principles and inconsistent implementation guidance. Finally, BDO Seidman wonders how regulators and the court system will react to corporate judgments made under principles-based accounting, particularly when a firm faces financial distress. Can principles-based accounting flourish in the U.S. without changes in the legal and regulatory infrastructure?

Computer Science Corporation is in favor of the principles-based approach to standards-setting, but quickly adds, "We do not believe any system can eliminate noncompliant and misleading reporting of companies led by irresponsible executives." The firm also feels that in today's litigious environment, a safe harbor provision would be helpful to protect those managers and auditors who make a good faith effort when applying accounting principles.

Intel does not support the proposal. The elimination of specificity would eventually reduce the quality and the transparency of financial reporting. The corporation feels that FASB should adopt the less ambitious goal of improving the current standards-setting model.

R. G. Associates opposes the idea; CEO Jack T. Ciesielski writes, "I believe that all of these justifications for moving to a principles-based standard setting approach grossly oversimplify matters or merely shift blame to another party. There's simply no way in the world to know whether or not capital would have been wasted in the same way had a different approach to standard-setting been in effect. (In fact, one could very easily argue that because principles-based accounting standards are open to interpretation by the preparer and auditor, there could have been even more gamesmanship.)" Ciesielski addresses the claim that countries that use principles-based accounting have not had such scandals with the answer that those countries also do not have market participants who put insane pressure on managers to "make the numbers" each quarter. With respect to the complexity argument, the firm says the complexity is due to the transactions. And with respect to an overload of standards, R. G. Associates inveighs against investment bankers who innovate new ways to skirt accounting standards.

Robert Anthony, retired accounting professor from Harvard, thinks proponents of a principles-based approach assume ethical behavior by managers and others. He thinks the assumption unrealistic. He then introduces a traffic analogy. Rules-based traffic controls use red lights; principles-based traffic controls would eliminate red lights and create principles by which drivers can sort out what to do. In the latter case society would hope that drivers remember these principles (stop for fire trucks, etc.) and would adhere to these principles.

Professor Sharav (Columbia) believes that we already have principles; in particular, full and fair disclosure requires managers to follow the spirit of the accounting standards. In addition, he thinks it will be "much harder to prove specific violations" under principles-based accounting and that managers will feel no pressure to be ethical when preparing financial reports.

Professor Zimbelman (Brigham Young University) objects to the notion that there will be less financial engineering under principles-based accounting; he thinks the approach will provide more opportunities for earnings management and that mangers will seize these opportunities. He also thinks a true and fair override will not be used by auditors unless they have something that could be used in court.

Finally, consider the comments by a former FASB member. David Mosso begins his observation with the claim that "professional judgment" is an euphemism for "client choice" and "client choice" is motivated by self-interest and not by some desire to provide quality and transparent financial reports. The issue is not rules versus principles, but choice versus restriction of choices. The Committee on Accounting Procedure and the Accounting Principles Board both confronted the issue, and both failed in part because they were unable politically to reduce the number of choices in financial accounting.

FASB and the SEC continue to take steps to implement a principles-based accounting standards-setting system. But, questions and concerns still abound. What exactly is an accounting rule and what is an accounting principle? Why is complexity viewed as a problem but managerial lying and thievery are not? Where is the evidence that principles-based accounting will help investors? For some strange reason, FASB and the SEC ignore these annoying questions and continue with religious fervor to support their idol. Too bad FASB and the SEC aren't listening to the Simon Cowell's of the profession because logic belongs to them.

This essay reflects the opinion of the author and not necessarily the opinion of The Pennsylvania State University.