Question

Contrast rules-based versus principles-based accounting,​

Answer 1

All companies need to prepare their financials as per law of the country. Some countries has rule based accounting while some countries has principle based accounting.

IFRS is typically regarded as Principle based accounting while US GAAP is regarded as Rules based accounting.

Under principle based accounting there exists potential of interpreting the same transaction in different manner by two different entities. Such situation will require more disclosure in financial statement. It provides flexibility to firm to adopt best suitable accounting method. Due to lack of rules two firm in same industry may use different approach for same transaction this may result in non-comparability. Sometime interpretation issues may lead the matter to the court for financials incorrectness. IFRS provides guidance statement which kind of work like supplementary rules for the principle.

Under rules based accounting rules are mandatorily need to be followed. This accounting method will have predefined sets of rules for particular kind of transaction. In such scenario there will be less ambiguity and it increases comparability across the companies – as all the peers are using same rules for accounting. Sometime rules based accounting may not provide true financial update for the company as there is very less room for using other than the given method of accounting which may not be most suitable approach for that particular industry/company.

In any circumstances accounting rule or principle should provide Relevant, Reliable & Comparable financial information.