February 17, 2017

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To improve the representational faithfulness of financial statements

As in all cases, the principles- based accounting has both advantages and disadvantages. The primary advantage rests in its broad guidelines that can be employed in numerous circumstances. Broad principles avoid the pitfalls accompanied with precise requirements that allow contracts to be written specifically to manipulate their intent.
It is worth recalling here in this juncture that managers try, on purpose, to structure leases as operating leases to avoid incurring additional liabilities. Providing broad guidelines may improve the representational faithfulness of financial statements. Principles-based accounting standards allow accountants to exercise professional judgment in assessment of the substance of a transaction. This approach is dramatically different from the underlying box-ticking approach common in the rules-based accounting standards.
In this regard, FASB chair Robert Herz would like to be quoted as saying that professionalism of financial statements would be enhanced if accountants are required to use their judgment instead of relying on the detailed rules. A principles-based system would result in simpler standards. In fact, principles would be easier to comprehend and apply to a broad range of transactions. As standards are developed based on rules, they are insufficiently flexible to accommodate future developments in the market places. This has resulted in accounting for unanticipated transactions that are less dangerous. In fact, the financial statements which are prepared under accounting standards, clearly state the accounting objectives and have few exceptions. The financial statements should be easier to understand, more meaningfully and informative; they are likely to result in similar transactions and events being accounted for similarly, and more likely to reflect the economic substance of a transactions partly because there will be less opportunity for financial engineering (Heffes, Ellen M , 2004).


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