Litigation and government investigations may pose the biggest obstacles to moving US accounting standards toward more principle-based accounting, said Ed Nusbaum, chief executive of accounting firm Grant Thornton.
"The regulators and lawyers need to accept principle-based guidance and use of judgement," Nusbaum said. "The SEC (US Securities and Exchange Commission), PCAOB (Public Company Accounting Oversight Board) and class action litigation are the three biggest hurdles against principle-based guidance."
For more than 50 years, US accounting standards, known as Generally Accepted Accounting Principles (GAAP), have created hundreds of intricate rules and standards for everything from revenue recognition to balance sheet item classification.
But increased emphasis on corporate governance from the SEC and a push toward convergence with international accounting standards has prompted the Financial Accounting Standards Board (FASB), which sets US accounting rules, to change the rule-based approach.
FASB chairman Bob Herz has said he is trying to move toward more principle-based standards that may better reflect economics, but require more judgement from management and auditors.
"But the real issue is whether the SEC and the legal system will allow principle-based standards," said Nusbaum, who heads the fifth biggest US accounting firm by revenue. "If they are going to second guess everything then everyone will just want the rules."
The SEC has been looking at the benefits of a more principle-based approach to accounting standards since the Sarbanes-Oxley accounting reforms were passed in 2002 in reaction to accounting scandals at Enron and WorldCom. In 2003, SEC staff recommended accountants take a broader, more principled approach to accounting standards, but since then, SEC staff has expressed concerns.
Just last year a senior SEC staffer, Edmund Bailey, told the American Institute of Certified Public Accountants that there would have to be attitude adjustments among regulators and more safeguards for auditor independence, to comfortably pursue a more principles-based approach.
For years companies have requested rules, to try to avoid litigation from shareholders or investigations, but a move toward principles could make that crutch for companies vanish.
"It does carry some risk," Nusbaum said. "Will everybody push the envelope? A lot of accounting issues are very complex and you need a tremendous amount of judgement. You need a tone from the audit committee and the company saying 'we don't want to push the envelope'."
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