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September 14, 2007

Striking the right balance

Striking the right balance

Finding the right balance between rules-based and principles-based standards is the key to the current accounting standards debate. Nicholas Moody attended a discussion on the topic in Brussels this month and spoke to two leaders about their thoughts on the matter

European Financial Reporting Advisory Group (EFRAG) technical expert group chairman Stig Enevoldsen says the choice between rules-based and principles-based standards does not need to be mutually exclusive. “I don’t think it’s an either/or [question], life is not black and white, it’s much more complicated than a simple argument. I think it’s more a movement in one direction or the other,” he says.

Enevoldsen made the comments following a panel discussion on the issue organised by the Institute of Chartered Accountants of Scotland and the European Federation of Accountants in Brussels this month.

Paul Koster, chairman of the financial arm of the Committee of European Securities Regulators (CESR-Fin) and fellow panel member at the Brussels discussion, says convergence is an intellectually charged debate that does not have a finite conclusion. “I think the discussion has not ended. I think there will be some convergence where countries that are really rules based will slowly shift toward a broader guideline approach and countries that are really principles based will discover that they need some more detail,” he says.

Direction of debate Koster, who is also a board member on the Authority for the Financial Markets in the Netherlands, says he does not know where the debate is heading. “We need principles but the truth is that most like some rules. So as soon as a regulator brings out some new guidelines and it is on a broad term, people can have their own interpretation and judgement. Nevertheless they always ask, ‘can you give us some more guidance?’” Koster says.

He adds that “true and fair” is the overall principle that should be followed with IFRS. “That is a very good principle but as soon as you get a standard, with new content, there will be moments where you might say ‘well we are not very happy with the way this is going’. And so you might slowly and surely see additional explanations and interpretations being given,” he says.

Koster sees merit in a principles-based system with guidance rules. “The problem with principles is you have [a very wide] interpretation rule and one of the players might find themeless on the far left of the spectrum and the other on the far right. I still think that there are very good elements to the US system and they shouldn’t just deny the benefits of their approach. London has had enormous success; everyone says it is principle based. There are however rumours at times that some are also wondering in the UK if there’s not too broad a concept that could be more specific,” he says.

Enevoldsen has a slightly different view and approves of a principles-based approach with guidance at a limited level. “I think in some respects US GAAP has too many details, too much guidance and the International Accounting Standards Board [IASB] is moving in that direction in my mind and they need to pull back. But that’s just one of the issues, to me the important issue is to get good financial reporting and robust financial statements,” he says.

The move toward the convergence of international accounting standards is also being helped by the “very fruitful” relationship with senior members of the US Securities and Exchange Commission (SEC), Koster tells TA.

“The general mood is that we are in a constructive episode and it is simply having one voice on accounting in Europe for the first time that has helped a great deal, making us a more critical partner vis à vis the US. This is also happening because the US is looking around for what they can do to make their markets the place to be. So I think our interests in the end are converging. This will be a far more important path with China, India, Russia and the Middle East coming up as significant financial centres since we will actually be collaborating toward a goal that will help all companies list in their territory,” says Koster.

Shift towards principles Enevoldsen also sees the SEC top brass moving toward using more principles-based regulations although he is sceptical about how easy it will be to implement the changes. “I think it’s genuine at the SEC. They are very good thinkers, people with genuine intentions of doing the right thing for investors in the US. But whether it results in a change is more difficult because you don’t move your environment so quickly. I’m more hesitant about [their] move into a principles-based direction because it’s a lot easier to say ‘well we have ticked every box and therefore it is right’. It is much more difficult to change attitudes,” he says.

Both regulators emphasise the intellectual, almost esoteric, nature of the principles versus rules debate and Enevoldsen favours conducting it in the background. “I think it’s a fascinating, slightly artificial, debate and not the everyday life we deal with, not even when you’re talking about accounting standards,” Enevoldsen tells TA. “I think it is good having the debate moving in the background to ensure that it gets to the IASB. It’s interesting how much influence the debate has on the practical world.”

Baker Tilly International president Geoff Barnes is also wary of pushing the rules- versus principles-based standards discussions too far into the public forum.

Barnes, who was also on the Brussels panel with Enevoldsen and Koster, warns “inconsistency [in deciding which approach is best] can damage the reputation of our profession”. It is vital to have a consistent global view about which path to take on the issue, he adds.

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