Principles‐ versus rules‐based accounting standards: the FASB's standard setting strategy

In response to criticism of rules‐based accounting standards and Section 108(d) of the Sarbanes‐Oxley Act of 2002, the SEC proposed principles‐based (or ‘objectives‐oriented’) standards. We identify several shortcomings with this approach and focus on two of them. First, the format (type) of a standard is dependent on the contents of what the standard regulates. Given the asset/liability approach combined with fair values, we argue that the combination of this measurement concept with principles‐based standards is inconsistent because it requires significant guidance for management judgment. Second, we propose the inclusion of a true‐and‐fair override as a necessary requirement for any format that is more than ‘principles‐only’ to deal with inconsistencies between principles and guidance. We discuss the benefits of this override and present evidence from the United Kingdom's experience.