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New York Institute of Technology

ACCT 101 Accounting I Summer I, 2012 Assignment III

Reem M. Alzari Dalal Al Jalahma Ahmed Taqawi

July 09, 2012

Reem Alzari Dr. Samy Nathan Accounting 101 14 October 2012 Rules vs. Principles-Based Accounting Standard Rules and principles, which one works better? Our daily life routine depends on rules and principles in everything that we do, whether at home, at work or at a theatre we are always bounded by those two. To briefly define the terms, rules are like a guide or a manual which will tell you exactly how or what to do, whereas principles will generally guide you but will give you the option to choose which way to handle a specific situation. In the following paragraphs we will be discussing Gerui (Grace) Kang and Jerry W. Lins article on rules-based and principles-based accounting standards and which one works more effectively for motivated management. The article examines whether the type of accounting standards influences the management accounting reporting behaviours with the presence of environmental variables and motivation. A study has been done with the participation of ninety-six senior accounting students to support the prediction that motivation has a major impact and affect on managements financial reporting decision. With motivation, management tends to report aggressively with rules-based rather than principle-based accounting standards and that motivation becomes consistent and regular in the managements accounting choice. Furthermore, this article mentions some studies that argue against the prediction. The studies state that accounting information develops under principlesbased accounting standards through limiting managements aggressive reporting. Other studies state that choosing the appropriate accounting standards when reporting is more of an individual act by individuals themselves when basing their judgments and decisions. When managers have the motivation to produce aggressive reports,
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they will attempt to tailor those reports according to their motivation no matter what type of accounting standards they use. In addition, applying rules-based accounting standards makes it easier for a motivated management to produce reasonable justification than applying principles-based standards and get challenged by auditors. Simultaneously, the U.S. lease accounting standard (SFAS No. 13) was used as an alternative for rules-based accounting standards and the International Accounting Standards (IAS 17) was used as an alternative for principles-based accounting standards in the studies conducted for this paper. It was found that when management had motivation to produce aggressive reporting selection, they accomplished that by choosing the rule-based accounting standard instead of the principles-based accounting standards. The main finding showed that the accuracy of accounting standards causes the choice of aggressive reporting by management. Moreover, the study had three other important outcomes. First, the FASB has been working with IASB to join the current U.S. GAAP with international financial reporting (IFRS) to make it more principle-based than rules-based standard. Second, it is necessary to enhance the current financial reporting method to manage the influence of motivation on the managements decision to report aggressively. Third, aggressive reporting possibility is less when managements decision is to choose principles-based instead of rules-based accounting standards, and having a principlesbased accounting cannot entirely reduce or demolish the managements aggressive reporting as long as they have the motivation to do so. Obviously, and according to psychological theories motivation is considered to play a major role in human behavioural change; in which the same relates to the change in managements behaviour. In the paper they examine what they have called motivated reasoning theory, which focuses on the effects of the motivations interaction with the accuracy of accounting standards and how it later influences

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managements reporting choice. It has been found that when management is motivated to report aggressively, it is easier for them to use the rules-based accounting standards to create rational explanation for the auditors to accept their choice. Hence, when management have motivation for aggressive reporting, they would prefer doing so by choosing a clear-cut accounting standard. Accordingly, the article is rich with information and various examinations in regard to the rules-based and principles-based accounting standards. It tends to influence the change of the accounting standards from being aggressive into being more lenient when producing reports. It stated that rules-based standards do not prevent dishonest practice; it eliminates the exercise of professional judgement and diverts it to the detail of the actual application. The article emphasized on how a motivated management will use aggressive reporting just to convince the auditors and that rules-based standards are much easier to implement at that stage. Furthermore, we disagree with what the article was trying to emphasize and we believe that the need of both rules-based and principles-based accounting standards are necessary. At the end of the day people judge according to specific situations and sometimes their emotions are involved in those judgements, therefore, it will be efficient to have both standards exercised and implemented at the same time. For example, rules-based standards can be used between employees and their direct managers to have a firm and accurate reports; lets call it stage one. On the other hand principles-based standards can be implemented on stage 2 where the communication becomes between the management and the clients or auditors. This will motivate the management to apply both standards within the organization. To enforce both standards at the same time, there must be one clear plan from FASB and IASB to set the points straight on how these standards will move forward.

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In Conclusion, converting rules to principles is not a simple task and it might take forever to change the current practiced standards into something new. Not forgetting the fact that most people hate change, therefore, the conversion might not be accepted easily. Judgement is an individual act, subsequently, making the choice of reporting aggressively will rely on that individual judgement. In fact, the issue here is not the type of standards but its more of a cultural issue which lacks professionalism in complying with the spirit and goal of the standards. Therefore, rules-based and principles-based accounting standards are both required for management decisions whether they choose to report aggressively or not because people are not programmed but they base their judgement on what they feel is right to do at that point.

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References
Kang, Gerui (Grace); Jerry W. Lin. "Effects of the Type of Accounting Standards and Motivation on Financial Reporting Decision." Journal of Accounting Business & Management (2011): 22.

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