Chapter 1 – Solutions
1-1 Define and discuss the merits of a principles-based and rules-based approach to
standard setting. How do they differ? Are there any similarities? What is an objectives-
based standard-setting model? How does it compare with the other two?
- Principles-based approach:
- Provides a conceptual basis to follow rather than detailed rules
- Built around principles/objectives which provide guidance to accountants
- Allows more room for the use of professional judgement since standards may not
exist for every situation one may encounter
- Broad guidelines – may be applied to many situations
- Easier to manage (size and understanding)
- Other
- Rules-based approach:
- Provides detailed rules for accountants to follow
- Provides more guidance for accountants as rules/standards can normally be found
for any situation
- Reduces the chance for bias, therefore reducing the chance for potential litigation
- Other
- Differences:
- Principles-based approach allows more room for professional judgement since
standards are not always tailored to specific situations; professional judgement
allows the chance for bias
- Rules-based approach does not provide much room for professional judgement as
rules exist for almost all situations and therefore provides more guidance for
accountants; less chance for bias
, - A rules-based system may become overbearing in size as rules must be in place for
all situations; the size of a principles-based system can be much more easily
managed
- Principles-based system has greater flexibility, especially when new situations or
transactions arise; if a new situation or transaction arises under a rules-based
system, a new standard/rule must be developed to account for the situation
- Other
- Similarities:
- Although the approach taken to applying accounting standards is different,
principles-based and rules-based accounting are generally based on the same
general principles and conceptual framework; therefore, the accounting results are
often similar.
- Objectives-based standard-setting model:
- The proposed standard setting model under US GAAP
- One that is neither purely rules-based nor purely principles-based
- Standards are written such that there is an objective at the beginning of each.
- Concise statement of relevant accounting principle defined and underlies standards
- Few if any exceptions/internal inconsistencies within the standard
- Supplemented by implementation guidance
- No bright line tests
- Consistent with the conceptual framework
- Similarities/differences
- Takes the best of both principle and rules based
- Like principles based, it is anchored in the principles and conceptual framework. It
is also devoid of bright line tests – allowing use of judgement
- Like the rules based approach, it includes an appropriate amount of implementation
guidance
, - In terms of volume of information (standards), it would likely be somewhere
between the two
1-2 Go to the IASB and FASB websites and look up the project summary relating to the
conceptual framework project. Identify some of the main differences between the old
frameworks and the proposed framework.
- Links:
- http://www.fasb.org/project/conceptual_framework.shtml
- http://www.iasb.org/Current+Projects/IASB+Projects/Conceptual+Framework/
Conceptual+Framework.htm
- Differences:
- Although the proposed framework looks very familiar to the current Canadian and
U.S. GAAP frameworks, some differences do exist.
- Some qualitative characteristics will be considered on different levels: fundamental
vs. enhancing
- Relevance and faithful representation are fundamental characteristics
- Comparability, verifiability, timeliness and understandability are enhancing
characteristics
- Other characteristics such as conservatism and reliability will be excluded from the
framework. It was felt that conservatism introduced bias and that the reliability
characteristic was not consistently applied. Faithful representation was felt to be
more representative of the general principle.
- Definitions of the elements of financial statements have also changed to provide
more guidance to accountants (see “Looking Ahead” on p. 14 for proposed
definitions).
1-3 Discuss the relative merits of a single set of global accounting standards. What are some
of the impediments or barriers?
, - Merits:
- Greater comparability
- Better access to global capital markets
- Better capital allocation - investors may be more willing to invest in foreign
companies as they are able to make informed decisions regarding the companies’
financial position and ability to produce future cash flows
- Reduces an accountant’s need to learn more than one set of accounting standards
(i.e. employees of U.S. listed Canadian companies being required to reconcile to U.S.
GAAP)
- May lead to the creation of an international accounting designation
- Facilitates mobility for accountants
- Promotes the increasingly global nature of the profession
- Other
- Impediments/barriers
- Some countries may have unique accounting needs – one set of standards may not
be suitable for all countries and companies (i.e. Canada’s oil and gas industry)
- How will the system be regulated? Currently each country regulates its own capital
markets.
- Resistance to change – desire to stick with home-grown systems. This is especially
true where a significant amount of funding has already gone into local country
standard setting (such as in the U.S.)
- Other
1-4 Standard setters often refer to bright-line tests. What are these and do you believe they
are useful in standard setting? What are some of the drawbacks to the use of bright-lines?
- Bright-line tests:
Bright-line refers to the inclusion of a specific number or threshold in an accounting
standard (i.e. reportable segments are identified based on whether their
revenues/assets/profits/losses are greater than 10% of the total for the company)
1-1 Define and discuss the merits of a principles-based and rules-based approach to
standard setting. How do they differ? Are there any similarities? What is an objectives-
based standard-setting model? How does it compare with the other two?
- Principles-based approach:
- Provides a conceptual basis to follow rather than detailed rules
- Built around principles/objectives which provide guidance to accountants
- Allows more room for the use of professional judgement since standards may not
exist for every situation one may encounter
- Broad guidelines – may be applied to many situations
- Easier to manage (size and understanding)
- Other
- Rules-based approach:
- Provides detailed rules for accountants to follow
- Provides more guidance for accountants as rules/standards can normally be found
for any situation
- Reduces the chance for bias, therefore reducing the chance for potential litigation
- Other
- Differences:
- Principles-based approach allows more room for professional judgement since
standards are not always tailored to specific situations; professional judgement
allows the chance for bias
- Rules-based approach does not provide much room for professional judgement as
rules exist for almost all situations and therefore provides more guidance for
accountants; less chance for bias
, - A rules-based system may become overbearing in size as rules must be in place for
all situations; the size of a principles-based system can be much more easily
managed
- Principles-based system has greater flexibility, especially when new situations or
transactions arise; if a new situation or transaction arises under a rules-based
system, a new standard/rule must be developed to account for the situation
- Other
- Similarities:
- Although the approach taken to applying accounting standards is different,
principles-based and rules-based accounting are generally based on the same
general principles and conceptual framework; therefore, the accounting results are
often similar.
- Objectives-based standard-setting model:
- The proposed standard setting model under US GAAP
- One that is neither purely rules-based nor purely principles-based
- Standards are written such that there is an objective at the beginning of each.
- Concise statement of relevant accounting principle defined and underlies standards
- Few if any exceptions/internal inconsistencies within the standard
- Supplemented by implementation guidance
- No bright line tests
- Consistent with the conceptual framework
- Similarities/differences
- Takes the best of both principle and rules based
- Like principles based, it is anchored in the principles and conceptual framework. It
is also devoid of bright line tests – allowing use of judgement
- Like the rules based approach, it includes an appropriate amount of implementation
guidance
, - In terms of volume of information (standards), it would likely be somewhere
between the two
1-2 Go to the IASB and FASB websites and look up the project summary relating to the
conceptual framework project. Identify some of the main differences between the old
frameworks and the proposed framework.
- Links:
- http://www.fasb.org/project/conceptual_framework.shtml
- http://www.iasb.org/Current+Projects/IASB+Projects/Conceptual+Framework/
Conceptual+Framework.htm
- Differences:
- Although the proposed framework looks very familiar to the current Canadian and
U.S. GAAP frameworks, some differences do exist.
- Some qualitative characteristics will be considered on different levels: fundamental
vs. enhancing
- Relevance and faithful representation are fundamental characteristics
- Comparability, verifiability, timeliness and understandability are enhancing
characteristics
- Other characteristics such as conservatism and reliability will be excluded from the
framework. It was felt that conservatism introduced bias and that the reliability
characteristic was not consistently applied. Faithful representation was felt to be
more representative of the general principle.
- Definitions of the elements of financial statements have also changed to provide
more guidance to accountants (see “Looking Ahead” on p. 14 for proposed
definitions).
1-3 Discuss the relative merits of a single set of global accounting standards. What are some
of the impediments or barriers?
, - Merits:
- Greater comparability
- Better access to global capital markets
- Better capital allocation - investors may be more willing to invest in foreign
companies as they are able to make informed decisions regarding the companies’
financial position and ability to produce future cash flows
- Reduces an accountant’s need to learn more than one set of accounting standards
(i.e. employees of U.S. listed Canadian companies being required to reconcile to U.S.
GAAP)
- May lead to the creation of an international accounting designation
- Facilitates mobility for accountants
- Promotes the increasingly global nature of the profession
- Other
- Impediments/barriers
- Some countries may have unique accounting needs – one set of standards may not
be suitable for all countries and companies (i.e. Canada’s oil and gas industry)
- How will the system be regulated? Currently each country regulates its own capital
markets.
- Resistance to change – desire to stick with home-grown systems. This is especially
true where a significant amount of funding has already gone into local country
standard setting (such as in the U.S.)
- Other
1-4 Standard setters often refer to bright-line tests. What are these and do you believe they
are useful in standard setting? What are some of the drawbacks to the use of bright-lines?
- Bright-line tests:
Bright-line refers to the inclusion of a specific number or threshold in an accounting
standard (i.e. reportable segments are identified based on whether their
revenues/assets/profits/losses are greater than 10% of the total for the company)
