The standard-setters’ toolkit: can principles prevail over bright lines?

Abstract

We study lease accounting in an international panel data set to examine how accounting outcomes vary with two features of accounting standards: the emphasis on using professional judgement to apply principles, and the presence or absence of bright-line tests. We study four countriesAustralia, Canada, the UK, and the US-and companies in two leaseintensive industries-retail and transportation. Our primary study period spans the time when Australia and the UK switched from domestic to international accounting standards, and in one test, we also consider Canada's transition to international standards. We find that neither an explicit requirement to apply a principle nor omitting bright-line tests materially increases the use of capital lease treatment among these firms. Overall, we conclude that this financial reporting outcome is relatively insensitive to these standard-setting tools.

Insurance: In or Out of the “Too Difficult” Box?

“…As such, there is room for judgment by the firm's managers, auditors, and actuaries. Experimental evidence suggests that a principles-based approach will constrain aggressive reporting (Cohen et al 2013;Cao and Coram 2020), but some empirical evidence suggests that there may be no fundamental differences (Henderson and O'Brien 2017). Thus, while there are no proscribed procedures, there are judgmental limits that may enhance reporting.…”

Rules‐ vs. Principles‐based Accounting Standard: Earnings Quality and the Role of Earnings in Contracting (An Analysis Employing the Adoption of ASC 606)

“…From a broader perspective, our paper contributes to the literature on the discussion surrounding principles-based vs. rules-based accounting standards. Our paper is unique from prior studies that compare the two concepts in accounting standards, either using different environments (e.g., an international setting with different countries) -such as Henderson and O'Brien (2017) and Collins et al (2012) -or using different accounting rules that serve different goals -such as Donelson et al (2012) and Folsom et al (2016). Although they strive to make comparisons in the fairest possible manner, our examination on the effects of the adoption of the ASC 606 enables us to compare the two standards that regulate the same topic of revenue recognition within the same company.…”

How Does the Nature of Accounting Standards Affect Audit Quality and Earnings Attributes?

“…On the other hand, auditors may "check boxes" without looking into the economic substance of transactions and, thus, are more likely to misstate financial information. However, in an international study by Henderson and O'Brien (2017), they find that the financial reporting outcome is relatively insensitive to either applying a principle or bright-line standard regarding the use of capital lease treatment among four countries: Australia, Canada, the UK, and the US. Overall, the impact of principles-(or rules-) based standards on restatements is inconclusive.…”