Accounting standards explanation: Objective oriented and Principles based standards

Objective-oriented accounting standards are when a standard has included enough specificity in the standard where there are few to no misunderstandings on the concepts being addressed. As well, the standard will give enough guidance on how to implement a transaction properly. Lastly, the standard should be consistent, and come from an established financial reporting conceptual framework so managers and auditors can make sure the reporting captures the transactions accurately.  Objectives-oriented sets forth a situation where management must accurately present the transactions and events in the financial statements.  The SEC believes implementing the objectives-oriented standards will outweigh the costs associated with the implementation. Also, these standards will more closely tie the interests of all stakeholders from management to investors to creditors to auditors.

Objectives-oriented standards will be used in a manner like a combination of the rules-based and principles-only standards best aspects. They will establish,” the objectives and the accounting model for the class of transactions, providing management and auditors with a framework that is sufficiently detailed for the standards to be operational. At the same time, if constructed with the optimal level of detail, such standards would provide users, as well as regulators and others who oversee or monitor the financial reporting process, with sufficient detail to better comprehend and properly gauge the results reported by management and attested to by the auditors.”[1] Furthermore, the new standards will allow users of financial information to have a deeper understanding of the data they are evaluating by researching a standard’s objective to understand the information it should be conveying.

The steps taken to ensure the objectives-oriented standards will be met are five step process. First, when a standard is being applied the preparers or auditors must focus on the accounting objective that is at the root of the transaction. Next, a conceptual framework must be the underlying basis of the accounting being done. Third, there can be no room for divergence in standards. Thus, there is a need for more guidance in how transactions are implemented. Fourth, it does not make any definite tests that could be applied to a transaction. Lastly, they will clearly give detailed guidance so a transaction can be appropriately recorded to the proper they of area necessary within the accounting system. 1  The specificity need not be so specific to pigeon hole items, but not broad enough to allow for too much of a diverse interpretation either. This way there will not have to be a voluminous amount of standards available.

The SEC arrived at objectives-oriented standards after an examination of the rules-based and principles-only standards. The rules-based standards lead to inconsistent application many times, because accountants are able to work their way around a rules-based system to arrive at their desired result. A good example of this is the distinction between an operating lease and a capital lease. Many times a company will have a capital lease they are about to sign, but instead will have terms adjusted so they are able to have an operating lease criteria instead. With the four criteria known that cause a lease to fall into the capital lease realm companies are able to structure the terms favorably towards operating leases. This is a clear weakness in the rules-based standards, and does not show the true representation of the corporation.

The principles-only standards allow for too much judgment to be introduced by the accountants or auditors who are creating, and auditing financial statements to make sure they represent operations in the same way across industries and companies. The weakness is in the ability to have comparability among financial statements, because accountants could believe a standard is supposed to be applied in a different manner then another accountant.

[1] Staff of the SEC. “Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System.” Sec.gov. 25 July 2003. Web. 7 October 2013. <http://www.sec.gov/news/studies/principlesbasedstand.htm>