American Accounting Association

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THE ACCOUNTING REVIEW Vol. 86, No. 3 2011 pp. 747–767

American Accounting Association DOI: 10.2308/accr.00000045

Principles-Based versus Rules-Based Accounting Standards: The Influence of Standard Precision and Audit Committee Strength on Financial Reporting Decisions Christopher P. Agoglia University of Massachusetts Amherst Timothy S. Doupnik University of South Carolina George T. Tsakumis Drexel University ABSTRACT: Recent accounting scandals have resulted in regulatory initiatives designed to strengthen audit committee oversight of corporate financial reporting and have led to a concern that U.S. GAAP has become too rules-based. We examine issues related to these initiatives using two experiments. CFOs in our experiments exhibit more agreement and are less likely to report aggressively under a less precise more principles-based standard than under a more precise more rules-based standard. Our results also indicate that CFOs applying a more precise standard are less likely to report aggressively in the presence of a strong audit committee than a weak audit committee. We find no effect of audit committee strength when the standard is less precise. Finally, we find support for a three-path mediating model examining mechanisms driving the effect of standard precision on aggressive reporting decisions. These results should be of interest to U.S. policymakers as they continue to contemplate a shift to more principles-based accounting standards e.g., IFRS . Keywords: standard precision; rules-based standards; principles-based standards; audit committee; IFRS. Data Availability: Contact the authors.

We thank Wendy Bailey, Cathy Beaudoin, Bill Dilla, Rick Hatfield, Scott Jackson, Tamara Lambert, Justin Leiby, Steve Perreault, Roger Silvers, Hun-Tong Tan, Brad Tuttle, Xiaochuan Zheng, Laureen Maines editor , Steve Kachelmeier senior editor , two anonymous reviewers, and participants at the 2009 AAA Annual Meeting, the 2009 AAA International Section Midyear Conference, and the 2010 Deloitte/University of Kansas Auditing Symposium for their helpful comments and assistance. Editor’s note: Accepted by Laureen Maines.

Submitted: April 2009 Accepted: December 2010 Published Online: April 2011 747


Agoglia, Doupnik, and Tsakumis

I. INTRODUCTION ur study examines the effect of accounting standard precision on financial statement preparers’ reporting judgments, as well as the potential role that the audit committee plays in mitigating aggressive financial reporting under differing levels of standard precision.1 A wave of corporate accounting scandals in recent years has led to a push for regulatory changes. As part of the Congressional plan to reform U.S. financial reporting, the Sarbanes-Oxley Act of 2002 SOX, U.S. House of Representatives 2002 introduced major regulatory initiatives in an attempt to overhaul financial reporting and corporate governance systems. These initiatives include two remedies aimed at dampening aggressive financial reporting: 1 the potential adoption of principles-based accounting standards and 2 enhancement of public company audit committees. Concern has been rising within the financial/investing community that U.S. accounting standards have become too “rules-based.” With bright-line tests and detailed guidance, U.S. standards have become so precise that many feel they invite opportunistic interpretation by corporate executives. The perception that a significant number of executives have been concerned with meeting the letter of a rule, more so than its spirit, has led to a call to consider a more “principlesbased” regime. Accordingly, SOX required the Securities and Exchange Commission SEC to conduct a study on the possible adoption of principles-based standards by the U.S. financial reporting system. Recently, the SEC moved the principles-versus-rules debate to the front burner by proposing a roadmap that could lead to the mandatory adoption of the more principles-based International Financial...
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