Buried in the recent Securities and Exchange Commission (SEC) publication of guidance for management on Sarbanes-Oxley was the admonition that companies should start to follow principles-based accounting, as long as it is compliant with Generally Accepted Accounting Principles (GAAP). Unfortunately, at this time, there is no meaningful definition of principles-based accounting for an executive to follow. Many people point to International Financial Reporting Standards (IFRS) as a model and want our system to converge with these standards. The concept sounds good in theory, but could result in either weaker U.S. rules or with so many exceptions that convergence would occur in name only.

Currently, the comprehensive list of principles to be applied to a U.S. business is so massive that it is not functional. For a list to be useful in a principles-based accounting environment, it would have to be adapted to GAAP in order for companies to meet the higher disclosure requirements in the U.S. Without a clear definition, even a well-meaning attempt at implementation is risking litigation, and some legal experts predict a surge in class action lawsuits when the switch is ultimately attempted. Worse, it also sets up a situation where companies could be interpreting the interrelationship between principles-based and GAAP very differently, making their financial results less comparable, but not necessarily obviously so.

These kind of vagaries help explain why the over-defined behavioral shelter of the rules-based system has held so much appeal for so many years. It's a "checklist" approach that provides a comfort level to risk-averse auditors.