BY PAUL B. W. MILLER AND PAUL R. BAHNSON
Principles-based or just
an agreement in principle?
Paul B. W. Miller is a professor at the
University of Colorado at Colorado Springs
and Paul R. Bahnson is a professor at Boise
State University. The authors’ views are
not necessarily those of their institutions.
Reach them at email@example.com.
Many claim that “principles-based” accounting standards are superior to “rules-based” standards.
For example, the chair of the International Accounting Standards Board, Sir David
Tweedie, made this proclamation in a 2008
speech in Toronto: “The use of principles
should eliminate the need for anti-abuse
provisions. It is harder to defeat a well-crafted
principle than a specific rule which financial
engineers can bypass.”
He and others are making a giant leap of
faith that managers will suddenly change
their personalities and start taking a higher
road because of principles-based standards.
They also mistakenly assume that such lofty
standards could ever be constructed in a political process.
To the contrary, we have often stated that
standards can only establish minimum reporting requirements that force unwilling
managers to provide information beyond
their self-serving inclinations, which are
stubbornly rooted in naive ideas about how
the markets work. We don’t see how politically compromised mandatory “
principles-based” standards will ever motivate them to
change that behavior.
We’re puzzled that Tweedie thinks otherwise, when history shows that managers
universally rush to create misleading positive
images by reporting as little as possible and
otherwise obscuring the truth.
As theoreticians, we share Tweedie’s idealism and hope for a better world, but our
scars make us question whether the IASB’s
boast that it issues principles-based standards is actually public relations spin aimed
at making a weak solution look strong. We
are particularly concerned about the joint
Financial Accounting Standards Board and
IASB convergence projects under the gun
of the unwise and unrealistic self-imposed
AGREEMENTS IN PRINCIPLE
Most negotiations start with a preliminary
agreement between the parties. A potential
buyer may say, “I’d like to buy that car,” while
the owner states, “I want to sell it.” In diplo-
macy, two opposing sides may agree they
don’t want war. Management and a union
may agree they want a new contract without
a strike. We also observe that protocol leads
the parties in crucial but stalled negotiations
to announce interim progress by saying they
have “agreed in principle,” even when they’re
really miles apart.
A simple lease has the lessee pay the lessor x
annual payments of y with a market interest rate of z percent, thus allowing precise
estimates of the lessee’s cost of the right to
use the leased property, the liability’s size,
and interest expense. On the other side, the
lessor would use identical numbers to report
the sale of that right, its receivable, and its
However, most managers deliberately de-
stroy their statements’ usefulness by inserting
confounding features that contort leases to
create bogus reporting “advantages.” Lessors
are quite willing to enable their subterfuge in
return for premium rents.
Previously, the boards claimed that the lessor’s accounting should parallel the lessee’s.
This agreement was apparently only “in principle,” because the draft essentially falls back
to the status quo distinction between operating and capital leases.
In some circumstances, it requires a lessor
to recognize a receivable at a present value of
future payments (including renewal options
that the lessor considers more likely than not)
and an equal but nebulous liability called a
See SPIRIT on 21