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International Financial Reporting Standard (IFRS): Principle based Standard

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     on  09 May 2012    

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IFRS are considered a "principles based" set of standards that establish broad rules for accounting.

 

Rules-based standards such as US GAAP have an accounting rule for almost every type transaction. There are various oversight bodies whose objective is to roll out accounting for every new transaction based on its materiality very now and then. It though minimizes confusion and the need to apply professional judgment in areas of accounting and reporting, these exhaustive rules and exceptions with various materiality limits, typically result in an increased level of complexity and lead to divergent accounting treatments for similar transactions. Another factor is that the Companies focus on mere technical compliance rather than on the objectives underlying the rules. The accountants restrict their application of mind only till finding a particular rule instead of conceptually addressing the unique transaction. Sometimes it may so happen that the accountant may not be aware of some rule that may have been written for a particular transaction and thus may account it in a regular manner in the absence of an overseeing principle.

 

Principle standards, on the other hand, define guidelines on a broad parameters or boundaries. It thus requires implementation team to exercise significant judgment and thought process to go to the underlying basis of conclusions. The structure of these standards giving a clear insight as to why the standard is introduced, what are its objectives, its scope of area, accounting guidelines, basis of conclusion with dissenting opinion of the board members and also the illustrative examples. Thus it provokes thoughts and establishes conceptual principles that can be applied universally and hence improving comparability. IFRS thus brings out the economic substance of the transaction. No single set of rules is likely to eliminate the need for accounting professionals to make occasional judgment calls. A principles-based system, however, remedies several of the ills of other standards and minimizes opportunities for companies to meet a standard's technical requirements while ignoring its underlying objective.

 

Some examples of Principles are as follows:

 

1. Continuous involvement with the asset:

 

This is one of the principle test applied when an entity has to consider whether it can book the transaction as sold or not. This can be seen very commonly in factoring i.e. discounting bills receivable. If the discounting of bills or receivable is done with recourse, then the transaction does not allow the entity to derecognize receivable and book cash in balance sheet. Instead the said flow of funds from discounting is considered as a borrowing from the bank. This is because, if the debtor fails, the lender will come to the entity for recovery of the underlying receivable.

 

2. Splitting time value of money:

 

Any transaction that has a credit period different from that of similar transaction is considered to have an inbuilt finance arrangement / benefit to either party. Take for example if an entity has received a non interest bearing long term advance for delivery of goods or services over next two years, the opportunity interest of those funds is considered as financial benefit received by the entity. Thus the advance is present valued using the market interest rate of deposits for initial recognition and the difference is considered as deferred revenue on balance sheet. The advance is then accreted with interest expense through profit & loss account and deferred revenue on the balance sheet is unwound by crediting the revenue as and when goods are delivered or services rendered.

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