Principles-based vs. rules-based accounting standards: The effects of auditee proposed accounting treatment and regulatory enforcement on auditor judgments and confidence

Abstract

Using an interest capitalization context, this paper examines the impact of accounting standard type (rules-based vs. principles-based) on the auditor's agreement with an auditee's proposed accounting treatment. Contrary to prior studies that have investigated lease classification contexts, results indicate that auditors are more likely to agree with the auditee's accounting treatment under a principles-based than a rules-based standard. The possibility of a Securities and Exchange Commission (SEC) investigation does not affect auditors' agreement with their auditee's accounting treatment. However, auditors are more confident in the rules-based scenario when they have no knowledge of a possible SEC investigation. Thus, the lack of precision inherent in a principles-based, interest capitalization standard may initially persuade auditors to agree with auditee judgments, but this perception may be moderated by a reduced level of confidence. Those interested in the standard setting process should look beyond the traditional lease structuring scenario and consider the possible effects of other principles-based standards on auditors' judgments and confidence.