Principles-Based Accounting Standards and Regulatory Enforcement

• In Event: Regulation and Auditing

Abstract

Practitioners claim that rules-based accounting standards provide a safe harbor shield against enforcement risk. In contrast, regulators suggest that principles-based reporting norms better protect preparers and auditors from undue enforcement threat due to its emphasis on substance over form (SEC 2003). I add to this debate by studying a proprietary dataset on accounting inspections from South Korea in conjunction with their mandated adoption of IFRS reporting in 2011. A temporal analysis of this dataset, which archives annual investigative details and enforcement actions relating to accounting allegations, suggests that a shift to a more principles-based regime is associated with (1) increased detection rates of GAAP violations per investigation, (2) larger share price discounts incurred by misreporting firms, and (3) greater declines in their perceived earnings quality. These results are policy relevant in light of the FASB’s and IASB’s joint proposal advocating a more principles-based approach to standard setting (FASB 2002, 2010).

Author

• Mark Paul Kim, University of California-Los Angeles