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    How Does the Strength of the Financial Regulatory Regime...
    research summary posted November 26, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 15.0 International Matters, 15.02 IFRS Changes – Impacts 
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    Title:
    How Does the Strength of the Financial Regulatory Regime Influence Auditors’ Judgments to Constrain Aggressive Reporting in a Principles-Based Versus Rules-Based Accounting Environment?
    Practical Implications:

    From a public policy perspective, the results indicate that auditors’ judgments under principles-based standards, regardless of the strength of the financial regulatory regime, lead to more conservative reporting when compared to rules-based standards coupled with a stronger financial regulatory regime, which is how the U.S. environment is often characterized. The results also provide insights to regulators who are concerned about the implementation of IFRS across different countries with varying regulatory standards.

    For more information on this study, please contact Jeffrey R. Cohen.

    Citation:

    Cohen, J. R., G. Krishnamoorthy, M. Peytcheva, and A. M. Wright. 2013. How does the strength of the financial regulatory regime influence auditors' judgments to constrain aggressive reporting in a principles-based versus rules-based accounting environment? Accounting Horizons 27 (3): 579-601.

    Keywords:
    financial regulatory regime; principles-based standards; rules-based standards; audit judgments; public policy
    Purpose of the Study:

    With the movement towards adoption of International Financial Reporting Standards (IFRS) worldwide, a question arises as to whether a principles-based approach such as IFRS will ultimately result in higher quality financial reporting. This issue is particularly relevant because, even though for now the SEC is not adopting IFRS, the securities markets and the SEC still need to ponder the implications of a decision that may lead to the ultimate adoption of IFRS, or at the least result in some degree of convergence with U.S. GAAP. Further, some argue that the strength of enforcement regimes within a country is as important as a focus on principles or rules in determining the quality of reporting.

    Design/Method/ Approach:

    To examine this issue, the authors employ an experiment with 97 experienced auditors as participants. Using a case setting involving the classification of a lease (operating versus capital), they vary the accounting standard type as rules-based or principles-based, and the regulatory regime as stronger or weaker. The lease setting is one where there are indications of management’s incentives to leave the debt off of the balance sheet and hence engage in aggressive reporting. The research evidence is collected in 2010—2011. Participants are assigned the role of an auditor and need to determine the final lease classification as a capital lease or an operating lease.

    Findings:

    The study finds, as expected, that auditors are more likely to constrain aggressive reporting under principles-based accounting standards than under rules-based standards, under both stronger and weaker regulatory regimes. 

    Category:
    Auditor Judgment, International Matters
    Sub-category:
    IFRS Changes – Impacts