PwC U.S. Chairman calls for balance between rules and principles.

• Author: Heffes, Ellen M.
• Position: PricewaterhouseCoopers - Accounting principles

Dennis Nally, on behalf of his firm, PricewaterhouseCoopers, wants to get the issue of principles-based accounting versus rules-based "out front and into the dialogue" of today's preparers, standard-setters, regulators and users of financial statements. "We have become so driven by a desire to make rules around financial reporting as explicit as we can," says the U.S. Chairman and Senior Partner of PwC, [that] "it has created a degree of complexity in the marketplace that makes it increasingly difficult for anybody to understand all of the rules."

Nally says this focus on compliance with the rules has him continually worrying about whether or not we're seeing the big picture, and whether accounting is really following the substance of transactions as contrasted to just strict compliance. "Principles," he says, "are much broader than rules alone."

Nally says the accounting model in the U.S. and the profession over the past 10 to 15 years has encouraged a lot of rules to be promulgated "so that we could have absolute clarity on the accounting and financial reporting." We did it, he notes, for a host of reasons, like the litigation environment or the regulatory environment. The irony of the situation, however, is "I don't think having all of the rules has really addressed the fundamental problem: Is financial reporting and accounting really reflecting the economic substance of a transaction?"

He believes that we need to have the right framework and then encourage preparers of financial statements, regulators and auditors to use judgment--all of which is "absolutely critical for high-quality financial reporting and accounting."

He concedes the current framework contains potential inconsistencies with rules, which creates much confusion. For example, he cites lease accounting, lamenting that the U.S. has "probably one of the most complicated set of standards that govern lease accounting," the rules for which he describes as akin to an on/off switch.

The overall premise is to reflect the underlying economic substance of a leasing arrangement between a company and another organization. If you meet certain criteria around accounting purposes, it's either a capital lease or an operating lease. One of the tests is: if the present value of lease payments equals 90 percent or more, then it is a capital lease; if it's 89.5 percent, it's an operating lease. Then you step back and say: "That is a bright test. That is a rule. It's an on/off switch in terms...