Figures Don’t Lie, But Liars Figure-Arguments for a Principles based approach in Accounting

It’s a debate that’s of more than academic interest.

Despite what the term suggests, U.S. Generally Accepted Accounting Principles(GAAP) are really not about principle, nor about doing what is right. So says U.S. Treasury Secretary Henry Paulson, who in a back-to-basics speech at Georgetown University said U.S. accountants should return to putting the emphasis on “principles” in GAAP.

“In my judgment, we must rise above a rules-based mindset that asks, ‘Is this legal?’ and adopt a more principles-based approach that asks, ‘Is this right?’” in order to get truly effective corporate governance that makes for a sounder stock market that earns investor confidence, Paulson said.

Paulson gave voice to a mounting clamor from guardians of financial veracity that is calling on regulators to toss out the rules-based approach in favor of a simple set of guiding principles in accounting.

The angst is that a rules-oriented accounting world, where executives and their auditors dot all the i’s and cross all the t’s, has become more about meeting the letter of the law and not the spirit of the law, about fretting to make financial reporting cookie-cutter right and not simply about doing what is right at the outset.

It’s a push to make an honest, simple confession–that if accounting really is an art and not a science, then it really does have subjectivity in it and so must be principles-based rather than rules-based.

The thinking also is, a rules-based accounting world has spawned a host of problems:

–More detailed accounting rules require a paper load equivalent to the Black Forest to publish and have created whoppers like the longest U.S. standard on accounting for financial derivatives, which runs to almost 1,000 pages and which you can’t pay three experts to agree on.

–A rules-based world has created a leviathan of a legal and accounting profession populated by modern-day Gnostics who feverishly interpret and re-interpret the rules in search of loopholes in exchange for fat fees.

–Though the accountants tried to envisage a rule for every situation, the rules-reliant standards that are U.S. GAAP have failed to protect investors from corporate failures like Enron.

It’s a debate that’s picked up speed in Congress. The House of Representatives recently unanimously passed legislation requiring regulators to testify each year on their efforts to develop principles-based accounting standards. The Securities & Exchange Commission is getting closer to letting foreign firms report their financial results in the U.S. using the supposedly more principles-based international accounting standards–with the thinking that, one day, U.S. companies would do the same.

The balance between rules- and principles-based standards has been debated since the abacus was invented. There is no doubt that the corporate scandals of five years ago showed that executives took advantage of the weaknesses in rules-based regimes.

But are those in the debate stretching that very point until it snaps? Would a principles-based regime really have stopped Tyco International‘s (nyse: TYC – news – people ) Dennis Kozlowski? Isn’t it a bit unhinged, if not untethered from reality, not to acknowledge that all standards are subject to interpretation?

Even now, don’t many bean counters worldwide pine for a return to principles-based accounting in even the international accounting standards, which ostensibly were going to be, well, principles-based? The current collection of international standards now runs to 2,400 pages; even there, rules-based thinking has picked up momentum.

The real problem is enforcement. For instance, the Securities & Exchange Commission still operates with this bit of institutionalized juvenilia, this fig-leaf code of ethics that virtually encourages people to break the law, where white-collar crooks can get off the hook by settling SEC enforcement actions, while neither having to admit nor deny their wrongdoing.

Executives know they’ll only get a slap on the wrist and have to pay tiny fines versus the fat compensation they get from monkeying around with their earnings reports–and that their companies instead will have to pay for their crimes by settling any lawsuit with shareholder money and insurance policies.

In accounting, always remember this: Figures don’t lie, but liars figure. That will always be the case under any accounting regime. “Any set of rules will be subject to someone’s interpretation. The rules will only be as good as those who use them,” says Shelley Jacobson-Taylor, a New York City enrolled agent. And by the way, that interpretation will still require lots of paper. So stay bullish on International Paper (nyse: IP – news – people ).