Professional Documents
Culture Documents
disclosure should make the financial statements more useful and less subject to
misinterpretation
Other examples of information which should be disclosed in financial statement s
include:
Summary of accounting methods used in the preparation of statements.
Shilling effects of any changes of these accounting methods during the current
period.
The Materiality Principle
Materiality principle requires accountants to use generally accepted accounting principles except
when to do so would be expensive or difficult, and where it makes no real difference if the rules
are ignored. If a rule is temporarily ignored, the net income of the company must not be
significantly affected, nor should the reader's ability to judge the financial statements be
impaired.
Constraints of Accounting:
The constraints of accounting refer to the limitations to providing financial information that exist
in the financial reporting environment. Financial reporting must follow the generally accepted
accounting principles, or GAAP. The constraints of accounting permit certain variations from the
basic accounting principles in reporting a companys financial information. Such variations are
not considered a violation of the GAAP because of the recognized constraints of accounting.
These constraints are:
(i)
Costs and Benefits
When deciding what course of action to take, try to insure the cost of providing the information
does not exceed the benefits derived from using the information. In effect, efforts should not be
greater than accomplishments
One major constraint of accounting is the costs of providing financial information. Financial
reporting is not cost free because companies must spend time and money to collect, process,
analyze and disseminate relevant information. In deciding what to include in a financial
reporting, companies must weigh the costs of providing particular information against the
benefits that can be derived from using the information. Therefore, companies may not require
particular accounting measurements or disclosures if the costs of implementing them exceed the
benefits accrued to users of the information.
(ii)
Materiality
Insignificant amounts need not be recorded and reported according to the GAAP rules. But this
does not mean that insignificant items cannot or should not be recorded and reported according
to the rules of GAAP its just that you have a choice.
While the cost-benefit constraint of accounting may limit the scope of the financial information
provided in an effort to control reporting costs, the materiality constraint allows companies to
omit certain information that is immaterial and wont have an impact or influence on information
users. In other words, companies must include all information that has a material impact on their
overall financial performance. Companies determine the materiality of information based on its
relative size and importance. When the amount involved is relatively small or the nature of the
information at issue is unimportant, companies may resort to the materiality constraint not to
report the information.
(iii)
Industry Practices
While cost-benefit and materiality constraints are the two overriding accounting constraints,
industry practices are a less dominant constraint but also part of the reporting environment.
Particular industry practices in financial reporting may cause departure from basic accounting
standards for companies in certain industries. For example, contrary to recording asset value at
historical cost as required by GAAP, companies in the agricultural business may report crops at
their market value because its difficult to estimate original crops cost. The constraint of industry
practices allows companies to deviate from some prescribed reporting standards on certain
financial information. Thus specialized types of businesses will have their own way of recording
and reporting certain items. I.e., a separate set of GAAP for some business types.
(iv)
Conservatism/ Prudence
When in doubt on how to record or report or when two different acceptable methods could be
used, choose the one that wont overstate assets or profits.
Similar to industry practices, conservatism is another less prevalent accounting constraint but
should be observed in financial reporting when applicable. Conservatism means that when in
doubt about how to report an accounting issue, choose the method that least likely overstates
assets and income or understates liabilities and losses. Sometimes companies may find difficult
situations in which simply following GAAP may not yield the best reporting results. For
example, GAAP doesnt require the accrual of losses on a likely future purchase of inventories,
but if the planned purchase is a firm commitment, its conservative to accrue the losses now from
any future price increases.