The Prudence Principle

The Prudence principle is similar to the conservative principle in that it speaks to the need for accountants to be more willing to understate than overstate profit. Under the prudence principle revenue should not be anticipated, while expenses and losses should be anticipated and charged against income. Materiality Principle : Finally the regular straightjacketed accountants get a chance to do their own thing. This principle allows the accountant to ignore generally accepted accounting principles if doing so would not influence the financial position of the company and/or would be costly and difficult to accomplish.

Where an entry affects the financial position of the business entity, the entry is considered material and should to be recorded according to GAAP stipulations. Most companies will establish its own materiality guidelines specific to certain activities. Example, a million dollar company may purchase a wheelbarrow for $100. The wheelbarrow, with a life exceeding three years (at least! ) should be capitalized (booked as a fixed asset). However, due to the low value and the difficulties in tracking a wheelbarrow, the accountant will more than likely expense the item.

In a case like this, the accountant may have set a value of $3,000 as the minimum for capitalization. “Assets” items costing less than $3,000 will therefore be expensed. Reliability: In accounting, the term relevance means it will make a difference to a decision maker. Accounting principles 7 For example, in the decision to replace equipment that has been used for the past six years, the original cost of the equipment does not have relevance. In other words, the original cost is irrelevant or is not relevant in the decision to replace the equipment.

What will have relevance are the future amounts, such as the cost of the new equipment, and the savings that will occur when the old equipment is replaced. Here’s another expression of relevance: Costs that will differ among alternatives. Costs that will not differ among alternatives do not have relevance. In order to have relevance, accounting information must be timely. Financial statements issued three weeks after the accounting period ends will have more relevance than financial statements issued several months after the period ends. Having timeliness and relevance may mean sacrificing some precision or reliability.

Consistency: Accountants are expected to be consistent when applying accounting principles, procedures, and practices. For example, if a company has a history of using the FIFO cost flow assumption, readers of the company’s most current financial statements have every reason to expect that the company is continuing to use the FIFO cost flow assumption. If the company changes this practice and begins using the LIFO cost flow assumption, that change must be clearly disclosed Accountingcoach. com Accounting principles 8 References www. accountingcoach. com www. wikipedia. org eIFRS 2008, iasb