Which concept requires that accounting transaction should be free from bias of accountants and others?

Mr. Sunrise started a business for buying and selling of stationery with ₹ 5,00,000 as an initial investment. Of which he paid ₹ 1,00,000 for furniture, ₹ 2,00,000 for buying stationery items. He employed a sales person and clerk. At the end of the month he paid ₹ 5,000 as their salaries. Out of the stationery bought he sold some stationery for ₹ 1,50,000 for cash and some other stationery for ₹ 1,00,000 on credit basis to Mr. Ravi. Subsequently, he bought stationery items of ₹ 1,50,000 from Mr. Peace. In the first week of next month there was a fire accident and he lost ₹ 30,000 worth of stationery. A part of the machinery, which cost ₹ 40,000, was sold for ₹ 45,000.

From the above, answer the following :
1. What is the amount of capital with which Mr. Sunrise started business?
2. What are the fixed assets he bought?
3. What is the value of the goods purchased?
4. Who is the creditor and state the amount payable to him?
5. What are the expenses?
6. What is the gain he earned?
7. What is the loss he incurred?
8. Who is the debtor? What is the amount receivable from him?
9. What is the total amount of expenses and losses incurred?
10. Determine if the following are assets, liabilities, revenues, expenses or none of the these: sales, debtors, creditors, salary to manager, discount to debtors, drawings by the owner.

What is the Materiality Principle?

The materiality principle states that an accounting standard can be ignored if the net impact of doing so has such a small impact on the financial statements that a user of the statements would not be misled. Under generally accepted accounting principles (GAAP), you do not have to implement the provisions of an accounting standard if an item is immaterial. This definition does not provide definitive guidance in distinguishing material information from immaterial information, so it is necessary to exercise judgment in deciding if a transaction is material.

The Securities and Exchange Commission has suggested for presentation purposes that an item representing at least 5% of total assets should be separately disclosed in the balance sheet. However, much smaller items may be considered material. For example, if a minor item would have changed a net profit to a net loss, then it could be considered material, no matter how small it might be. Similarly, a transaction would be considered material if its inclusion in the financial statements would change a ratio sufficiently to bring an entity out of compliance with its lender covenants.

The materiality concept varies based on the size of the entity. A massive multi-national company may consider a $1 million transaction to be immaterial in proportion to its total activity, but $1 million could exceed the revenues of a small local firm, and so would be very material for that smaller company.

The materiality principle is especially important when deciding whether a transaction should be recorded as part of the closing process, since eliminating some transactions can significantly reduce the amount of time required to issue financial statements. It is useful to discuss with the company's auditors what constitutes a material item, so that there will be no issues with these items when the financial statements are audited.

Example of the Materiality Principle

As an example of a clearly immaterial item, you may have prepaid $100 of rent on a post office box that covers the next six months; under the matching principle, you should charge the rent to expense over six months. However, the amount of the expense is so small that no reader of the financial statements will be misled if the entire $100 is charged to expense in the current period, rather than spreading it over the usage period. In fact, if the financial statements are rounded to the nearest thousand or million dollars, this transaction would not alter the financial statements at all.

Terms Similar to Materiality Principle

The materiality principle is also known as the materiality concept.

Accounting principles are the foundation of accounting according to GAAP.

These principles are used in every step of the accounting process for the proper representation of the financial position of the business.

5 principles of accounting are;

1. Revenue Recognition Principle,
2. Historical Cost Principle,
3. Matching Principle,
4. Full Disclosure Principle, and
5. Objectivity Principle.

These are explained below;

Revenue Recognition Principle

Revenue Recognition Principle is mainly concerned with the revenue being recognized in the income statement of an enterprise.

Revenue is the gross inflow of cash, receivables or other considerations arising in the course of ordinary activities of an enterprise from the sale of goods, rendering of services and use of enterprise resources by others yielding interests, royalties, and dividends.

It excludes the amount collected on behalf of third parties such as certain taxes. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other considerations.

Historical Cost Principle

According to Historical Cost principle, an asset is ordinarily recorded in the accounting records at the price paid to acquire it at the time of its acquisition and the cost becomes the basis for the accounts during the period of acquisition and subsequent accounting periods.

Accordingly, if nothing is paid to acquire an asset; the same will not be usually recorded as an asset, e.g. a favorable location, and increasing reputation of the concern will remain unrecorded though these are valuable assets.

The justification for the use of the cost concept lies in the fact that it is objectively verifiable.

Matching Principle

According to Matching Principle, the expenses incurred in an accounting period should be matched with the revenues recognized in that period, e.g., if revenue is recognized on all goods sold during a period, the cost of those goods sold should also be charged to that period.

It is wrong to recognize revenue on all sales, but charge expenses only on such sales as are collected in cash till that period.

This concept is basically an accrual concept since it disregards the timing and the amount of actual cash inflow or cash outflow and concentrates on the occurrence (i.e. accrual) of revenue and expenses.

This concept calls for an adjustment to be made in respect of prepaid expenses, outstanding expenses, accrued revenue, and unaccrued revenues.

Matching does not mean that expenses must be identifiable with revenues.

Expenses charged to a period may or may not be related to the revenue recognized in that period, e.g. cost of goods sold and commission to salesmen are directly related to sales whereas rent, interest, depreciation accruing with the passage of time and stock lost by fire are not directly related to sales revenue yet, they are charged to the accounting period to which they relate.

Read more: 6 Constraints of Accounting

Full Disclosure Principle

According to this principle, the financial statements should act as a means of conveying and not concealing.

The financial statements must disclose all the relevant and reliable information which they purport to represent so that the information may be useful for the users.

For this, it is necessary that the information is accounted for and presented in accordance with its substance and economic reality and not merely with its legal form.

The practice of appending notes to the financial statements has developed as a result of the principle of full disclosure.

Objectivity Principle

According to the Objectivity Principle, the accounting data should be definite, verifiable and free from the personal bias of the accountant.

In other words, the Objectivity Principle requires that each recorded transaction/event in the books of accounts should have adequate evidence to support it.

In historical cost accounting, the accounting data are verifiable since the transactions are recorded on the basis of source documents such as vouchers, receipts, cash memos, invoices, etc.

At the same time, the accounting data is ‘bias-free’ since the accounting data are not subject to the bias of either management or of the accountant who prepares the accounts.

On the other hand, in value-based accounting (e.g. current cost accounting) accounting data is not bias-free because the value may mean different things for different persons.

Which accounting objective requires that financial statements be free from bias?

Why should Accountants be free from bias?

What are the 4 concepts in accounting?

What is objective principle in accounting?