Accounting Constraints [Notes with PDF]
In this article, we will learn in-depth about accounting constraints, including their definition, 4 important constraints, and much more.
What is Accounting Constraint?
The idea that influences the application of accounting principles is called accounting constraint.
Since they are hindered in the application of accounting principles, they are called accounting constraints.
4 Important Accounting Constraints
The 4 important accounting constraints are discussed below:
1. Materiality Principle
The main task of accounting is to calculate the capital, liabilities, assets, and profit or loss of a business and to serve the people interested in the consequences. The main objective of accounting is to publish important information in this regard.
According to this principle, it is necessary to judge the relevance of all such information when recording all information.
The materiality principle states that the economic impact of all issues or events is of little or no consideration to the needs of users, these issues are of no importance at all and they cannot be published.
For example, if a company purchases a building for $8, 99,950, and the value of that building can be shown at $9, 00,000 in the Balance Sheet.
Although money is often small, it can be important and should be shown according to the significance of the event.
For example, if an employee stole $10 from a cash fund, the figure is less important, but this information is very relevant and should be shown in accounts.
2. Conservatism Principle
When preparing financial statements, all transactions that have uncertainties need to be conservative in view so that property and income do not appear excessively in the financial statements.
For example,
In Mr. Wood’s book of accounts at the end of 2018
Furniture:
purchase price $10,000 and Market Value $8,000
Machinery:
Purchase price $25,000 and Market value $ 28,000
Closing stock:
Purchase price $5,000 and Market value $ 3,000
Now, according to the principle of conservatism, the assets will be accounted for at the lowest price between market value and purchase price.
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3. Cost-Benefit Comparison
According to this assumption, the benefit of accounting information users get from the specific information will be more than the responsibility for it. If the benefit is less than the expense, the information is not acceptable to the users.
According to the full disclosure principle, the organization is required to publish accurate and reliable information in the financial statements. No information can be kept secret. But the information that contradicts the business interests is worth not disclosing. It will cost more than the benefits derived from that information. So it hinders the full disclosure principle.
Again, from the point of view of accounting, pen, pencil, rubber, etc. are the assets of the business. But these should be shown as costs rather than as an asset.
Because the cost of these is so low that bringing them to bookkeeping as an asset will cost them more than the benefits of enrolling them.
Therefore, they have to be taken into account when comparing cost benefits, so it is better not to disclose if the cost of collecting any information can be considered to be more than the benefit attained from it.
4. Industrial Practice
Due to the diversity of the business, the financial statements have to be prepared despite deviating from the recognized accounting principles.
That is, special accounting is approved for a particular specialty business organization, and that company prepares its final financial statements according to that particular affiliate account.
For example, special accounting methods have been specified for the service providers (Railway, Bank-Insurance, etc.)
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