GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND CONSTRAINTS

The cost principle

Historical cost is usually definite and verifiable. As per this principle, assets are initially
recorded at cost. In most cases no adjustment is made to this evaluation in later periods,
except to allocate a portion of the original cost to expense as the assets expire. At the time
the asset is acquired, cost represents the fair market value as evidenced by arms length
transaction. With the passage of time, the fair market value of an asset may change
greatly from its original cost (Historical cost).
The revenue realization principle
The revenue realization principle guidance in answering the questing of when should
revenue be recognized. Revenue is generally recognized when the earning effort is
substantially expended or completed. Revenue is realized when both the following
conditions are met:
The earning process is essentially complete.
Objective evidence exists as to the amount of revenue earned.
The matching principle
To measure the profitability of an economic entity, revenue is to be matched against costs
associated in generating this revenue. The matching of business enterprises extensively
influences the cost of goods and services to be used to obtain revenue) with its revenue is
the primary activity in the measurement of the results of operations for that period.
Costs are matched with revenue transactions.
Direct association with specific revenue transactions.
Systematic allocation of costs over the useful life of the expenditure.
The objectivity principle
The term objective refers to measurements that are unbiased and subject to verification
by independent entities. The parties involved in any transaction have opposing interests
and bargain to arrive at the equilibrium of exchange equivalents. If evaluation is
objective, a disinterested third party within the same facts would come up with the same
valuation. This is generally referred to as an Arm length transaction.
The consistency principle
The principle of consistency implies that there should be consistent treatment of similar
or the same items form one accounting period to another. In principle once an accounting
procedure has been adopted for a class of items, it should be consistent applied from
period to period. The principle of consistency does not mean that a company should never
make a change if a proposed new accounting method will provide more useful
information than does the method presently used.
The disclosure principle
Adequate disclosure means that all material and relevant facts financial position and the
results of operations are communicated to users. This can be accomplished either in the
financial statements or in the notes accompanying the financial statements. Such

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.