Cost Principle and Materiality Constraint

1
Cost Principle and Materiality Constraint

• By Martin Shackleton, Konstantinos
  Konstantinidis and Charles Fallow

2
Cost Principle

• Requires assets to be recorded at cost
• Cost is both relevant and reliable
• Relevant because it represents the commitment
  made at the date of acquisition
• Reliable because it is objectively measurable,
  factual, and verifiable
• Cost is basis used in preparing financial
  statements

3

• Has been criticized
• Not relevant because acquisition cost is not
  equivalent to market or current value
• Despite inevitability of changing prices,
  accounting profession still follows monetary unit
  assumption that only transaction data expressed
  in monetary terms should be included in
  accounting records
• Profession believes the unit of measure the
  dollar- has remained sufficiently constant over
  time
• Example if Charles bought a car for 50 000 but
  it was now worth 30 000, the accountant would
  use amortization to account for the difference

4
Materiality Constraint

• Relates and items impact on a firms overall
  condition and operations
• Item is material when it is likely to influence
  the decision of a reasonably careful investor or
  creditor
• If an item does not make a difference in
  decision-making, GAAP does not have to be
  followed
• To determine materiality, an accountant compares
  it to such items as total assets, total
  liabilities, gross revenue and cash

5

• Example if a company purchases a number of
  wastepaper baskets, the proper accounting would
  appear to amortize them. However, they are
  expensed immediately because their cost is
  immaterial. It would be costly and timely to
  establish an amortization schedule and it will
  not make a material difference to the assets or
  net income