Characteristics of Consistency Principle

Characteristics of Consistency Principle

In this article we would explain characteristics of consistency principle of accounting. These characteristics include fundamental requirement for comparability, consistency of presentation, consistency of policies, condition for changed presentation etc.

Important Characteristics of Consistency

Some important characteristics of consistency principle have been explained below.

1.   Fundamental Requirement

Consistency principle is a fundamental requirement for comparability of financial statements. Thus consistency plays an important role in developing understanding of the financial statements, because comparability is essential requirement for user understanding.

2.   Consistency of Presentation

Classification of item shall not change from period to period. This is important for comparison of information. The information are no more comparable, if presentation changes.

3.   Consistency of Policy

Consistency of policy is also important for ensuring comparability of financial statements. Changes in policy affect the comparability. For example, if the depreciation policy is changed from reducing to fixed installment methods, then deprecation would be no more comparable.

4.   Condition for Change Presentation.

There are two conditions under which presentation can be changed.

a.    Change is required International Financial reporting Standard.

b.    Change would improve the understanding of user.

List of Consistency principle Characteristics

Some important characteristics of consistency accounting principle are listed below.

a.    Consistency is fundamental requirement for comparison.

b.    Consistency includes both consistency of presentation & consistency in policy.

c.    Consistency may be changed in special circumstances.

Characteristics of Going Concern Principle

Characteristics of Going Concern Principle

Going concern principle deals with the assumption of continuity of business for long time. The characteristics of going concern assumption have been explained below.

Important Characteristics of Going Concern Principle

Some important characteristics of going concern assumption includes the continuity of business, management responsibility of making assumption, impact on financial statement and circumstance under which going concern assumption is not valid have been briefly explained below.

1.   Continuity of Business

In going concern, it is assumed that business will continue for foreseeable future and neither management has intention or circumstance suggest the cession of business.

2.   Management make Assessment

Going concern assessment is made by the management and this assessment is made at least for 12 month from the balance sheet date.

3.   Entity is not Going Concern

There are two circumstance under which entity is considered to be not going concern i.e. management intends to cease trading and automatic.

4.   Impact on Financial statement

If the going concern assumption is not valid, then financial statements are prepared under the special circumstances and asset and liabilities are shown at recoverable amount.

5.   Circumstance of Going Concern

Following is the list of circumstance under which management may suggest that going concern assumption is not valid.

a)    Heavy losses.

b)   License cancellation.

c)    Bane on nature of business.

d)   Sale major operations.

Characteristics of Prudence Principle

Characteristics of Prudence Principle

In this article we would explain some important characteristics of Prudence principle. prudence concept discourages the favorable projection of financial position and financial performance the company. Prudence concept provides useful guideline for estimation process in the financial accounting.

Characteristics of prudence principle

Some important characteristics have been briefly explained below.

1.   Relevance in Estimation

Prudence principle play important role in estimation process. We know that management is required to make many estimates during the preparation of financial statement like estimates for provision for bad debt, provision for warranty etc.

2.   Cautious Approach

Prudence concept suggests cautious approach in recognition of financial items. It means that organization should not give optimistic look or view of the financial statement, rather financial statement should be given a pessimistic view.

3.   Risk Minimizing Approach.

Prudence principle is basically a risk minimizing approach. This approach will reduce the risk of investors; creditor etc. investment on the bases of favorable financial position is more risky. Thus we can say that this approach is investor protection approach.

4.   Asset & Income not overstated

Under prudence concept the assets and income are not to be overstated by the company. Thus we can say that prudence approach financial position should not give a pleasant picture.

5.   Liabilities & Expenses are not understated

Under prudence concept liabilities & expenses are not to be understated. Thus financial performance and financial position would not be giving a favorable position.

Prudence principle characteristics list

Prudence principle characteristics are listed below

a)    Prudence principle is a cautious approach of preparing FS.

b)   Prudence is widely used by accountant in estimation of financial items.

c)    Prudence concept reduces the risk of investor.

Characteristics of Substance over Form

Characteristics of Substance over Form

In substance over form principle, the transactions are recorded on the bases of the economic reality than their legal form. Thus economic reality is preferred over the legal form of the transaction.

Important Characteristics of substance over form

Some important characteristics of substance over form have been explained below.

1.   Economic Reality is More Important

Economic reality is more importance than legal form for the recording of financial transactions in the books of accounts. It means economic reality is preferred over legal form for transaction recording in the books of accounts.

2.   Reflection of Actual Transaction

Substance over form principle facilitates more realistic reflection of a transaction/financial item in the financial statements. Business is a combination of commercial/economic activities and therefore economic it is more logical to reflect or record the financial item on the bases of economic  reality.

3.   Discourages Concealment of Facts

Substance over form principle discourages the concealment of facts of the financial transaction. Financial statement are used for economic decision making, therefore any concealment of fact would negatively affect the economic decision making.

4.   Finance Lease Example

Some important example of substance over form is finance lease, where the asset held under finance lease is recognized as asset despite the asset ownership is not transferred to the organization, because organization is expected to use the asset for maximum period of its useful life.

5.   Sale and buy transaction

Another important example of substance over form is sale and buys back at higher price. This traction is treated as loan, because primarily it is loan arrangement (first you sale and then take back as higher price).

List of Characteristics of Substance over form

Some important characteristics of substance over form principle are listed below

1)   Economic reality is more important than legal form.

2)   Reflect the actual nature of transaction.

3)   Prudence over form achieves faith full presentation.

Characteristics of Materiality principle

Characteristics of Materiality Principle

In this article, we would explain some important characteristics of materiality principle. Under materiality principle each material item must be disclosed separately in the financial statement to facilitate economic decision making.

Following are some important characteristics of materiality principle

1.   Influence Economic Decision

An element is said to be material, if it could influence the economic decision of the user/stakeholder of financial statement taken on the bases of financial statements.

2.   Determining Factors of Materiality

There are two important factors for defining or determining  the materiality of a financial items i.e. nature & size of the financial item. It is important to note that these factors may be considered individually or collectively to determine the materiality of a financial item. These factors have been explained with example ;

3.   Size & Materiality

Size of the financial item is the most important factor for determining the materiality of financial items. An item is more material with large size, where an item is less material with small size.

It is important to remember that size is a relative to the overall financial statement size. Thus an financial item of $10,000 may be material for small company which has a balance sheet size of $ 100,000, but may be immaterial for a large company which has a balance sheet size of $ 1 billion.

4.   Nature & Materiality

Another important factor for determining the materiality is nature of the financial item. For example a repair expense of 10,000 may not be material, but an entertainment expense of $ 5,000 is material due to nature of expense. in very rare circumstance nature alone determines the materiality of a financial item. 

5.   Materiality Level

Materiality or materiality level cannot be absolutely defined; rather it is defined in context of a specific industry and specific company. There are no hard and fast rules for defining the materiality level.

Materiality level is defined or determined by the management of the company. Some company may define a material item is 2% of asset; other may define it as 3% of profit.

Materiality principle Characteristic List

Some important Characteristics of materiality are listed below

a)   Financial item influences economic decision is material.

b)  Important factor for materiality determination are size & nature of item.

c)   Materiality or materiality level is not an absolute measure.

Characteristics of Equity

Characteristics of Equity

Equity is basically residual interest of equity holder in the company. In other words we can say that Equity is remaining investment of the equity holder in the company. This investment is calculated as net asset i.e. asset- liabilities.

Important Characteristics of Equity

Following are some important characteristics of equity

1.   Accumulated Investment balance

Equity is basically a residual interest of equity holder. In other word we can say that equity is accumulated balance of investment of equity holder. Thus equity is initial investment plus accumulated retained earnings.

2.   Equity is not Fixed

As equity is an accumulated balance of investor investment, thus it changes year to year. Net income increases the equity, where a net loss reduces the equity. Thus performance of the company has direct linkage with equity.

3.   Equity Formula

Equity can be calculated with simple formula paid up capital plus accumulated retained earnings. Equity may also be calculated as net asset i.e. assets – liabilities.

4.   Equity Calculation

Equity can be calculated from the statement of financial position. If the company assets are 300 million and its liabilities are 200 million, then its equity would be 100 million i.e. asset minus liabilities.

5.   Items of Equity

Typically following items form part of equity.

a.    Paid up capital.

b.    Retained earnings.

c.    Revaluation surplus.

d.    Share premium account.

e.    Changes in accounting policies.

f.     Correction of error.

g.    Other items directly recognized in equity.

6.   Statement in Changes in equity

As name suggests that this statement shows the changes occur during the year in equity. These changes typically explain in term of changes in paid up capital, retained earnings, revolution surplus and share premium account.

This statement is divided into three sections i.e. opening balance, changed during the year and closing balances of above mentioned heads. A simple statement of changes equity has been given for understanding.

	Share Capital	Retained Earning	Share premium	Total
Opening	10,000	5,000	20,000	35,000
During Year	5,000	2,000	3,000	10,000
Closing	15,000	7,000	23,000	45,000

List of important characteristics of equity

Some important characteristics of equity are listed below

a.    Equity is residual interest of equity holder.

b.    Equity can be calculated as net asset.

c.    Equity is not fixed.

d.    Income increases the equity, while an expense reduces equity.

Characteristics of Expenses

Characteristics of Expenses

Expenses are incurred to finance day to day operations of the entity and these expenses reduce the equity. Expenses are costs incurred to generate profits. Thus we can say that expenses are cost of doing business.

Important Characteristics of Expenses

Some important characteristic of expenses have been explained below.

1.   Support operations

Expenses are incurred to run day to day operations of the entity. This is the most important characteristic or function of the expenses. Thus Expenses is one of the most important factors for the existence of the business.

2.   Generate profit

Another important characteristic of expense is profit generation. For example the cost of sales being as expense is incurred to generate revenue and profit. Production & selling both are technically not possible without incurring expenditure.

3.   Statement of Comprehensive Income

Expenses are shown in statement of comprehensive income. Expenses are shown in the first part of statement of comprehensive income, other part of comprehensive income deals financial items of special nature like gain on disposal of income.

4.   Reduce Equity

An expense reduces the equity of the entity. In practice accounting, expenses are not directly charged to equity, rather it is first charged to income statement and then net income is charged to equity. Thus net income reduces the equity.

5.   Equity Holder Distribution

Distribution to equity holder like dividend is not considered expense of the company. Similarly the contribution of equity holder does not consider the income of the company or entity. Thus both distribution and contribution to the equity does not form part of income statement.

6.   Capital & Revenue Expenditure

Expenses can be classified into capital and revenue expenses. Those expenses that provide short term benefit are called revenue expenses like salary , rent, etc, while those expenses which benefit is to be exhausted/received in long run are called capital expenses like purchase of machinery etc.

7.   Break Down Expenses

Typically the expenses can be break down into following main classes. Each of this class may have different type of function. This classification is also known as break down by function.

a.    Marketing & Selling Expenses

b.    Cost of sales expenses

c.    Factory overhead expenses.

d.    Finance Expenses

Expenses may also be classified in term of their nature.

a.    Deprecation.

b.    Material Expenses.

c.    Employee’s salary.

8.   Recognition of Expenses

Expenses are recognized in book subject to fulfillment of following conditions

a.    Expenses satisfy the definition.

b.    Economic associated with expense will flow to organization.

c.    Expense can be measured reliably.

List of important Characteristics of Expenses

Some important characteristics of expenses are listed below

a.    Expenses are facilitates operations.

b.    Expenses facilitate income generation.

c.    Expenses provide long and long term benefit.

d.    An expense reduces the equity of the company.

e.    A distribution to equity holder is not an expense.