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 item’s impact on a firm’s 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