ACG3101: Hierarchy of Accounting Qualities, Assumptions, and Principles of Accounting

Relevance

One of the two fundamental qualities that make accounting information useful for decision-making. If the accounting information does not make a difference in a decision, it is irrelevant. The information is considered to have this quality when it is material and has predictive value, confirmatory value, or both.

Predictive Value

A relevance component and quality of accounting information that helps users form their own expectations.

Confirmatory Value

A relevance component and quality of accounting information that confirms or corrects a user’s earlier expectations.

Materiality

A relevance component that is company-specific. Assessing this component is challenging because it requires evaluating the relative size and importance of an item. Accounting information has this component if a reasonable person’s judgement would have been changed by its inclusion or correction.

Faithful Representation

One of the two fundamental qualities that make accounting information useful for decision-making. It refers to the idea that the numbers and descriptions match what really existed or happened. It is a necessity because most users have neither the time nor the expertise to evaluate the factual content of the information. The information is considered to have this quality if it is complete, neutral, and free of material error.

Completeness

A faithful representation component that exists if all necessary information is provided. This component is violated if something that positively happened did not get recorded.

Neutrality

A faithful representation component that states that a company cannot select information to favor one set of interested parties over another. It ignores the economic consequences of a rule by making unbiased information the overriding consideration.

Free from Error

A faithful representation that states that information that is free from error will be a more accurate representation of a financial item.

Comparability

A qualitative enhancing quality for relevance and faithful representation that is employed when companies in the same industry use the same accounting principles. It is essential for providing comparisons of a company from period to period. Another type of this enhancing quality is consistency.

Consistency

A different type of comparability that is present when a company applies the same accounting method to similar events from period to period. This idea does not mean that a company cannot switch from one accounting method to another. However, if it does change its method, it must demonstrate its preference for the new method and disclose the nature and effect of the accounting change in the period in which it made the change.

Verifiability

A qualitative enhancing quality for relevance and faithful representation that occurs when two independent measurers, using the same methods, obtain similar results.

Timeliness

A qualitative enhancing quality for relevance and faithful representation that means having information available to decision-makers before it loses its capacity to influence decisions. Having relevant information available sooner can enhance its capacity to influence decisions.

Understandability

A qualitative enhancing quality for relevance and faithful representation that lets reasonably informed users see the significance of certain information. These “reasonable users” are assumed to have decent knowledge of business and economic activities.

Economic Entity Assumption

One of the four accounting assumptions that means that economic activity can be identified with a particular unit of accountability. In other words, a company keeps its activities separate from its owners and any other business unit. It also justifies the use of consolidated statements.

Going Concern Assumption

One of the four accounting assumptions that suggests that a company will have a long life, operate as normal, and follow GAAP procedures. Its three implications are that the historical cost principle is of limited usefulness if we assume eventual liquidation, depreciation and amortization approaches may need to be adjusted, and the current and noncurrent classification of assets and liabilities may lose their significance.

Monetary Unit Assumption

One of the four accounting assumptions that means that money is the common denominator of economic activity, which also provides an appropriate basis for accounting measurement and analysis.

Periodicity Assumption

One of the four accounting assumptions that implies that a company can divide its economic activities into artificial periods. Although these periods vary, the most common ones are monthly, quarterly, and yearly. The shorter the period, the more difficult it is to determine its proper net income.

Measurement Principle

One of the four accounting principles that determines the monetary value used to record assets, liabilities, revenues, and expenses on financial statements. It balances the historical cost principle for reporting items at their original transaction price and the fair value principle for reflecting current market values.

Revenue Recognition Principle

One of the four accounting principles that states that revenue must be recognized when the performance obligation is satisfied. In other words, revenue must be earned and realized.

Expense Recognition Principle (Matching Principle)

One of the four accounting principles that states that expenses must follow revenues. Companies recognize expenses when the product or service contributes to revenue. In other words, companies implement this principle by matching their efforts (expenses) with accomplishments (revenues).

Full Disclosure Principle

One of the four accounting principles that recognizes that the nature and amount of information included in financial reports reflect a series of trade-offs that further require judgement. These trade-offs try to balance sufficient detail that makes a difference to users with sufficient condensation to make the information understandable. The principle also states that anything that could influence a user must be disclosed.

Conservatism

The most important accounting principle that states that overstating assets is not good, understating liabilities is not good, and overstating income is not good (i.e., income statements are supposed to give us the lowest possible net income for a period).