1.

Objectivity principle:

The objectivity principle is the concept that the

financial statements of an organization be based
on solid evidence. The intent behind this principle
is to keep the management team and the
accounting department of an entity from
producing financial statements that are slanted by
their opinions and biases

Example:
cash sales are evidenced by cash memos, credit
sales by invoices, and payments through the bank
by check. Purchase of larger value such as land,
building, and vehicles are generally supported by
elaborate legal documentation, including title
deeds, sale deeds, and so on.

2. Cost principle
Cost principle offers accurate information
regarding the amount received from a sale. The
numbers need to be the exact like the actual
expenses from business transactions from a
specific period. The basic accounting principle is
that all the cost principle accounting information
needs to be based on a cash or cash-equivalent
principle.
Example:
When there is a trade-in, a company can get a
great deal of a car. The car might have a value of
$20,000, but they pay $15,000 for it. When
recording on the balance sheet, the company will
use $15,000 as the actual amount paid even
though the car has a value of $20,000. When
issuing an invoice, it will still be the same amount
as the cash received and not the car’s value.

3. Accrual Principle

Accrual accounting recognizes the revenue earned

at the time of sale and expenses incurred by the
company. Its examples include sales of the goods
on credit, where sales will be recorded in the
books of account on the date of sale irrespective
of whether it is on credit or cash.
Examples
Credit Sales
Credit Sales refer to sales in which the customer or
purchaser is allowed to make payment later
instead of at the purchase time. In this sale, the
customer gets adequate time to make payment.

Income tax is a type of expense that is to be paid by every

person or organization on the income earned by them in each
financial year as per the norms prescribed in the income tax
laws. It results in cash outflow as income tax liability is paid out
through bank transfers to the income tax department.

Insurance expense, also known as insurance premium, is the

cost one pays to insurance companies to cover their risk from
any unexpected catastrophe. It is calculated as a set percentage
of the sum insured and is paid at a regular pre-specified period.

Example #1
Generally, a manufacturing concern must pay an insurance cost
of 2.89% of the asset value. From the below value of the assets,
calculate the insurance expense to be paid by XYZ Ltd.:

Machinery: $9,000,000
Industrial shed: $123,100
Spares: $45,000
Forklift: $32,000
Safety equipment: $18,500
Total: $9,218,600

=9,000,000*2.89%
=260,100.00

Example #2
Example 2 -Insurance

Anthony has a habit of smoking. He is presently pursuing a master’s from

Boston University. His father is interested in taking the insurance for Anthony’s
health due to his bad habit of smoking. Therefore, he consulted the PQR
insurance company for medical insurance. They provided the following details
related to the medical plan:

70 and
Age 0-15 16-24 25-50 51-70
above

1.30
Base Premium Rate for Mediclaim 2.01% 2.19% 2.70% 3.50%
%

Additional premium to cover a

1% 1.20% 1.50% 1.70% 2%
specific illness

0.50
Additional premium if smoking 0.65% 0.80% 1% 1.20%
%

Calculate the insurance expense for the medical

plan, including coverage of a specific illness of
$500,000,which
https://www.wallstreetmojo.com/insurance-
premium/needed to be paid by Anthony’s father.

Solution:

Anthony is 23-years old. Hence, all the premium

rates will apply to the slab of 16-24 years.
Similarly, we can calculate insurance expense which is shown below:

Total Premium to be Paid will be –

 =10,050+6,000+3,250
=$19,300.
Thus, the total insurance expense to
be paid is $19,300 for the sum
insured of $500,000.

Additional Examples
Rent Paid in Advance

Interest Received on FD

Electricity Expenses

Post-sales Discount

Depreciation

Audit Fees

4. Materiality
Materiality is an accounting principle which states
that all items that are reasonably likely to impact
investors’ decision-making must be recorded or
reported in detail in a business’s financial
statements using GAAP standards.

Essentially, materiality is related to the significance

of information within a company’s financial
statements. If a transaction or business decision is
significant enough to warrant reporting to
investors or other users of the financial
statements, that information is “material” to the
business and cannot be omitted.

EXAMPLES OF MATERIALITY

1. Expensing vs. Depreciating

Imagine a company purchases an electric pencil

sharpener for $15. Typically, the sharpener should
be recorded as an asset and then depreciation
expense should be recorded throughout its useful
life. However, materiality allows you to expense
the entire $15 at once.

In this scenario, you’re able to expense the entire

transaction at once because the information is
immaterial. Recording the transaction in this way
is unlikely to impact the decision-making process
of investors, therefore the $15 cost of the pencil
sharpener is immaterial.

2. Losses Compared to Net Income

If a company were to incur a significant loss due to
unforeseen circumstances, whether or not this
loss is reported depends on the size of the loss
compared to the company’s net income.

Imagine that a manufacturing company’s

warehouse floods and $20,000 in merchandise is
destroyed. If the company’s net income is $50
million a year, then the $20,000 loss is immaterial
and can be left off its income statement. On the
other hand, if the company’s net income is only
$40,000, that would be a 50 percent loss. In this
case, the loss is material, so it’s crucial that the
company makes the information known to its
investors and other financial statement users.

In accounting, consistency requires that a

company's financial statements follow the same
accounting principles, methods, practices and
procedures from one accounting period to the
next. This allows the readers of the financial
statements to make meaningful comparisons
between years.
 5. Consistency
Consistency does allow a company to make a
change to a more preferred accounting method.
However, the change and its effects must be
clearly disclosed for the benefit of the readers of
the financial statements.

The consistency principle states that all accounting

treatments should be followed consistently
throughout the current and future period unless
required by law to change or the change gives a
better presentation in accounts. This principle
prevents manipulation in accounts and makes
financial statements comparable across historical
periods.

Examples

If the business entity follows the straight-line

method of depreciation
and after some time law changes, every entity
must follow the written down value method of
depreciation retrospectively. Now, an entity has to
provide depreciation as per written down value
method
retrospectively and accordingly charge the
depreciation and effect on profit due to a change
 in method of depreciation to be disclosed and the
fact that method of depreciation has been
changed due to change in law also to be disclosed
in the financial statement so that users can
understand easily.

Straight Line Depreciation Method is one of the most

popular methods of depreciation where the asset
uniformly depreciates over its useful life, and the asset’s
cost is evenly spread over its useful and functional life.
Thus, the depreciation expense in the income statement
remains the same for a particular asset over the period. As
such, the income statement is expensed evenly, and so is
the asset’s value on the balance sheet. The asset’s carrying
amount on the balance sheet reduces by the same
amount.

Suppose a business has bought a machine for $ 10,000.

They have estimated the machine’s useful life to be eight
years, with a salvage value of $ 2,000.

Now, as per the straight-line method of depreciation:

 Cost of the asset = $ 10,000

 Salvage Value = $ 2000
 Total Depreciation Cost = Cost of asset – Salvage Value =
10000  – 2000 = $ 8000
 The useful life of the asset = 8 years

Thus, annual depreciation cost = (Cost of asset – Salvage

Cost)/Useful Life = 8000/8 = $ 1000
 Hence, the Company will depreciate the machine by $1000
annually for eight years.

 We can also calculate the depreciation rate, given the

annual depreciation amount and the total depreciation
amount, which is the annual depreciation amount/total
depreciation amount.
 Hence, depreciation rate = (annual depreciation
amount/total depreciation amount)*100 =
(1000/8000)*100 = 12.5%

Full Disclosure principle

The full disclosure principle exists so that

the users of the financial statements
including the investors and creditors have
complete information regarding the
financial position of the company. Without
this principle, it would be highly likely that
companies would withhold information that
could possibly put the company’s financial
position in a negative light.

The importance of full disclosure

principle
The full disclosure principle is the key to
building trust and credibility among
shareholders and stakeholders.
Shareholders, lenders, and other
stakeholders need material information to
make informed decisions that will benefit
them in the long run such as whether or
not they should sell their stocks or if a
company deserves loans.

Examples
– Guitar Emporium is a nationwide guitar
retailer. It reports $10.5M in guitar
inventory last year. In the notes of its
financial statements, GE should disclose
its significant accounting policies. This
would include its inventory evaluation
methods. GE should disclose whether its
financial statements are prepared uses
FIFO or LIFO inventory cost methods.