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1.22 Theoretical Framework Principles and Practices of Accounting Paper 1
the same manner for other event or transaction if the policy adopted is not in
keeping with the qualitative characteristics of relevance and reliability. It is also
inappropriate for an organisation to leave its accounting policies unchanged when
more relevant and reliable alternatives exist.
Materiality: Misstatement (i.e. omission or erroneous statement) is material if it
could influence the economic decisions of users taken on the basis of the financial
information. Materiality depends on the nature and size of the item or error, judged
in the particular circumstances of its misstatement. Materiality provides a threshold
or cut-off point.
Faithful Representation: Information must faithfully represent the transactions and
other events it either purports to represent or could reasonably be expected to
represent for it to be reliable.
Substance Over Form: It is necessary that information is accounted for and
presented in accordance with their substance and economic reality and not merely
their legal form. The substance of transactions or other events may not be always
consistent with that which is apparent from their legal form.
For example, A has agreed to buy a building from B. Beneficial interest and rights
have been transferred to A but legal formalities are pending. A will record the build-
ing as an asset in its books, as in “substance”. A has bought the building and is the
owner of the building subject to legal formalities.
Neutrality: Information contained in financial statements must be neutral, that is,
free from bias, for it to be reliable. Financial statements are not considered neutral
if, by the selection or presentation of information, they tend to influence the making
of a decision or judgement in order to achieve a predetermined result or outcome.
Prudence: Since the preparers of financial statements have to contend with the
uncertainties that inevitably surround many events and circumstances they exercise
prudence. Prudence is the act of inclusion of a degree of caution in the exercise of
the judgments needed in making the estimates required under uncertain conditions.
The aim of this concept is to ensure that the assets or income are not overstated and
liabilities or expenses are not understated.
Fair, Full and Adequate Disclosure: It means the disclosure of all the reliable and
relevant information about the business organisation to management and also to their
external users which enables them to take rational and reasonable decision. Financial
statements are to be prepared in conformity with Generally Accepted Accounting
Principles (GAAP).
Completeness: For the information to be reliable, it must be complete within the
bounds of cost and materiality. An omission can cause information to be misleading or
false and thus unreliable and deficient in terms of its relevance.
Among the listed qualitative characteristics, the four principal characteristics are
relevance, understandability, reliability and comparability.
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