comparability

7.2 Accounting Policies – Achieving Comparability

1. What is an Accounting Policy?

An accounting policy is a specific principle, rule or practice that a company adopts when preparing and presenting its financial statements. It determines how transactions and events are recognised, measured and disclosed.

2. Objectives of Financial Reporting

Cambridge IGCSE expects students to link accounting policies to the four qualitative objectives of financial information:

• Comparability – users can compare financial information across periods and between entities.
• Relevance – information is capable of influencing users’ decisions.
• Reliability (Faithful Representation) – information is complete, neutral and free from material error.
• Understandability – information is presented clearly so that users can grasp its meaning.

Consistent accounting policies are the main way of achieving all four objectives. When the same policies are applied from one period to the next, the figures become comparable, relevant, reliable and easy to understand.

3. Why Comparability Is Important

Comparability enables users of financial statements to:

• Assess the performance and financial position of the same business over time.
• Compare different businesses operating in the same industry.
• Make informed decisions about investing, lending or other economic activities.

Without comparable information, trends cannot be identified and the impact of changes in the business environment cannot be assessed.

4. Accounting Principles that Support Comparability

The following fundamental accounting principles are required by the syllabus. Each principle is stated in the exact wording used by Cambridge and a brief “Why it matters” note explains its link to comparability.

1. Business Entity – The affairs of the business are kept separate from those of its owners.
   Why it matters: Ensures that only the entity’s own transactions are reported, allowing consistent comparison with other entities.
2. Going Concern – The business is assumed to continue operating for the foreseeable future.
   Why it matters: Allows assets and liabilities to be measured on a consistent basis (e.g., cost rather than liquidation values) across periods.
3. Historic Cost – Assets and liabilities are recorded at the amount paid or received at the time of the transaction.
   Why it matters: Provides an objective, verifiable basis that can be applied consistently year after year.
4. Money Measurement – Only transactions that can be expressed in monetary terms are recorded.
   Why it matters: Gives a common unit (money) so that figures from different periods are directly comparable.
5. Matching (Accrual) Principle – Expenses are recognised in the same period as the revenues they help generate.
   Why it matters: Produces comparable profit figures by linking costs with the related income.
6. Consistency – The same accounting policies are applied from one period to the next unless a change is justified.
   Why it matters: The cornerstone of comparability; any change must be disclosed and applied retrospectively.
7. Prudence (Conservatism) – Anticipate no profit, but provide for all known losses.
   Why it matters: Prevents over‑statement of profit, ensuring that comparable figures are not inflated.
8. Materiality – Only items that could influence users’ decisions need to be disclosed.
   Why it matters: Keeps the statements focused on significant items, making comparisons clearer.
9. Dual Aspect (Double‑Entry) – Every transaction affects at least two accounts.
   Why it matters: Guarantees that the accounting equation remains balanced in every period, supporting reliable comparison.
10. Realisation (Revenue Recognition) – Revenue is recorded when it is earned, not necessarily when cash is received.
    Why it matters: Aligns revenue with the period in which the related performance obligations are satisfied, aiding comparability of turnover.

5. When a Change in Accounting Policy Is Required

A change to an accounting policy should be made only when one (or more) of the following occurs:

• A new accounting standard or guidance is introduced.
• The existing policy no longer provides reliable or relevant information.
• A more appropriate method becomes available (e.g., a different depreciation method).

6. How Changes in Policy Should Be Treated

• Retrospective application – Apply the new policy to the current year **and**, where practicable, restate the figures for earlier years so that all periods are presented on the same basis.
• Explain the reason – State why the policy has been changed.
• Show the effect – Quantify the impact on profit (or loss) and on any related balances for the current year and, if restated, for the earlier years.

7. Disclosure Requirements (Notes to the Financial Statements)

Cambridge IGCSE requires four specific items to appear in the notes:

8. Illustrative Example – Changing the Depreciation Policy

Situation: Company B has been using the straight‑line method to depreciate plant and machinery. Management decides that the reducing‑balance method better reflects the pattern of economic benefits from the assets.

Steps to maintain comparability:

1. Re‑calculate depreciation for each earlier year using the reducing‑balance method.
2. Adjust the opening balance of retained earnings for the earliest comparative year to reflect the new depreciation figures.
3. Prepare a note that includes:
   • The old policy (straight‑line) and the new policy (reducing‑balance).
   • The reason for the change (more appropriate reflection of asset usage).
   • The effect on profit for each year presented (e.g., “Profit increased by £2,500 in 2023 and £1,800 in 2022”).

9. Summary Checklist – Ensuring Comparability

• Identify every accounting policy used in the current period.
• Confirm that each policy has been applied consistently in all comparative periods.
• Check whether any new standards or better methods require a change.
• If a change is needed, apply it retrospectively where practicable.
• Prepare clear notes that disclose:
  • Basis of preparation.
  • All specific policies.
  • Any changes – the reason and the quantitative effect.
  • Key judgements and estimates.
• Verify that the financial statements now allow users to:
  • Compare the same entity over time.
  • Compare the entity with other businesses.