Cambridge Syllabus Notes

7.1 Accounting Principles – Overview

1. The Ten Fundamental Accounting Principles (Cambridge IGCSE/A‑Level)

Principle	Definition (≈1 sentence)	Typical Illustration
Business Entity	A business is regarded as a separate entity from its owners and other businesses.	Personal expenses of the owner are not recorded in the company’s accounts.
Money Measurement	Only transactions that can be expressed in monetary terms are recorded.	Employee morale is not shown in the financial statements, but salaries are.
Going‑Concern	Financial statements are prepared on the assumption that the business will continue to operate for the foreseeable future.	Assets are valued at cost less depreciation, not at liquidation values.
Historical Cost	Assets are recorded at the amount of cash (or cash equivalents) paid to acquire them.	A machine bought for $30 000 is shown at $30 000, not at its current market price.
Matching (Accrual) Principle	Expenses are recognised in the same period as the revenue they help generate.	Depreciation of a machine is charged in each year the machine produces sales.
Realisation (Revenue Recognition) Principle	Revenue is recorded when it is earned, not necessarily when cash is received.	Sales on credit are recognised when the goods are delivered.
Prudence (Conservatism)	Potential losses are recognised as soon as they are foreseeable, whereas gains are recorded only when realised.	Provision for doubtful debts is created even though some customers may still pay.
Materiality	Only information that could influence the economic decisions of users needs to be disclosed.	A $5 error in a $2 million profit statement is immaterial and may be ignored.
Duality (Double‑Entry)	Every transaction affects at least two accounts – one debit and one credit – keeping the accounting equation in balance.	Purchasing inventory on credit debits Inventory and credits Accounts Payable.
Consistency	Accounting policies and procedures must be applied in the same way from one period to the next, unless a change is justified, disclosed, and applied in accordance with the standards.	Depreciation method is kept the same each year unless a valid reason exists to change it.

2. Accounting Policies – Selection Criteria

When a business prepares its financial statements it must choose accounting policies that satisfy four objectives:

Relevance: Information should be capable of influencing users’ decisions.
Reliability: Information must be free from material error and bias.
Comparability: Users should be able to compare figures over time and with other entities.
Understandability: Information should be presented clearly and concisely.

These objectives guide the choice of methods for depreciation, inventory valuation, revenue recognition, etc.

3. Influence of International Accounting Standards (IAS/IFRS)

Although the IGCSE/A‑Level syllabus is based on UK GAAP, students must recognise that many accounting policies are shaped by International Accounting Standards. For example, IAS 16 permits the use of either cost model or revaluation model for property, plant and equipment; IAS 2 prescribes FIFO, weighted‑average or specific identification for inventories. When a new IAS is issued, companies may have to change an existing policy, triggering the consistency requirements described below.

7.1 Accounting Principles – Consistency

1. What the Consistency Principle Requires

Use the same accounting policies (e.g., depreciation method, inventory costing) in every reporting period.
If a change is made, it must be:
- Justified (new standard, more reliable information, change in circumstances),
- Fully disclosed in the notes, and
- Applied retrospectively (restating prior‑period figures) unless the change is immaterial.
Consistent application enables users to compare performance and position across periods.

2. Why Consistency Matters

Facilitates meaningful trend analysis.
Prevents manipulation by switching methods to achieve a desired profit.
Ensures that changes in reported figures reflect real economic events, not merely a change in technique.
Supports the matching and going‑concern concepts by keeping the basis of measurement stable.

3. Key Requirements When a Change Is Made

Nature of the change – clearly describe the old and new policy.
Reason for the change – e.g., adoption of a new IAS, better relevance or reliability, or a change in business circumstances.
Quantitative effect – show the impact on profit (or loss) for the current period and on the relevant balance‑sheet items.
Retrospective application – adjust opening balances of the affected assets/liabilities and restate comparative figures, unless the change is immaterial.

4. Immaterial Changes

A change is immaterial when it would not influence the economic decisions of users. In such cases the company may:

Apply the new method prospectively only (i.e., from the date of change forward).
Omit the quantitative restatement, but still disclose the nature and reason for the change.

5. Justifiable Reasons for Changing an Accounting Policy

Adoption of a new or revised accounting standard (e.g., IAS 16 revaluation model).
Improved relevance or reliability of the information (e.g., moving from straight‑line to units‑of‑production depreciation to better reflect usage).
Significant change in business circumstances that makes the old method inappropriate (e.g., a shift from manufacturing to service provision).

6. Common Areas Affected by Consistency

Accounting Area	Typical Methods	Effect of Changing Method
Depreciation	Straight‑line, Reducing balance, Units of production	Alters expense recognised each period and the carrying amount of the asset.
Inventory Valuation	FIFO, Weighted average, Specific identification	Changes cost of goods sold (COGS) and closing inventory values.
Revenue Recognition	Cash basis, Accrual basis	Impacts timing of revenue and the matching of related expenses.
Allowance for Doubtful Debts	Percentage of receivables, Ageing analysis	Alters provision expense and net receivables.

7. Illustrative Example – Depreciation

Scenario: A machine costs $30 000, residual value $5 000, useful life 5 years.

Step 1 – Straight‑line (SL) depreciation (Years 1‑2)

Annual expense = (Cost – Residual) / Life = (30,000 – 5,000) / 5 = $5,000

Step 2 – Change in Year 3 to Reducing‑balance (RB) at 40 % p.a.

Carrying amount at start of Year 3 (SL) = 30,000 – (2 × 5,000) = $20,000  
RB depreciation = 40 % × 20,000 = $8,000

Step 3 – Effect on profit (simplified)

Method	Depreciation (Year 3)	Profit before tax (original)	Profit before tax (after change)	Difference
Straight‑line	$5,000	$120,000	$120,000	$0
Reducing‑balance	$8,000	$120,000	$117,000	‑$3,000

Disclosure (model paragraph)

“During Year 3 the company changed its depreciation method for plant and equipment from straight‑line to reducing‑balance (40 % per annum). The change was made to better reflect the pattern of economic benefits derived from the assets. The effect of the change is a reduction of profit before tax by $3,000 and a corresponding decrease in net assets at 31 December Year 3 of $3,000.”

8. Mini‑Example – Inventory Valuation

Assume:

Opening inventory = 1,000 units @ $10 each.
Purchases during the year = 600 units @ $12 each.
Closing inventory = 500 units.

Method	COGS	Closing inventory
FIFO	(1,000 × 10) + (100 × 12) = $11,200	500 × 12 = $6,000
Weighted average	Total cost = (1,000 × 10) + (600 × 12) = $16,200 Avg cost = 16,200 / 1,600 = $10.13 COGS = (1,100 × 10.13) = $11,143	500 × 10.13 = $5,065

Effect of the change: Profit before tax is higher by $57 when moving from FIFO to weighted average, and closing inventory is lower by $935. The notes must disclose the nature, reason (e.g., more reliable cost flow assumption) and the quantitative effect on both the income statement and the statement of financial position.

9. Mini‑Example – Allowance for Doubtful Debts

Trade receivables = $50,000.

Old policy: 2 % of receivables → $1,000 provision.
New policy: ageing analysis → $1,200 provision.
Increase = $200 → expense rises by $200, profit falls by $200, net receivables fall by $200.

Disclosure paragraph:

“The allowance for doubtful debts was revised from 2 % of trade receivables to an ageing‑based estimate of $1,200. The change increased the provision by $200, decreasing profit before tax by $200 and net trade receivables by the same amount.”

10. Steps to Apply Consistency in Practice

Identify the accounting policies used in the current period.
Compare them with the policies applied in the previous period.
If a change is required, assess whether it is:
- Beneficial for more relevant or reliable information, or
- Mandated by a new accounting standard.
Prepare a disclosure note that includes:
- Nature of the change.
- Reason for the change.
- Quantitative effect on profit (or loss) and on the statement of financial position.
Apply the change retrospectively:
- Adjust opening balances of the affected assets/liabilities.
- Restate comparative figures, unless the change is immaterial.

Checklist – Consistency

✓ Identify the policy used.
✓ Compare with prior‑period policy.
✓ Evaluate need & justification.
✓ Draft disclosure (nature, reason, effect).
✓ Apply retrospectively or note immateriality.

11. Typical Exam Questions (AO‑1, AO‑2, AO‑3)

Explain why the consistency principle is important for users of financial statements and how it relates to the matching and going‑concern concepts.
Describe the steps a company must take when it changes its inventory valuation method, including the required disclosure.
Given the data below, calculate the effect on profit and on closing inventory when a company switches from FIFO to weighted‑average costing.
Prepare a model disclosure paragraph for a change in the allowance for doubtful debts policy.
List all ten accounting principles and give a brief practical illustration for each (AO‑1).

12. Summary

The consistency principle ensures that financial statements are comparable over time by requiring the same accounting methods to be used each period. When a change is necessary, it must be justified, fully disclosed, and applied retrospectively (adjusting opening balances) unless the change is immaterial. Understanding the ten fundamental accounting principles, the criteria for selecting accounting policies, and the influence of international standards equips students to answer AO‑1, AO‑2 and AO‑3 exam items with confidence.

consistency