reliability

Topic 7 – Accounting Principles and Policies (Reliability & the Other Qualitative Characteristics)

1. Accounting principles (Section 7.1 of the Cambridge IGCSE 0452 syllabus)

The seven core accounting principles form the foundation for all reliable financial information. Each principle helps to ensure that the figures reported are trustworthy and useful.

2. Why are accounting policies needed?

Accounting policies are the specific principles, bases, conventions and rules a company adopts to prepare and present its financial statements. They translate the broad accounting principles into practical, day‑to‑day choices and ensure that the information produced is:

• Relevant – capable of influencing users’ decisions.
• Reliable – faithfully represents the underlying economic phenomena.
• Comparable – allows users to compare performance over time and with other entities.
• Understandable – presented in a clear, concise manner.

These four objectives together satisfy the qualitative characteristics of useful financial information set out in the IAS/IFRS Framework.

3. Qualitative characteristics and reliability

4. Selecting an accounting policy (Section 7.2 of the syllabus)

When a company faces alternative methods, the IAS/IFRS framework requires the following criteria to be considered:

1. Objective evidence – Preference for methods that can be supported by verifiable documentation.
2. Consistency – The same policy should be applied to similar transactions in each reporting period.
3. Cost‑benefit – The benefit of a more precise method must outweigh the additional cost of obtaining the information.
4. Neutrality & lack of bias – The policy should not be chosen to manipulate profit or asset values.
5. Relevance to the business – The method must reflect the economic reality of the entity’s operations.

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

IAS/IFRS provide the “framework” that guides policy selection. At IGCSE level the most relevant standards are:

• IAS 16 – Property, Plant and Equipment: measurement bases (historical cost or permitted revaluation) and allowable depreciation methods.
• IAS 2 – Inventories: cost formulas (FIFO, weighted‑average, specific identification) and the requirement to write‑down to net realiseable value.
• IFRS 15 (formerly IAS 18) – Revenue: criteria for recognising revenue when the performance obligation is satisfied.

Students should be able to name the relevant standard when justifying a policy choice.

6. Changing an accounting policy

• Justification required – a change is allowed only if it results in **more reliable and/or more relevant** information.
• Impact analysis – quantify the effect on profit, assets and equity for the current period and, where required, restate prior‑period figures.
• Disclosure – explain the nature of the change, the reason for it, and its financial impact in the notes to the financial statements.
• Comparability – restate prior‑period amounts (if necessary) so that users can compare the same policy across periods.
• When NOT to change – do not change a policy simply to smooth profit, reduce tax, or avoid a loss; such changes would breach the neutrality and faithful‑representation components of reliability.

7. Disclosure of accounting policies (IAS 1)

IAS 1 requires that **all significant accounting policies** be disclosed in the notes. The note should include, at a minimum:

1. Measurement basis used for each class of assets and liabilities (historical cost, revaluation, fair value where permitted).
2. Depreciation method(s) and estimated useful lives for property, plant and equipment.
3. Inventory valuation method (FIFO, weighted‑average, specific identification) and any write‑down policy.
4. Revenue‑recognition criteria (when control passes, when performance obligations are satisfied).
5. Any recent changes to policies, the reason for the change, and the quantitative impact.
6. Other significant policies not covered above (e.g., impairment of assets, foreign‑currency translation) if they affect the financial statements.

8. Reliable vs. Unreliable policies (Illustrative table)

9. Sample calculations – Applying reliable policies

9.1 Straight‑line depreciation (IAS 16)

Machine cost = $12 000
Useful life = 4 years
Residual value = $0

Annual depreciation = (Cost – Residual) ÷ Useful life = (12 000 – 0) ÷ 4 = $3 000

After two years, carrying amount = Cost – (Depreciation × 2) = 12 000 – (3 000 × 2) = $6 000

9.2 Reducing‑balance depreciation (IAS 16 – alternative method)

Same machine, depreciation rate = 40 % per annum.

After two years the carrying amount is $4 320, showing how a different (still IAS‑compliant) policy changes the figure.

10. Practical steps for students (Ensuring reliability)

1. Identify the relevant IAS/IFRS (e.g., IAS 16 for PPE, IAS 2 for inventories, IFRS 15 for revenue).
2. Refer to the syllabus list of accounting principles and the six selection criteria; choose the policy that offers the most objective evidence.
3. Apply the chosen policy **consistently** in every reporting period.
4. Maintain full supporting documentation – invoices, contracts, valuation reports, depreciation schedules.
5. If a change is needed, prepare a brief justification, calculate the impact, and draft the required note‑disclosure.
6. Cross‑check figures with the source documents (verifiability) before finalising the accounts.

11. Common pitfalls that reduce reliability

• Changing depreciation methods or inventory formulas without a valid reason or proper disclosure.
• Estimating inventory values without physical counts or purchase invoices.
• Recognising revenue before the performance obligation is satisfied.
• Omitting the “Accounting Policies” note or providing an incomplete description.
• Using subjective estimates where objective evidence is available, thereby introducing bias.
• Changing a policy merely to smooth profit, avoid a loss, or gain a tax advantage.

12. Summary checklist – Is the policy reliable?

1. Is the policy based on an accepted measurement basis (historical cost, or permitted fair value)?
2. Is there objective, verifiable evidence to support the amounts recorded?
3. Is the policy applied consistently from one period to the next?
4. Has any change been justified, quantified and disclosed in the notes?
5. Does the policy avoid bias and enhance comparability, relevance and understandability?