Acca f3 Financial Accounting (int) Study Text

42

3: Accounting conventions   Part B  The qualitative characteristics of financial information and the fundamental bases of accounting 

(g)

Understandability. Information may be difficult to understand if it is incomplete, but too much 

detail can also confuse the issue. 

Question

Consistency

Which of the following statements 

best describes the consistency concept? 

A 

Only material items are disclosed 

B 

The way an item is presented always remains the same 

C 

Presentation and classification of items should remain the same unless a change is required by an 

IFRS

Answer

The correct answer is C. 

4 Criticisms of accounting conventions 

Accounting conventions  are not 'set in stone'. They can be, and have been, criticised. 

It is easy to assume that these accounting conventions are the best ones we could use. However, this is 

not necessarily the case. This is potentially a vast topic, so we will look at only to two or three examples. 

The syllabus and study guide show that you must understand the balance between qualitative 

characteristics. Do not neglect this section. 

4.1 Criticisms of the prudence concept 

'Prudence' and 'accountant' would appear to go together. Surely this bedrock of accounting is 

unassailable?

Question

Prudence 

Before we go any further, can you remember exactly what prudence is? 

Answer

The prudence concept lays down that revenue and profits are not anticipated but should only be recorded 

when earning is reasonably certain. Expenses and liabilities should, however, be recorded when 

anticipated, as best estimates if no actual figures are available. 

Loss in value of assets, whether realised or not, should be recorded when it arises, but a gain in value of 

an asset should not be recorded except via an unrealised reserve and only then if properly warranted. 

An example of the application of the prudence concept is the requirement to value inventory at the lower

of cost and net realisable value. 

FAST FORWARD

Exam focus 

point

---

Part B  The qualitative characteristics of financial information and the fundamental bases of accounting

  3:  Accounting conventions

43

This is all very well, but it can lead to problems, of which the following can be identified as the most 

significant.

(a)

Prudence most obviously conflicts with the accrual assumption because it requires that the 

matching of costs and revenues should not take place if there is any doubt about the future 

recoverability of deferred costs. This conflict has been summarised as 'should we report the worst 

possible situation (prudence) or the most likely position?' 

(b)

Prudence also conflicts with the going concern assumption because it may not be prudent to 

assume that a business is a going concern (although it is realistic). 

(c)

Prudence makes it difficult to treat items consistently because circumstances in one period may 

require a different treatment from previous periods in order to be prudent. 

(d)

Prudence also undermines several other assumptions. For instance, objectivity is regarded as 

important by most users of accounts but prudence (or conservatism as it is sometimes called) 

implies a subjectivity in coming to accounting judgements. It is also difficult to reconcile prudence 

with the use of anything other than the 

historical cost convention for valuing assets (see 

Section 5

). 

4.2 Criticisms of the accruals assumption 

Try this question before you go any further. 

Question

Accruals

Can you remember what the accruals assumption is? 

Answer

Under the accruals assumption, revenue and expenditure are matched and recorded in the accounts when 

earned or incurred, rather than being dependent on the associated cash movement. 

This applies most obviously for credit sales, but also results in the identification of inventory at the end of 

each accounting period rather than writing all purchases off to the trading account. Only purchases which 

result in a sale recorded in the period or are used for promotional or similar purposes should be matched 

with sales for the period. Therefore, if purchased goods still on hand at the period end are of saleable 

quality and the company will still be trading in the next period (ie the prudence and going concern 

concepts are satisfied) then any unsold goods can be treated as current assets and their value can be 

deducted from purchases and opening inventory. 

What could possibly be wrong with that? The main criticism relates to the conflict with historical cost 

accounting.

It can be argued that the accrual assumption is not applied in historical cost accounting. The assumption 

states that revenue earned must be matched against expenditure incurred in earning it. The cost of goods 

sold in the income statement is normally computed on the basis of their historical cost. However, a 

continuing business will want to replace inventories sold and will have to do so at ever higher prices. This 

means that some of the 'profit' shown by the accounts is not profit at all, but must be spent in restoring 

the assets of the business to their previous level. 

It may be argued that the accrual assumption could be better applied under a system of replacement cost. 

Thus the historical cost profit would be adjusted by the 'cost of sales adjustment' which aims to charge 

the income statement with the current cost of each item of inventory sold at the date of sale. 

Other criticisms of the accrual assumption include the following. 

(a) 

The nature of the matching process is often 

arbitrary, for example in selecting a depreciation 

method.

(b) 

The accrual assumption 

conflicts with the prudence concept as indicated above. 

---