Accounting Constraints - Explained
What is an Accounting Constraint?
Written by J. Mance Gordon
Updated at April 18th, 2024
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What is an Accounting Constraint?
Accounting constraints are those that constrain us from reporting certain things on the financial statements. There are two main constraints that would allow us to not report information that we would otherwise report on the statements.
- Materiality Constraint, and
- Benefit Constraint
What is the Materiality Constraint?
The materiality constraint states that only information that would influence a decision of a reasonable person needs to be disclosed.
For example, let's say that I reported 50 million dollars in accounts receivable. It then realize that my statement is off by approximately 1 thousand dollars. Would that discrepancy cause me to restate the financial statements? Probably not, as $1k is material in relation to $50m. It would not change somebody else's decision on whether to invest in me or not.
The same example, but I added a few extra zeros and it's only $50,000 in accounts receivable. That would definitely be material. I need to restate that to accurately reflect the position of the firm, as this information is really going to change a reasonable person's decision on whether they're going to invest in me.
What is the Benefit Constraint?
The benefit constraint states that only information with benefits of disclosure greater than the cost of providing it need to be disclosed. Basically, you only disclose things that provide a greater value to the recipient than it costs to make the disclosure.
The important point here is that it costs a great deal of money and effort to identify, organize, and disclose certain information. If the costs of undertaking this effort outweigh benefits to those for whom the disclosure is intended, then disclosure (and all the tasks necessary to bring about disclosure) are not necessary.