Contents: 7 sections
Cambridge IGCSE Accounting 0452 · Core and Extended
Syllabus points
- Explain the objectives of accounting: comparability, relevance, reliability and understandability.
- Explain how accounting policies are selected to meet those objectives.
- Recognise the influence of international accounting standards.
Accounting policies
An accounting policy is the particular treatment a business chooses where more than one is allowed. Common examples:
- Which depreciation method to use, and at what rate.
- How to calculate the allowance for irrecoverable debts.
- How to value inventory.
- Whether to revalue non-current assets.
Policies must be chosen so that the financial statements meet four objectives, and must then be applied consistently. Where a policy is changed, the change must have a good reason and must be disclosed.
The four objectives
Comparability. A user should be able to compare this year with last year, and this business with another. That is why consistency of policy matters: change the depreciation method and the profit changes even though the trading did not, so any comparison becomes meaningless without disclosure.
Relevance. The information must be capable of affecting a decision. Information that arrives too late, or that is buried in unnecessary detail, is not relevant however accurate it is.
Reliability. The information must be free from significant error and bias, and must represent what actually happened. A figure that can be verified against a document is more reliable than one based on an estimate.
Understandability. The statements must be presented so that a user with reasonable knowledge can follow them, using standard layouts and standard headings.
Where the objectives pull against each other
This is worth a sentence in an evaluation answer, because it explains why accounting involves judgement rather than rules alone.
- Relevance against reliability. A current valuation of premises is more relevant than a cost from twenty years ago, but it is an estimate and so less reliable. Historic cost is the reverse: reliable, and potentially out of date.
- Relevance against understandability. More detail can be more relevant and also harder to follow.
- Comparability against relevance. Keeping an old policy for comparability may mean keeping one that no longer suits the business.
Businesses choose a balance. There is no policy that maximises all four at once.
Why policies must be applied consistently
A business that changed its depreciation method every year could report almost any profit it liked. Consistency stops the choice of policy being used to manage the reported result, and it makes a trend over several years meaningful.
Changing a policy is not forbidden. It is allowed where the new treatment gives a fairer presentation, and the change and its effect must be disclosed, so users can still compare.
International accounting standards
International Financial Reporting Standards (IFRS) set out how transactions must be treated and how the statements must be presented.
They exist because:
- Investors, lenders and suppliers increasingly operate across countries and need statements they can compare.
- Common rules reduce the scope for manipulation.
- Users can rely on a consistent meaning for terms such as inventory, revenue and non-current asset.
Their most visible effect at this level is on terminology, and questions expect the current words:
| Older term | Current term |
|---|---|
| Debtors | Trade receivables |
| Creditors | Trade payables |
| Stock | Inventory |
| Fixed assets | Non-current assets |
| Profit and loss account | Income statement |
| Balance sheet | Statement of financial position |
| Bad debts | Irrecoverable debts |
| Provision for doubtful debts | Allowance for irrecoverable debts |
| Net book value | Carrying amount |
| Turnover or sales | Revenue |
Note that provision for depreciation keeps its name. The word "provision" was replaced in the doubtful debts case and not in the depreciation case, which is exactly the kind of detail a question uses to separate candidates.
Common mistakes
- Confusing an accounting policy, which is a choice of treatment, with an accounting principle, which is a rule the treatment must respect.
- Saying comparability means every business must use the same policy. It means each business must be consistent and must disclose changes.
- Saying a policy can never be changed.
- Naming the four objectives without applying them to the situation in the question.
- Using the older terminology in an answer.
- Saying international standards remove all judgement from accounting.