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FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE REGULATORY FRAMEWORK OF ACCOUNTING
This creates a problem in that the accruals convention states that the expense should be
accounted for in that period, but the matching convention states that expense should be
matched to revenue.
Generally, a prudent view is taken of expenses. If they have been incurred during the
period, they are taken into that period’s income statement, even though they may have
been incurred to provide future revenue. It is only where they can be reasonably identifi ed
with future earning potential that they are carried forward to future periods, and so most
expenses are charged to the income statement for the period in which they were incurred.
Similarly, a prudent view must also be taken of revenue. If monies have been received
during a period in respect of revenue that has not yet been earned (e.g. the receipt of a
deposit for a customer’s order that has not yet been fulfi lled), this must not be treated as
revenue in that period, but carried forward until the order has been satisfi ed, and matched
with the relevant expense incurred.
10.2.9 The materiality convention
Accounting statements are prepared for the benefi t of various user groups. It is essential
that the information provided is both signifi cant and easily understood. The materiality
convention ensures that the information provided is clear by omitting items that are not
signifi cant to the user in understanding the overall fi nancial position of the organisation.
Thus the materiality convention should make the fi nancial statements relevant to users.
The distinction between what is signifi cant and what is not varies depending on the size
of the organisation, and is a matter for judgement. Determining at what point an item
becomes material depends partly on value, partly on the nature of the item concerned and
partly on its effect on the results that will be reported.
As a general rule, items with a relatively small (5 per cent of net profi t) monetary value
are not signifi cant unless they change a profi t into a loss or vice versa or affect sensitive
issues. The convention can be applied to the classifi cation of items as ‘ revenue expenditure ’
rather than ‘ capital expenditure ’ . For example, the purchase of storage boxes for fl oppy
disks is strictly capital expenditure as the boxes will be used over several years (and there-
fore they should be depreciated over their estimated useful life). However, their value is
very small and therefore it is justifi able to treat them as revenue expenditure and included
in the income statement in the period in which they were bought. Another example is the
treatment of inventories of stationery at the end of a period – the matching convention
dictates that the cost of unused inventory should be carried forward as an asset, but most
organisations would fi nd this cumbersome, and the effect on profi t minimal, and there-
fore many would choose to make no adjustment for such inventories, unless their value
is material.
Materiality can also be applied to ‘ aggregation ’ . Material items should be disclosed sepa-
rately in the fi nancial statements, but immaterial items may be aggregated together. For
example, the charge for depreciation and the loss on sale of a non-current asset could be
aggregated where both are immaterial.
Materiality can be applied to ‘ offsetting ’ . In general, assets and liabilities should not
be offset; nor should revenue and expenses. However, where the amounts are immaterial,
then offsetting may occur. For example, discounts received and discounts allowed should
normally be shown separately, but if they are immaterial, they may be offset to give a
net fi gure.