Neutrality


Information contained in the financial statements must be free from bias. It should reflect a balanced view of the affairs of the company without attempting to present them in a favored light. Information may be deliberately biased or systematically biased.

Deliberate bias

Deliberate bias occurs where circumstances and conditions cause management to intentionally misstate the financial statements.

Examples

  • Managers of a company are provided bonus on the basis of reported profit. This might tempt management to adopt accounting policies that result in higher profits rather than those that better reflect the company's performance inline with GAAP.
  • A company is facing serious liquidity problems. Management may decide to window dress the financial statements in a manner that improves the company's current ratios in order to hide the gravity of the situation.
  • A company is facing litigation. Although reasonable estimate of the amount of possible settlement could be made, management decides to discloses its inability to measure the potential liability with sufficient reliability.

Systematic bias

Systematic bias occurs where accounting systems have developed an inherent tendency of favoring one outcome over the other over time.

Example

Accounting policies within an organization may be overly prudent because of cultural influence of an over cautious leadership.

Test Your Understanding

Under which of the following circumstances will neutrality of information be compromised?

Fixed Asset with a useful life of 5 years is depreciated over 3 years because management believes it is more prudent to charge higher depreciation expense in the earlier years of an asset's life.

Inventory recognized at the lower of cost or net revenue