Objectivity Principle

Updated on January 3, 2024
Article bySourav Sinha
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Objectivity Principle?

The Objectivity Principle in accounting states that financial statements should be objective, i.e., the accounting information should be unbiased and free from any external or internal influence. This helps financial statements to be trustworthy and useful for evaluation.

Objectivity Principle

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This principle ensures that proper ethical standards are followed in a company, failing to guarantee which could impose strict actions against it. While auditing, checking the financial statements against objectivity is a must to make sure the data presented are free from biases or personal preferences.

Objectivity Principle Explained

Objectivity principle eradicates the chances of the financial statements of a firm to be influenced by any other factors except actual facts. Many a times, companies put in data into the financial statements per their opinion or out of bias. This principle makes these firms stick to ethical standards and be transparent when presenting figures in the financial statements.

Adopting this principle ensures no discrepancies in the financial statements, i.e., the statements indicate the real account information without any external influence on them. Each and every entry made in the statements, according to this principle, must have solid evidence to prove it. Reliability and accuracy of financial details are what implementing this principle of objectivity guarantees.

Financial statements are verified independently by auditors, investors, and other stakeholders who refer to these statements for effective decision-making. While auditor check these statements against accuracy to figure out and validate the resources used and the profit made, investors refer to these financial documents to check on the progress of the firm to decide whether to invest in it or not.

The ways in which these statements, be it the income statement or a cash flow statement, are used by different stakeholders make adoption of the objectivity principle for accounting becomes a must.

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Examples

Let us consider the following instances to understand the objectivity principle definition better and also check how it works:

Example #1

Company XYZ has asked an auditing company to do an external audit of financial records for the company. However, when the external auditor started to validate the records, he asked for receipts from customers to validate the Accounts receivableAccounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more. If company XYZ can’t present proper receipts to the auditorAuditorAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws.read more, the objectivity principle is violated. As a result, the statements can’t be verified, so the records can’t be used.

Example #2

In 2009, Satyam Computer Services, an Indian-based company, presented falsified accounts to elevate profit. Ramalinga Raju, the chairman of Satyam computers, confessed to the crime, and it is considered the biggest accounting scandalAccounting ScandalAccounting Scandals refer to situations which demonstrate intentional falsification or misrepresentation of financial documents. Some of the most famous ones are by Enron, Freddie Mac, HealthSouth, & American Insurance Group etc. read more in India. Falsifying accounting statementsAccounting StatementsAn accounting statement or account statement refers to a document that summarizes the financial details of an account during a given period. An example of an accounting statement is a bank account statement. A bank account statement reflects the source and amount of every transaction within a selected period. Different accounting statements serve other purposes, but they all act as written proof that helps resolve disputes.read more, such as entering fictitious orders and increasing accounts receivable, is a breach of the Objectivity Principle. Therefore, the funds you enter in your books must be objective and verifiable.

Example #3

ABC Limited has applied for loans in the bank. The loan is collateralized and needs audited asset documentation to get approved. When the loan documentation process began, the company was asked to present the audited papers of assets. Those will be kept as collateral. If the company fails to do so, it is quite likely that the loan will not be given to the company. This is the objectivity principle, where all the assets shown in the books should have proper documentation and be audited.

Importance

Auditing is the inspection of the company’s books done by internal and external auditors of the company. Auditors need to be very careful while examining records and need to substantiate each record with proper documentation, receipt, bills, papers, etc. So auditors depend greatly on the objectivity principle and make sure that each record is objective and accurate. For example the company’s books contains Balance SheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more, Profit and loss Statement, Cash Flow StatementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more, and Shareholder equityShareholder EquityShareholder’s equity is the residual interest of the shareholders in the company and is calculated as the difference between Assets and Liabilities. The Shareholders' Equity Statement on the balance sheet details the change in the value of shareholder's equity from the beginning to the end of an accounting period.read more.  So all the entries in the respective books should be based on the objectivity principle. Any false record will question the credibility of the entire book. So auditors are extremely careful while auditing books and go through every documentation minutely.

Advantages

Objectivity principle is the criteria that every accounting professional and the management itself should try to stick to while maintaining financial statements for the company. This principle builds a foundation towards an ethically sound working environment that is transparent and clear about the finances, answering all doubts that may arise in the mind of internal or external auditors when gone through.

Listed below are the benefits of following objectivity principle to have a look at:

  • Investors, suppliers, stakeholders, government agencies, shareholders, and other parties follow the company’s books. The information reflected in the books must be correct and transparent. It makes the books objective and trustworthy. A firm following an accounting standard with the objectivity principle proves that the books are correct. All the records in the book are objective and are backed by proper documentation.
  • It proves that records shown in books are not based on opinion. So the records are completely factual, and it makes the book transparent.
  • It creates goodwill for the company. Misstating information has led to severe image degradation for companies in the past. It has been proven that when companies keep their books clean, then the trust and faith of investors increase, and the company’s share price also increases.
  • Misstating information attracts severe penalties as well as jail terms. So companies that follow good accounting standards based on the objectivity principle are free from the pressure of government sanctions.

Disadvantages

Though the advantages of objectivity principle of accounting are many, they are not devoid of flaws. There are a few demerits of this principle, which one must of before fully relying on firms following it for maintaining their financial statements. Let us look at the disadvantages of the concept below:

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