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 be useful for evaluation.
Company XYZ has asked an auditing company to do an external audit of financial records for the company. When the external auditor started to validate the records, he asked for receipts from customers in order to validate the Accounts receivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.. 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., then the objectivity principle is violated. As the statements can’t be verified, so the records can’t be used.
In 2009, Satyam Computer Services, an Indian based company, presented falsified accounts in order to elevate profit. Ramalinga Raju, the chairman of Satyam computers, confessed 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. in India. Falsifying accounting statements, such as entering fictitious orders and then increasing accounts receivable, is a breach of the Objectivity Principle. The accounts that you are entering in your books must be objective and verifiable.
ABC Limited has applied for loans in the bank. The loan is a collateralized loan and needs audited documentation of the asset in order to get approved. When the process of loan documentation 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, then 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 should be audited.
Objectivity Principle in Auditing
Auditing is the inspection of the company’s books done by internal as well as 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 on a great extent on the objectivity principle and make sure that each record is objective and accurate. 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., Profit and loss Statement, Cash Flow StatementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities., 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.. 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. Auditors are extremely careful while auditing books and goes through each and every documentation minutely.
- The company’s books are followed by investors, suppliers, stakeholders, government agencies, shareholders, and other parties. It is really important that the information reflected in the books are correct and transparent. It makes the books objective and trustworthy. A firm following an accounting standard which has 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 share price of the company also increases.
- Misstating information attracts severe penalties as well as jail terms. So companies that follow good accounting standards based on objectivity principle are free from the pressure of government sanctions.
- Huge data is being produced by companies in day to day operations. So all the data, if needed to be in accordance with accepted accounting standards, then it will require good software to record them and store them. This will require documentation for all entries. So this type of record-keeping is very costly and requires a lot of procedures in place to do so.
- The collection of documents, proofs to meet the objectivity principle is extremely time-consuming and affects the daily operation of a business as the management spends more time in order to document everything accurately.
- The hiring of an external auditing team is costly. It increases the cost of the normal operation of a business, and the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. reduces.
- Accounting principles change from time to time. So there should be a team appointed by the company in order to keep track of the changing accounting principles and act accordingly from time to time.
This has been a guide to What is Objectivity Principle & its Definition. Here we discuss its examples along with advantages and disadvantages. You can learn more about from the following articles –