What is Objectivity Principle?

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Examples

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.

Objectivity Principle in Auditing

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

  • 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

  • Companies in day-to-day operations are producing huge data. So all the data, if needed to be by accepted accounting standards, will require good software to record 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 to do so.Collecting documents and proofs to meet the objectivity principle is extremely time-consuming. It affects the daily operation of a business as the management spends more time documenting 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. read more reduces.Accounting principles change from time to time. So there should be a team appointed by the company to keep track of the changing accounting principles and act accordingly from time to time.

This has been a guide to What is the Objectivity Principle & its Definition. Here we discuss its examples along with its advantages and disadvantages. You can learn more about it from the following articles –

  • Realization PrincipleConsistency PrincipleExpense Recognition PrincipleFull Disclosure PrincipleCost Principle