Question

1. In much of life we hear of the relationship of cost to benefit, so too does it exist in accounting. In the conceptual framework, the cost-benefit relationship is referred to as the pervasive constraint. This means that the benefits to be derived from providing certain accounting information should exceed the costs of providing that information. Discuss the difficulty in applying this constraint to accounting information.

Answer 1

Financial information is a commodity. Financial reporting of this information imposes costs.

Unless the benefit expected from a commodity exceeds its costs, the commodity will not be sought after. This benefit-greater-than-cost relationship is a limitation of providing useful financial information, and is called the cost constraint.

The determination of whether the benefits of providing (and receiving) financial information justify the related costs is usually more of a qualitative assessment than a quantitative one.

The benefits of financial information are that the information helps capital providers make better decisions, which in turn results in the more efficient functioning of capital markets and a lower cost of capital.

The costs to a company of providing financial information include the costs of collecting and processing the information, the costs of verifying it, and the costs of disseminating the information.

Users also incur the costs of analysis and interpretation of the financial information. Thus, standard-setting regulatory bodies must weigh the costs of providing financial information against the benefits of the information. In so doing, they must also consider the costs of not providing decision-useful information. If this information is not provided in financial reports, external users must obtain, or attempt to estimate, needed information using incomplete data in financial reports or data available elsewhere

Cost / benefit along with materiality are considered the leading constraints within this framework.

In the past, accountants would informally attempt to balance the expediency and practicality of obtaining information reported in a company's financial statements. Today, many companies apply a cost / benefit constraint, which means the benefits derived from the information must exceed the cost to provide it to the readers.

From a practical standpoint, the cost portion of this constraint is fairly easy to quantify. For example, there are costs associated with gathering, assembling, storing, processing, analyzing, auditing, and disseminating data.

The benefits associated with this information are oftentimes more difficult to quantify. For example, the information may provide the preparer and reader with a more accurate assessment of taxes owed or resources available to the business. However, assigning a value to this information is sometimes problematic.

In practice, companies oftentimes require a cost / benefit analysis when establishing or modifying their internal accounting processes.