Objectivity Principle

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21 Aug, 2024

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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.

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.

What Is Objectivity Principle?

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.

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 receivable. If company XYZ can’t present proper receipts to the auditor, 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 scandal in India. Falsifying accounting statements, 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 Sheet, Profit and loss Statement, Cash Flow Statement, and Shareholder equity. 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:

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 margin 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.