EPFO APFC 2023 General Studies · Question 79 of 120

Correct — B, (b) Consistency. The word 'not' is printed in bold italics, so the question wants the odd one out, and three of the four options are correct. Accounting Standard 1, on the disclosure of accounting policies, states in terms that the major considerations governing the selection and application of accounting policies are prudence, substance over form and materiality. Consistency is not on that list. It belongs to a different and equally important list in the same standard: the three fundamental accounting assumptions, which are going concern, consistency and accrual. The distinction the question is built on is real and not merely verbal. A fundamental accounting assumption is presumed to have been followed in preparing financial statements, so it needs no disclosure unless it has been departed from, in which case the departure must be disclosed. A major consideration, by contrast, is a criterion the preparer applies when choosing between the alternative treatments that are available for a transaction — whether to anticipate a loss, whether to follow the legal form of an arrangement or its economic reality, whether an item is large enough to merit separate disclosure. Consistency does not help make that choice at all. It operates one level up, requiring that whatever policy is selected be applied in the same way from one accounting period to the next so that successive years can be compared, and that any change in policy be disclosed together with its effect. A firm could apply an imprudent policy with perfect consistency; consistency constrains the movement between treatments, while prudence, substance over form and materiality decide which treatment to adopt in the first place.

• (a)Prudence — Prudence is one of the three major considerations, so it cannot be the answer to a question asking which is not. It requires that, in view of the uncertainty attaching to future events, profits are not anticipated but are recognised only when realised, while provision is made for all known liabilities and losses even where the amount cannot be determined with certainty and can only be a best estimate on the information available. That asymmetry between gains and losses is what gives the consideration its bite, and it explains a whole family of familiar treatments: valuing inventory at the lower of cost and net realisable value, providing for doubtful debts before they are known to be irrecoverable, and providing for a contingent liability that is probable while merely disclosing a contingent gain. Prudence is sometimes described as conservatism, and it is the consideration most often invoked when two permissible treatments would give different profits.
• (c)Substance over form — This too is one of the three major considerations named by the standard. It requires that transactions and other events be accounted for and presented in accordance with their substance and financial reality, and not merely with their legal form. The standard illustration is hire purchase, where legal ownership of the asset remains with the seller until the last instalment is paid but the buyer has the use and the risks of the asset from the outset, and so records it as an asset with a corresponding liability. The same reasoning underlies the treatment of finance leases, of sale and repurchase arrangements, and of transactions routed through an intermediary that leave the economic exposure exactly where it began. As a consideration it does precisely what the question describes, guiding the selection of a policy where legal form and economic reality diverge.
• (d)Materiality — Materiality is the third of the major considerations. It holds that financial statements should disclose all material items, a material item being one whose knowledge might influence the decisions of a user of those statements, and it works in both directions: it requires separate disclosure of what matters and permits aggregation or approximation of what does not. Materiality is judged by size and by nature together, so a small amount can be material because of what it is — a payment to a director, or a transaction that turns a profit into a loss — while a large amount may be immaterial in the context of the enterprise's scale. Because it decides whether a particular treatment or disclosure is worth adopting, it is a criterion for selecting and applying policies, which is exactly what the standard means by a major consideration.

Accounting Standard 1 on the disclosure of accounting policies organises its material into two lists that are easy to confuse and are frequently examined against each other. The first is the fundamental accounting assumptions: going concern, that the enterprise will continue in operation for the foreseeable future; consistency, that accounting policies are applied in the same way from one period to the next; and accrual, that revenues and costs are recognised as they are earned or incurred rather than as cash moves. These are presumed to have been followed, and a departure from any of them must be disclosed. The second is the major considerations governing the selection and application of accounting policies: prudence, substance over form and materiality. These are the criteria a preparer applies in choosing among the treatments that the standards permit for a particular transaction. The standard then requires that all significant accounting policies adopted be disclosed, that the disclosure form part of the financial statements and be made in one place, and that a change in policy having a material effect be disclosed together with the amount of that effect, or the fact that the amount is not ascertainable. Holding the two lists apart, and remembering that consistency sits in the first while prudence, substance over form and materiality sit in the second, disposes of most questions on this standard.

This is a negative question, and the booklet signals it by printing the negation in bold italics, as it does on the other questions in the paper whose ask is negative. The signal is worth using but not worth relying on: the same paper carries negations inside numbered statements, in ordinary weight, under a positively worded ask, so the safe habit is to read the ask itself and treat the typography as confirmation. On a negative question with four plausible items, the efficient method is to confirm the three that belong rather than to hunt for the one that does not, because confirming membership requires only recall of a list while identifying the odd one out requires recall plus a judgement about why it is odd. Here the three that belong are exactly the three named in the standard, and once they are confirmed the fourth follows without any need to decide what consistency is instead. The deeper point the question tests is the difference between an assumption presumed unless denied and a criterion applied when choosing, and that difference matters in practice: an enterprise that changes an accounting policy must disclose the change and its effect, whereas an enterprise that departs from a fundamental assumption must disclose that fact as a matter going to the whole basis on which its statements have been drawn up.

• Accounting Standard 1 states that the major considerations governing the selection and application of accounting policies are prudence, substance over form and materiality.
• The three fundamental accounting assumptions in the same standard are going concern, consistency and accrual; they are presumed to have been followed, and any departure from them must be disclosed.
• Prudence requires that profits are not anticipated but recognised only when realised, while provision is made for all known liabilities and losses even where the amount is only a best estimate.
• Substance over form requires transactions and events to be accounted for according to their financial reality rather than their legal form, as with hire purchase, where the buyer records the asset although legal title remains with the seller.
• Materiality requires disclosure of all items whose knowledge might influence a user's decisions, and materiality is judged by the nature of an item as well as by its amount.
• The standard also requires that all significant accounting policies be disclosed in one place as part of the financial statements, and that a change of policy with a material effect be disclosed along with the amount of that effect or the fact that it is not ascertainable.

• Confusing the list of fundamental accounting assumptions with the list of major considerations; consistency belongs to the first and prudence, substance over form and materiality to the second
• Reading the ask positively and choosing prudence or materiality because they are genuinely important; the question asks which is not a major consideration
• Assuming materiality is only about size; an item can be material because of its nature, such as a transaction with a director, however small the amount
• Treating prudence as a licence to create hidden reserves; it requires losses to be provided for and gains not to be anticipated, not the deliberate understatement of profit
• Forgetting that a departure from a fundamental assumption and a change in accounting policy carry different disclosure consequences under the standard

The paper asks the accounting standards as list membership, and Accounting Standard 1 is the standard most often used for the purpose because it contains two short lists that can be set against each other. Typical questions ask which item is or is not a fundamental accounting assumption, which is or is not a major consideration in selecting accounting policies, or what must be disclosed when a policy changes. Negative phrasing is common, and this booklet marks it in bold italics. Because the answer is always a matter of which list an item belongs to, the whole family of questions is answered by memorising two triads — going concern, consistency and accrual on one side, prudence, substance over form and materiality on the other — and by understanding well enough what each term means to recognise it when the paper describes rather than names it.

No directly related past PYQ was found.

• practice — not a real PYQ

  The treatment of an asset acquired on hire purchase as an asset of the buyer, although the legal title remains with the seller until the last instalment is paid, is an application of which one of the following?

  • (a)Prudence
  • (b)Materiality
  • (c)Substance over form
  • (d)Consistency

  Answer(c) Substance over form — the buyer has the use of the asset and bears its risks from the outset, so the financial reality of the arrangement is that the asset belongs to the buyer with a corresponding liability, and it is accounted for that way notwithstanding the legal position on title. Substance over form is one of the three major considerations governing the selection and application of accounting policies under Accounting Standard 1, alongside prudence and materiality.

• practice — not a real PYQ

  Under Accounting Standard 1, if a fundamental accounting assumption is not followed in preparing financial statements,

  • (a)no disclosure is required, since the assumptions are only presumptions
  • (b)the fact must be disclosed
  • (c)the financial statements must be re-cast on the assumption
  • (d)the auditor alone is required to report it

  Answer(b) the fact must be disclosed — the three fundamental accounting assumptions of going concern, consistency and accrual are presumed to have been followed, so no positive statement about them is needed; it is precisely when one of them has not been followed that the standard requires the fact to be disclosed. This is what distinguishes an assumption, which is presumed unless denied, from an accounting policy, whose adoption must be disclosed affirmatively.