The objectivity principle is one of the basic principles of accounting. It states that financial statements should be based on objective, verifiable evidence, not personal feelings or biases. The purpose of this principle is to ensure that the financial information presented by a company is accurate, reliable, and can be independently verified by auditors, investors, lenders, and other stakeholders.
According to the objectivity principle, any item that is reported in the financial statements must be supported by evidence, such as receipts, invoices, contracts, or other documents. The principle helps maintain the integrity of the financial reporting process and builds trust between the company and its stakeholders.
The objectivity principle also implies that the accounting data should not be influenced by the personal bias or judgment of those preparing the financial statements. While some level of judgment is often necessary in accounting, especially in areas such as estimating allowances for doubtful accounts or depreciating assets, these judgments should be based on factual, objective evidence as much as possible.
Example of the Objectivity Principle
Imagine you own a small business and you purchased a machine for your production line. You paid $20,000 for this machine. According to the objectivity principle, you would record this machine in your accounting records at the actual cost paid, which is $20,000, not at the value you personally believe the machine is worth.
Let’s say you feel this machine is extremely efficient and would drastically improve your production, and thus, you estimate its value to be $30,000. However, despite your personal belief, you should not record the machine’s cost at $30,000 in your books. Instead, you must stick to the objective, verifiable cost of $20,000, which can be supported by the purchase invoice.
This application of the objectivity principle ensures the financial records are based on verifiable and reliable information, and not influenced by personal bias or subjective judgments. This allows stakeholders, such as investors, creditors, or auditors, to have confidence in the financial information provided by the company.