The cost benefit principle or cost benefit relationship states that the cost of providing financial information in the financial statements must not outweigh the benefit of that information to the users. In other words, financial information is not free. Companies spend millions of dollars every year gathering and organizing financial information to assemble into financial statements.
Ideally, investors and creditors would like to know every piece of information about a company as possible. Unfortunately, this level of disclosure would place a huge financial burden on the company. Some financial information external users don’t receive a large benefit from knowing such as how much money Apple spends giving the public tours of its headquarters. Other information would be far too costly to obtain like audit, potential litigation, and competitor’s information.
Essentially, the cost benefit principle is a common sense rule. Management can ask, “does it make sense to gather this financial information to put it in financial statement? Do the costs of gathering this information outweigh the benefit to the users?” Essentially, do users need this information enough to spend this money getting it? If the answer is yes, the company can leave the information out of the financial statements.
The cost benefit principle also applies to internal company processes.
Examples
– Big Towing, Inc. issues financial statements in January for its prior year. These statements correct an error in the previous year’s financial statements. The error was estimated to be $200,000. The exact error amount is unknown and would cost approximately $50M to exactly pinpoint. The cost benefit principle states that Big Towing does not have to find the exact amount of the error. A reasonable estimate is acceptable due to the high cost of researching the actual cost of the error.
– Paul’s Retail, LLC discovered that an employee was stealing from its cash register. The amount is suspected to be over $1,000, but Paul is not sure. It’s estimated that Paul would pay his accountant and attorney $5,000 to dig through his records and discover the exact amount of the theft. In this case, it would not be beneficial for Paul to do further research and sue his former employee.
– Lisa’s Salad Shop, a restaurant, is under audit with the IRS. The IRS assets that Lisa’s expenses were only $15,000– not the $30,000 that Lisa reported on her tax return. Lisa’s accountant estimates that it will cost $10,000 in research costs to find the receipts and documentation for these expenses. If the tax returns are restated with only $15,000 of expenses, the additional taxes will only be $1,000. The cost of researching the expenses outweighs the benefit of lowering the potential tax bill.
