Cost benefit principle

The cost benefit principle holds that the cost of providing information via the financial statements should not exceed its utility to readers. This is a significant issue from two perspectives, which are:

  • Level of detail provided. The company controller should not spend an inordinate amount of time fine-tuning the financial statements with immaterial adjustments. This also means not providing an inordinate amount of supporting information in the accompanying footnotes.
  • Types of information required. The standard setting entities need to judge the level of information they require organizations to report in their financial statements, so that the requirements do not cause an excessive amount of work for these businesses.

A further consideration is that providing additional information requires more time to produce the financial statements. If an inordinate amount of time passes because of the need to prepare more information, it can be argued that the utility of the resulting financial statements is reduced for readers, since the information is no longer timely.

Examples of situations in which the cost benefit principle arises are as follows:

  • A business has just acquired another entity, and finds that there is some uncertainty regarding the final outcome of derivatives to which the acquiree is a party. An extensive amount of modeling could define the extent of the possible gains and losses associated with these derivatives, but the cost of the modeling would be $100,000. It is more cost-beneficial for the business to wait a few months for the derivatives to resolve themselves.
  • The controller learns that a long-term employee has been engaged in a low level of petty cash theft for the past ten years. The estimated amount of the loss is a few thousand dollars, though an extensive review by the firm's auditors could probably pin down a more precise figure, at the cost of a $10,000 audit. The controller elects to skip the audit, since the cost-benefit relationship is so poor.

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