1. The Cost-Benefit Constraint
Financial reporting is not free. The cost of gathering, processing, auditing, and communicating financial data must not exceed the benefits that users get from having that information. This constraint limits the level of detail required in public disclosures.
2. Materiality Thresholds
Information is material if omitting, misstating, or obscuring it could reasonably be expected to influence decisions made by primary users. Materiality is relative and depends on size and nature:
  • Quantitative Materiality: An error of $10,000 might be immaterial to a multi-billion dollar firm, but could wipe out the net income of a small business.
  • Qualitative Materiality: A small $500 transaction can be material if it changes a net loss into a profit, or if it conceals an illegal bribe or a breach of a loan covenant.

3. Accounting Conservatism (Prudence)
Prudence is the exercise of caution when making accounting judgments under conditions of uncertainty.
  • Asymmetrical Recognition: Expenses and liabilities should be recognized as soon as they are probable. Assets and income should only be recognized when they are virtually certain or realized.
  • Overstatement Prevention: This ensures that assets and income are not overstated, and liabilities and expenses are not understated.
  • Warning: Prudence does not allow for deliberate understatement of assets or creation of hidden reserves, as this violates neutrality.

 
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