Cost Benefit PrincipleDefined along with Examples

Written By:
Lisa Borga

What is the Cost-Benefit Principle?

The cost-benefit principle states that the cost of providing financial information in financial statements should not be greater than the benefit of this information to users.

Explaining the Cost-Benefit Principle

When companies are applying the cost-benefit principle, they consider whether the benefits someone is receiving from an activity are worth the cost of that activity.

Businesses should not incur the cost of action if the benefit is not at least equal to that cost.

Generally, for businesses, this involves the cost of providing financial statements.

Large businesses spend millions of dollars preparing financial statements.

They do this to ensure that the financial statements they provide will be beneficial to those who use them.

Companies using the cost-benefit principle consider whether or not the information they are providing financial statement users is worth the cost of that information.

Some information may not be relevant to the users of the company’s financial statements.

Other information may be useful but too expensive to be worth the cost.

If the benefit of the information the company is providing in its financial statements is not worth the cost, then the company should not be providing the information.

Cost-Benefit Examples

We will now give two examples of the cost-benefit principle being used to make it easier to understand.

Example One

The owner of a mini-mart has discovered that one of his employees has been stealing from the cash register.

The owner thinks the employee has stolen approximately $500 over time.

However, he is not sure of the exact amount of the theft.

It would cost the owner $4,000 to have an accountant determine the exact amount of the theft.

The cost of determining the exact amount of the theft would far outweigh any benefits the owner would receive.

So the owner should not hire an accountant to find out the exact amount of the theft.

Example Two

Suppose Company A releases financial statements for the past year in March.

The statements point out an error that the company made in the previous year’s financial statements that amounted to approximately $100,000.

The company does not know what the exact amount of the error was, and it would cost the company $30 million to determine the precise amount of the error.

However, according to the cost-benefit principle, it is not necessary for company A to determine the exact amount of the error.

An approximate amount is sufficient because the cost of determining the exact amount of the error exceeds the benefit the company’s financial statement users would receive.