What is the reasonableness test?
When is the test of reasonableness used?
How is it applied in contract law, criminal law, tort law, audit and accounting?
We will define it from a legal and accounting perspective, look at its applications in different areas such as criminal law, tort law, contract law, audit, finance and accounting.
Be sure to read this post in full as you’ll learn things on this topic that you’ll find highly valuable.
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What is the reasonableness test
The reasonableness test is a test used in different fields, particularly in law and accounting.
Let’s look at what the reasonableness test entails by looking at the legal definition followed by the accounting definition.
Legal definition
According to Investopedia, the legal definition of reasonableness test is as follows:
A benchmark used in court when reviewing the decisions made by a particular party. The reasonableness standard is a test which asks whether the decisions made were legitimate and designed to remedy a certain issue under the circumstances at the time.
In law, the reasonableness test is performed by assessing a legal dispute or issue through the eyes of a “reasonable person”.
Accounting definition
The reasonableness test or reasonableness analysis in accounting refers to an examination procedure intended to verify the validity and reasonableness of accounting information.
One example of how an accountant may perform a reasonableness test is by comparing a company’s gross margin percentage to that of its peers in the same industry.
Reasonableness testing is an audit technique allowing an auditor to validate accounting records, numbers reported in a financial statement, inventory reports, account receivable reports and so on.
Reasonableness test in contract law
In contract law, there are many instances where the court must use the reasonableness test to assess whether the actions or conduct of the parties were reasonable in the circumstances.
The reasonable man test or reasonable person test is used to determine contractual intent or whether a contractual breach was the result of a person violating the standard of care.
Courts evaluate a contractual party’s intent
Once the intent of a contracting party is determined and the reasonableness test used, then the court can better evaluate the consideration, expectations, conduct and circumstances of the dispute.
Reasonableness test in criminal law
The “reasonable person” legal fiction and reasonableness test is crucial in criminal law giving the courts a process or a mechanism to evaluate a person’s negligence and level of care or prudence exercised by a person.
The gravity of a person’s actions or omissions can be compared to that of a reasonable person in the same circumstances.
Reasonableness test in tort law
In lawsuits and cases involving negligence and tort law, the courts have devised the test of reasonableness to draw the line between the standard of care versus negligent conduct.
Courts assess a person’s exercise of the standard of care versus negligent conduct
When the court finds that a person failed to abide by the proper standard of care, that person can be held liable for damages caused as a result of his or her actions.
In the law of negligence and tort law, the courts use the legal fiction of a “reasonable person” to test whether the conduct was tortious or not.
A reasonable person is a person who exercises ordinary prudence, care and diligence in normal circumstances.
Reasonableness test in audit
The audit reasonableness test is a common test used to audit, accounting and finance to assess income and expenses recorded in a company’s income statement or other events and transactions.
An auditor will consider data from two different sources or two different data points to assess the validity of the numbers reported.
For example:
There is a high correlation between the inventory data or the cost of goods sold with a company’s reported income.
An auditor may assess the inventory data or cost of goods data to assess the validity or reasonableness of the reported income.
The objective of an audit reasonable testing or reasonability test is to use an accounting transaction or event to forecast the reasonability of related events or transactions.
Be sure to read our post on system audit to better understand the auditing process.
Data validation
The reasonableness check is a process used when a professional needs to examine the validity of any type of data.
A data scientist may use the reasonableness check to ensure the validity and quality of data in a particular data set to ensure that the data is complete or relevant.
Reasonableness check is like a common-sense check
Reasonableness test FAQ
What is the reasonableness standard?
The reasonableness standard in commercial contracts and contract law is the standard used by the court to interpret contracts and the intention of the parties when they entered into a contract.
What would a reasonable person having all the relevant information and knowledge at the time of signing of the contract do or act during the execution of the contract?
Courts consider the reasonableness standard in evaluating the intention of the parties upon signature of the context of a breach of contract
The duties of a contractual party can also be derived from the exercise of reasonable care, skill and prudence.
A reasonable test may also be used in evaluating the standard of care of a contractual party during the execution of the contract and post-contractual obligations.
What does reasonableness mean in law?
The reasonable test law is a benchmark used by the court to evaluate the actions of a party in comparison to that of a person exercising a proper standard of care.
Reasonableness in law means to what extent the actions and conduct of a person were justified as opposed to negligent or careless.
For example:
John gets into a car accident and causes severe injuries to another.
Did John drive recklessly and with negligence or was it a pure accident?
The courts will look at the reasonableness of John’s actions and conduct in the circumstances to evaluate if his actions tipped him over to the side of “negligence” or not.
Is reasonableness a validation check?
Yes, in fields where data is being analyzed such as in accounting, finance and audit, reasonableness can be a validation check to verify the validity or reasonableness of numbers reported.
For example:
An auditor will assess a company’s inventory reports and the cost of goods sold to assess whether the reported income looks fair and reasonable.
A comptroller may use an interest reasonable test to validate whether or not the interest charged on an inter-company transaction can be deemed reasonable
A programmer may look at data in a database and exercise a reasonableness test to validate the quality of the data.
In law, on the other hand, the reasonableness test is a benchmark or evaluation of a person’s conduct or the reasonability of contractual language, contractual clauses or obligations of a party.
