In effect, the conservatism principle reduces the likelihood of two occurrences: it is better to overstate expenses and liabilities than to understate them. On the other hand, the reverse is true for expenses and the value of liabilities on the balance sheet – i.e. However, the conservatism principle is NOT intentionally understating the value of assets and revenue, but rather, it is intended to prevent the overstatement of the two.Ĭentral to the conservatism concept is the underlying belief that it would be better for a company to understate revenue (and the value of assets) than to overstate them. The conservatism concept can lead to a “downward bias” in the values of a company’s assets and revenue. “Bad Debt”/Uncollectible Receivables)Ĭonservatism Principle Effect on Valuation Expected Losses → Accounted For in Financials (e.g.Expected Gains → Left Unaccounted in Financials (e.g.Regarding the accounting treatment of expected future gains and losses: there is a reasonable certainty in delivery). That said, “potential” revenue and anticipated profits cannot yet be recognized – instead, only the verifiable revenue and profits can be recorded (i.e. In particular, for any revenue or expense to be recognized on the financial statements, there must be clear evidence of occurrence with a measurable monetary amount. Potential Loss → If there is uncertainty about incurring a loss, an accountant should be predisposed to record the loss on the financials.Potential Gain → If there is uncertainty regarding future revenue and profits, the accountant should avoid recognizing the gain.The financials of companies are expected to be presented fairly without any misleading stated values, so accountants must carefully verify and use caution when preparing and auditing financial statements. Under GAAP accounting standards, the conservatism principle – also called the “prudence concept” – must be applied when preparing the financial statements of companies. The Conservatism Principle states that gains should be recorded only if their occurrence is certain, but all potential losses, even those with a remote chance of incurrence, are to be recognized.
0 Comments
Leave a Reply. |
AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesCategories |