In
accounting, the convention of conservatism, also known as the doctrine of prudence, is a policy of anticipating possible future losses but not future gains. This policy tends to understate rather than overstate net assets and net income, and therefore lead companies to "play safe". When given a choice between several outcomes where the probabilities of occurrence are equally likely, you should recognize that transaction resulting in the lower amount of profit, or at least the deferral of a profit.
In accounting, it states that when choosing between two solutions, the one that will be least likely to overstate assets and income should be selected. Essentially, "expected losses are losses but expected gains are not gains".
The conservatism principle is the foundation for the lower of cost or market rule, which states that you should record inventory at the lower of either its acquisition cost or its current market value.
Conservatism plays an important role in a number of accounting rules, including the allowance for
doubtful debts and the
lower of cost or market Lower of cost or market (LCM or LOCOM) is a conservative approach to valuing and reporting inventory. Normally, ending inventory is stated at historical cost. However, there are times when the original cost of the ending inventory is greater than ...
rule.
See also
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Generally Accepted Accounting Principles
Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
(GAAP)
*
U.S. GAAP
Generally Accepted Accounting Principles (GAAP or U.S. GAAP, pronounced like "gap") is the accounting standard adopted by the U.S. Securities and Exchange Commission (SEC) and is the default accounting standard used by companies based in the Uni ...
*
International Financial Reporting Standards
International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's f ...
(IFRS)
* Conservatism concept
* Prudence concept
References
Further reading
* André, P., Filip, A., & Paugam, L. (2013)
Impact of Mandatory IFRS Adoption on Conditional Conservatism in Europe ESSEC Working Papers WP1311, ESSEC Research Center, ESSEC Business School. ''Available a
SSRN 1979748'.
External links
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Valuation (finance)
Investment
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