In
accounting
Accounting, also known as accountancy, is the process of recording and processing information about economic entity, economic entities, such as businesses and corporations. Accounting measures the results of an organization's economic activit ...
, the convention of conservatism, also known as the doctrine of prudence, is a policy of anticipating possible future losses but not future gains. It states that when choosing between two solutions, the one that will be least likely to overstate
asset
In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...
s and
income
Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. F ...
should be selected. This policy tends to understate
net assets and
net income
In business and Accountancy, accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and Amortization (a ...
, and therefore lead companies to "play safe". When given a choice between several outcomes where the probabilities of occurrence are equally likely, one should recognize that transaction resulting in the lower amount of
profit, or at least the
deferral of a profit.
Conservatism plays an important role in a number of accounting rules, including the allowance for
doubtful debts and the
lower of cost or market rule, which states that one should record inventory at the lower of either its acquisition cost or its current
market value.
See also
*
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 t ...
(GAAP)
*
U.S. GAAP
*
International Financial Reporting Standards (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
*
Valuation (finance)
Investment
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