Convention of conservatism
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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.[1][2]
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[3] and the lower of cost or market rule.[4]
See also
- Generally Accepted Accounting Principles (GAAP)
- U.S. GAAP
- International Financial Reporting Standards (IFRS)
- Conservatism concept [5]
- Prudence concept[6]
References
- ^ "The conservatism principle".
- ^ Naseem Ahmed (2008). Financial Accounting. Atlantic Publishers & Dist. ISBN 978-81-269-0993-3. Retrieved 4 March 2013.
- ^ Jackson, Scott B.; Liu, Xiaotao (kelvin) (2010-06-01). "The Allowance for Uncollectible Accounts, Conservatism, and Earnings Management". Journal of Accounting Research. 48 (3): 565–601. doi:10.1111/j.1475-679X.2009.00364.x. ISSN 1475-679X.
- ^ "Lower of Cost or Market (LCM) | Explanation | AccountingCoach". AccountingCoach.com. Retrieved 2016-10-01.
- ^ "The conservatism principle".
- ^ "The conservatism principle".
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 at SSRN 1979748.
External links
- "Accounting terminology guide". New York State Society of CPAs. Retrieved 24 April 2017.
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