What Is The Prudence Concept In Accounting?


10 Answers

Alishan Samdani Profile
Alishan Samdani answered
The prudence concept in accounting states that a company should never overstate it's income, and it should never understate it's expenses. This means that the highest level for the expenses should be used and the lowest level of profits in making financial statements.
Anonymous Profile
Anonymous answered
The prudence concept:
In reporting activities, conservatism concept is used to minimize the possibility of overstating the value of assets or income in the future. Example, in determination of bad dept, conservatism approach is to expert that some dept may occur from the transactions.
Anonymous Profile
Anonymous answered
In condition of uncertainty assets are not overstated and liabilites are not understated.
Anonymous Profile
Anonymous answered
This concept states that businesses should not over state so that when their financial statements are scrutinized they are accurate.
Faisal Bhatti Profile
Faisal Bhatti answered
Its an Accounting Principle and it means that assets and income shall not be overstated and liabilities and charges shall not be understated. However, the principle of prudence does not allow the creation of hidden reserves or undue provisions.
Anonymous Profile
Anonymous answered
For prudence, IAS 1 (1975) declared that
“uncertainties inevitably surround many
transactions. This should be recognised by
exercising prudence in preparing financial
statements. Prudence does not, however, justify
the creation of secret or hidden reserves”. In
the United States, ‘conservatism’ is the term
used to reflect ‘prudence’. Certain US GAAP /
IAS differences may be identified as rule or
principle-based depending on the extent that this
concept is applied. Among them are the asset
impairment tests in IAS 36, provisions in IAS
37, and intangible assets in IAS 38.
In IAS 36, the asset impairment test uses
recoverable amount, defined as the higher of
an asset’s net selling price and its value in use.
The present value of expected future cash flows
determines the recoverable amount and the
amount obtainable in an arm’s length transaction
determines the net selling price. US GAAP uses
‘fair value’ and undiscounted cash flows in the
impairment test. Whether an impairment test is
based on fair value rather than recoverable
amount certainly is a question of which more
closely relates to the basic reliability principle
of prudence or conservatism. In this case, US
GAAP is more conservative in that it does not
recognise the reversal of an impairment loss
once it is recognised.
One difference leading to reporting differences
for many US enterprises is that US GAAP requires
a provision to be recognised when there is a
probability of an outflow of resources without
having to be a present obligation. IAS 37 is more
specific in this case in that it specifies that, when
the effect of the time value is material, the
present value of the expected expenditure should
be recognised. Thus, both US GAAP and IAS are
conservative for recognising provisions but in
different ways. Relatedly, IAS accounting is more
conservative for vested past service pension
plan costs which are recognised immediately
under IAS but are amortised under US GAAP.
For goodwill, IAS 38 provides that there is a
rebuttable presumption that the useful life will
not exceed twenty years from initial recognition.
US GAAP had declared that goodwill does have
a useful life with a maximum of 40 years for
amortisation. Under the recently promulgated
SFAS 142 however, goodwill is now viewed as
an asset with an indefinite life, subject to
impairment testing. Since the measurability of
Autumn 2002 perspective 19
Goodwill after acquisition becomes problematic,
rules may have to result to provide guidance
for measurability. This evident in some recent
events. For example, Telefonica S.A. , Spanish
company recently amended its 2001 earnings
to meet the new US accounting procedures for
goodwill, an adjustment from 2.11 Euro profit
under Spanish rules into a 7.18 Euro loss under
US rules.7 Overstatement of intangibles has
been key accounting problem not only in
recent years but as long ago as 1932. Of
WorldCom’s US$104 billion in assets this year,
about US$50 billion derived from good and other
Seventy years ago in the Igar Krueger scandal,
the International Match Company had to write
off US$27 million of intangibles, mostly recorded
monopoly rights.9 In this regard, the US GAAP
is more specific in pointing out that, in a business
acquisition, consideration needs to be given to
allocation of part of the purchase price to inprocess
research and development which would
be expensed in the period after acquisition.
Significantly, the goodwill amortisation issue is
a major cause of GAAP differences for foreign
issuer adopters of IAS for reporting in the US. A
recent study shows that the US principles
provided for a more conservative reporting of
net income and corporate equity.10
The conservative requirements for recording and
amortising goodwill and other intangibles based
on objectivity is ingrained in US GAAP literature
and incorporated as prudence requirements in
the IAS. However, the use of current values or
amortisation postponement with impairment
tests appears not only to be causes for reporting
differences but also to create a need for more
specific rules.
Anonymous Profile
Anonymous answered
E.g. You wouldn't say your house was worth £1mil if it was a 2 bedroom semi worth about 100k
Anonymous Profile
Anonymous answered
It is the recording of accounting for liabilities and recognising losses for provision for liabilities..
Anonymous Profile
Anonymous answered
Can I get a answer for  " the importance of prudence concept in the preparation of final accounts"...pls for my exams.....

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