Accounting – Prudence Concept

Accounting – Prudence Concept

Also known as the conservatism principle, the prudence concept is a concept that most accountants, including the accountants from an accounting firm in Johor Bahru, would follow. This accounting principle ensures that the company has not overstated its income and assets. It also makes sure that the company has made provisions for all determined losses and expenses (Also see Expenses That Companies Should Pay Attention To) no matter whether it is only an estimation, or the company has known the exact amount. In essence, the prudence concept helps to ensure that a company do not understate its liabilities and expenses in its books of accounts.

The prudence concept considers all losses that the company may probably suffer, but it does not include the profits that the company may earn. By applying this concept, one can be sure that the financial statements of a company show a true and fair view of its financial position (Also see 4 Alerting Indications on Your Financial Statements). Hence, the readers do not need to worry that these statements show a better picture than reality.

According to the prudence concept, you should not recognise any possible income in the books of accounts. Hence, when you prepare your books of accounts or financial statements like the balance sheet or the income statement (Also see What is the Relationship between the Profit and Loss Statement and the Balance Sheet?), you should not recognise that possible income as part of your income in the financial records for the current year. The main idea of this concept is that one should not overstate his income except if he has possessed that amount of income.

When it comes to the recognition of expenses, the prudence concept requires you to include any expenses that you will possibly incur in your books of accounts. This means that you should never underestimate your expenses. If there is a possibility that you may incur an expense, you should make a provision in your books of accounts.

The prudence concept is one of the most popular accounting principles (Also see Financial Accounting – Basic Principles, Conventions and Assumptions) used by the accountants all over the world. This concept helps to make sure that the company’s financial statements illustrate the true and fair view of its assets, liabilities, revenues and expenses. Apart from preventing business owners from overstating the assets that a business owns, the prudence concept also avoids underestimation of the losses and financial risks that the company is facing. Thus, this is very helpful for the business owners to minimise losses they will probably suffer.

Although the prudence concept can bring a lot of advantages, it has some downsides too. This concept does not always include accurate facts, which cause financial statements to be misleading. Also, one cannot implement this concept on accounting frameworks other than the GAAP and IFRS.