Principle Of Conservatism

1. Principle Of Conservatism

2. What is Principle Of Conservatism The conservatism principle is the general concept of recognizing expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognize revenues and assets when they are assured of being received. Thus, 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. Similarly, if a choice of outcomes with similar probabilities of occurrence will impact the value of an asset, recognize the transaction resulting in a lower recorded asset valuation.

3. The Purpose of the Principle Of Conservatism • If a situation arises where there are two acceptable alternatives for reporting an item, conservatism directs the accountant to choose the alternative that will result in less net income and/or less asset amount. Conservatism helps the accountant to "break a tie." It does not direct accountants to be conservative. Accountants are expected to be unbiased and objective.

4. Why is it important? • This principle gives accountants guidance when they are faced with a choice between two divergent amounts. The conservatism principle directs them to choose the amount that results in a smaller asset amount and/or less profit.

5. The rule for the principle of conservatism • The conservatism principle is only a guideline. As an accountant, use your best judgment to evaluate a situation and to record a transaction in relation to the information you have at that time. Do not use the principle to consistently record the lowest possible earnings for a company.

6. How should we use it • Under the conservatism principle, if there is uncertainty about incurring a loss, you should tend toward recording the loss. Conversely, if there is uncertainty about recording a gain, you should not record the gain. • Another conservative approach in accounting is overestimating the allowance for bad debts. Companies that sell goods or services usually find they have high account receivable balances; this means several customers owe the company cash in order to completely finalize a transaction.

7. Example The conservatism principle can also be applied to recognizing estimates. For example, if the collections staff believes that a cluster of receivables will have a 2% bad debt percentage because of historical trend lines, but the sales staff is leaning towards a higher 5% figure because of a sudden drop in industry sales, use the 5% figure when creating an allowance for doubtful accounts, unless there is strong evidence to the contrary.

8. Activity

9. Activity We are going to split the class into two groups, there's 1 question, multiple choice, first person to shout the right answer gets the point for their group.

10. Multiple choice You want to be ____________ when following this principle. • Aggressive b. Cautious c. Dangerous d. Careless