1. PRUDENCE Definition 1.Anticipate no gains, but provide for all possible loss 2.Should be pessimist, not optimist 3.Minimize the reported profits and the valuation of assets

2. Why do we use prudence concept 1.Too optimistic to the results-more chance the account users will be hurt Pessimistic-less chance the account users will be hurt Pessimistic-less chance the account users will be hurt 2.Offset the optimism of the management 3.Optimistic to the results-overstatement of profits-pay more dividend-DANGEROUS 4.Less fluctuation to the profits

3. Examples 1.Stock valuation-Lower of cost and net realizable value 2.Provision for fixed assets and bad debts 3.Amortization of intangible fixed assets, such as GOODWILL, DEVELOPMENT EXPENDITURE and COPYRIGHTS

4. 4.Contingent gain should not be recognized because no invoice supports it. The outcome is uncertain. Contingent liabilities should be counted because a best estimate has to be made Contingent liabilities should be counted because a best estimate has to be made 5.PRELIMINARY EXPENSES, SHARE ISSUANCE EXPENSES, and RESEARCH COSTS and RESEARCH COSTS should be written off should be written off immediately when they immediately when they are incurred. are incurred.

5. Criticism 1.Conflicts between prudence and the historical concept Matching-assets are valued at their original acquisition cost. Matching-assets are valued at their original acquisition cost. PRUDENCE-fixed assets should be either depreciated or amortized and the stock are valued at lower of cost and net realizable value. PRUDENCE-fixed assets should be either depreciated or amortized and the stock are valued at lower of cost and net realizable value.

6. 2.Conflicts between prudence and consistency Choosing the lower value of either cost or net realizable also violates the consistency convention that a selected valuation method should be consistently used different periods. Choosing the lower value of either cost or net realizable also violates the consistency convention that a selected valuation method should be consistently used different periods.

7. 3.Conflicts between prudence and matching concepts Eg. Matching- development expenditure should be deferred and written of against future benefits. Prudence-written of immediately if future benefits is uncertain.

8. 4.Accounting reports should try to represent the most accurate picture feasible – neither too high nor too low. Accountants defend their attitude by saying that erring in the direction of conservatism would usually have less severe economic consequences than erring in the direction of overstating assets and net income. 4.Accounting reports should try to represent the most accurate picture feasible – neither too high nor too low. Accountants defend their attitude by saying that erring in the direction of conservatism would usually have less severe economic consequences than erring in the direction of overstating assets and net income.

9. 5.Conservatism leads to understanding net income in one period also creates an overstatement of net income in the future period. Ex : if a $100 inventory is written down to $80, net income is reduced by $20 in the period of the write- down but increased by $20 in the period the inventory is sold.

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