The Role of Conservatism in Financial Reporting
The Role of Conservatism in Financial Reporting
Table of Contents
Introduction 3 Applications of Conservatism in Accounting 4 Advantages associated with Conservatism 7 Disadvantages associated with Conservatism 11 Recommendations and conclusions 14 References 17
Introduction
This report investigates the application of conservatism in accounting and its role in financial reporting. We also examine and compare the advantages and disadvantages associated with conservatism and provide our opinion about conservatism. Conservatism may be a controversial accounting measurement principle but it has a long history and its use is far-reaching. Conservatism by definition is that all probable losses or expenditures will be recognized as they are discovered and revenue will be deferred until it is verified. As an important accounting principle, it has been widely used for preventing the overstatement of assets and income, understatement of debt and cost, and plays the role of early warning signal to help reduce risks.
Conservatism principle's origins can be traced back to the Middle Ages. For the purpose of alleviating responsibilities of entrusted property, the custodians did not appreciate any expected value for its custody property; then as the 19th century the popularity of accounting accountability, the idea was gradually recognized and accepted by the accounting profession in order to reduce the rising litigation risks accountants were facing. However, the principle implicates that accountants can use all sorts of means to undervalue assets and income, overestimate liabilities and cost, in order to reduce accountability; also this view is lack of accounting and economics theory basis; consequently, leading to many criticisms. During the 1980s, along with accounting target by accountability view shift to decision-making usefulness, the criticism towards conservatism has increasingly intensified. The principle of prudence and its connotation was reviewed by
Table of Contents
Introduction 3 Applications of Conservatism in Accounting 4 Advantages associated with Conservatism 7 Disadvantages associated with Conservatism 11 Recommendations and conclusions 14 References 17
Introduction
This report investigates the application of conservatism in accounting and its role in financial reporting. We also examine and compare the advantages and disadvantages associated with conservatism and provide our opinion about conservatism. Conservatism may be a controversial accounting measurement principle but it has a long history and its use is far-reaching. Conservatism by definition is that all probable losses or expenditures will be recognized as they are discovered and revenue will be deferred until it is verified. As an important accounting principle, it has been widely used for preventing the overstatement of assets and income, understatement of debt and cost, and plays the role of early warning signal to help reduce risks.
Conservatism principle's origins can be traced back to the Middle Ages. For the purpose of alleviating responsibilities of entrusted property, the custodians did not appreciate any expected value for its custody property; then as the 19th century the popularity of accounting accountability, the idea was gradually recognized and accepted by the accounting profession in order to reduce the rising litigation risks accountants were facing. However, the principle implicates that accountants can use all sorts of means to undervalue assets and income, overestimate liabilities and cost, in order to reduce accountability; also this view is lack of accounting and economics theory basis; consequently, leading to many criticisms. During the 1980s, along with accounting target by accountability view shift to decision-making usefulness, the criticism towards conservatism has increasingly intensified. The principle of prudence and its connotation was reviewed by
References: Basu, Sudipta. The Conservatism Principle and the Asymmetric. Diss. Baruch College, 1997. New York: Journal of Accounting and Economics, 1997. Print. Chi, Wuchun, Chiawen Liu, and Taychang Wang