Simultaneously a company must always adopt a proactive approach towards the recognition of liabilities, losses and expenses. Periodic evaluations of assets are made to make sure their carrying value does not exceed the benefits expected to be derived from the asset, and if it does exceed, the impairment of fixed asset is recorded by reducing its carrying amount.
The provision does not show the debtors that have resulted as bad debts rather it shows the debtors that may end up as bad debts based on their trading history with the company or their specific circumstances, and ultimately company may not recover money from these debtors.
It may seem that prudence concept requires the company to go for every less favorable situation to be recorded, but it does not. We have to make estimates requiring judgment to counter the uncertainty. It means that the preparer must always show a conservative approach while reporting profits, revenues and assets and must only record these when they are actually realized.
The concept basically urges that financial statements must present a realistic perspective about every possible event that may impact the decision of the users of financial statements. Some liabilities are contingent upon future occurrence or non-occurrence of an event such a law suit, etc.
Prudence is a key accounting principle which makes sure that assets and income are not overstated and liabilities and expenses are not understated.
In simple terms the business must not overvalue its profits and assets until irrefutable evidence is obtained, as well as it must not undervalue its losses and expenses and must record provisions even if a possibility of occurrence exists.
These debtors are included in the provision under prudence concept of accounting. Hence, we stop liability and expense from being understated.
Examples Bad debts are probable in many businesses, so they create a special contra-account to accounts receivable called allowance for bad debts which brings the accounts receivable balance to the amount which is expected to be realized and hence prevents overstatement of assets.
An expense called bad debts expense is also booked to stop net income from being overstated. There are many liabilities which are not certain either in terms of amount or in terms of date but they have high possibility of occurrence.
Accounting principles and concepts explanations Definition and explanation Prudence concept of accounting states that an entity must not overestimate its revenues, assets and profits, besides this it must not underestimate its liabilities, losses and expenses.
In such cases, the liabilities are recorded in the statements and a corresponding expense is also recorded. Prudence concept is a very fundamental concept of accounting that increases the trustworthiness of the figures that are reported in the financial statements of a business.
While making judgment we need to be cautious and prudent.
So it makes sure that liabilities are not undervalued. The concept advises that the final accounts of a company must always show caution while reporting any figures specifically impacting the income and expenses.Accounting concepts and principles > Prudence Preparation of financial statements requires the use of professional judgment in the adoption of accountancy policies and estimates.
Prudence is a key accounting principle which makes sure that assets and income are not overstated and liabilities and expenses are not understated. Under the prudence concept, do not overestimate the amount of revenues recognized or underestimate the amount of expenses.
You should also be conservative in recording the amount of assets, and not underestimate liabilities. The result should be conservatively-stated financial statements.
The prudence concept, also known as the conservatism principle, is an accounting principle that requires an accountant to record liabilities and expenses as soon as they occur, but revenues only when they are assured or realized. Prudence concept of accounting states that an entity must not overestimate its revenues, assets and profits, besides this it must not underestimate its liabilities, losses and expenses.
Prudence concept is a very fundamental concept of accounting that increases the trustworthiness of the figures that are reported in the financial statements of a business.Download