Prudence isa guideline used within the accounting industry which is recommended toaccounts and highly demanded to follow by with overstating current liabilitiesand understating current liabilities and understating current assets as thisdisplays a false representation of a business financial representation such aslocal business annual report. for example, for being in a better or worsefinancial stated then what is displayed in its financial statements. Theuncertainties within the accounting industry require thoughtful throughjudgement to prevent an ongoing occurrence. Its preferred for accountants tomaintain caution also to be over unhand and overstated, to prevent liabilitiesfrom being understated1.Prudence isbeing discussed recently due to all of the controversy if its needed or not “prudence is a fundamental requirement “2 the reason why I agree with the followstatement is because I agree that prudence protects and informs others as astrict standard has been set to prevent false displays of financial statementsand provides creditability to those who follow its guideline.Theprudence concept demands when a business gains a loss it has to provide suchinformation of its loss and make it known.
this the provides a greater insightfor example towards investors on decision making by relying on up to date dataon a business financial state this provides a greater risk assessment for otherentities that may have an interest. Taking this into consideration business needto provide truthful and valid information of their entity financial state toprevent false disclosure of information as soon as possible as this alsoreduces the risk of spread of false information .The risk that may occur or has be highlighted is businesswith large competitors benefit heavily from a good report of their annualprofits this is due to management take the advantage as assets and income aremost likely to be overstated than understated with this being said financialstatements will show improvements of profitability and financial positioninghowever prudence is in place to prevent a bias encounter by applying cautionwhen displaying accounting policies as there’s a constant risk of leverage withinaccounting policies. When an entity records its current inventory this willthen be listed at a lower cost when its meant to be the expected selling pricethis leads to profit on sales of inventory when it takes place.
This meansfalse information is being portrayed until evidence can be provided to suggestsif the information is correct. The Accrual concept vs the Prudence concept The Accrual concept suggests expenses and revenue that have incurredare meant to be stated and shown in the same timeline as the accounts eventhough receipts or invoices may say a different period. However, prudencerevenue should be shown within the timeline in which it is earned regardless ifit was received or not during the suggested period.
The accrual concept provides more leniencetowards the adaptation of information compared to the prudence concept whichprovides more information. Some accountants prefer the prudence concept howeverseem its guideline is too strict which I disagree as sensitive informationwhich can change the course of decision making should be neutral instead of onesided like the accrual concept. The going concerns concept, Neutrality and itslink to Prudence The going concern concept also suggests anentity’s lifespan shouldn’t plummet or cease to exist without evidence statingwhy it should be in its current state with this in mind When handling information its preferred as the generalpublic or any sensuous to have relevant information that can be deemed useful, relevanceis the characteristic needed for information to be useful as the informationhas the ability to influence decisions made by the users of who may extractinformation from financial statements for example accountants. Such financialinformation is only valuable if it has predictive value or confirmatory value.predictive value can be used to predict the future of either a business financialstate, value of assets, rise or decrease in profits. Confirmatory value helpsprovide unique feedback about previous evaluations with such information thiscan help us make clear and thought through decisions with the use of relevantinformation.
To make the best possible decision would require allthe most relevant evidence available to make the most beneficial option that doesn’tconflict with any other decision or attribute , this requires information gathered to be complete as itinforms instead o stating or highlighting the contents .prudence of financial of financialstatements provides such security as its strict policy prevents the misconductof firms and business from providing incomplete information at a poor qualityor false narratives as this can sway opinions of others if prudence wasn’t enabled. Faithful representation Faithful representation is important as it’s the foundationof the gathering financial information when providing financial statements.
Forinformation to be used or to be considered useful an entity must first show ifsuch information is neutral from both sides, biased from implications as theinformation gathered is not meant to be emphasised, weighted de-emphasis asthis can show evidence of favourability or opposite depending on who it may benefitas it’s a technique to attract and show the profitability of the business tomake others perceive the success of the business or show its downfall. Prudenceis linked to faithful representation as prudence is aimed to prevent and avoidthe the possibility of unstated gains incoexists with guarding against loss that may occur in the future3. Timeliness and Accounting standards whenprudence is usedAccounting standards have been set to highlight and inforce free from error which suggests all financial information should have gonethrough the right means so reports are fair and correct however all informationbe 100% accurate or true. so preparers are required to follow rules regulationsthat be standards as it significantly reduces errors such as timeliness whichis an important guideline for example.
London stock exchange or any other stockexchange must publish annual reports at the end of every year failing to followthis would result in users not being able to make informed decisions. Timelinessrelates back to the relevance of such information as the information gatheredis desirable and important for investors as it indicates the state andpotential of a asset for example, without timeliness comparison will be hard asit would difficult to show if a company has made improvements and how long didit take to make the improvements or the rise in profits. To in force timelinessseveral countries may authorise who regulate can impose restrictions on the maximumnumber of days companies can take to issue their financial statement. Prudence isused in the valuing of current assets, receivables and investments also fixedassets when inventories is based on prudence the standard states the currentassets need to be valued for financial statements only at a realisable valuethis is used to counter false misrepresentation and avoid false information ascompanies can only provide realisable. Prudence as aQualitative Characteristic Framework: ‘qualitative characteristics are attributes that make theinformation provided in financial statements useful to users ‘. The characteristicsare understand ability, relevance, reliability and comparability which most ofthem have been explained above. ASB’s 1999 representation of QualitativeCharacteristic includes prudence as prudence is said to be by the framework theinclusion of a degree of caution in the exercise of judgement” as they go on tosay ‘the exercise of prudence does not allow the creation of hidden reserves orexcessive provisions because the financial statements would not be neutral’.
However prudence has been used wrongfully over the years with themanipulation of reserves to obtain bonuses as three senior managers of Nortel madea decision not to release excess reserves when noticing Nortel had $300million In excess reserves theissue with this is the US GAAP are a set of accounting rules and standards forfinancial reporting.4 Whichrequires the release of excess reserves into income instead the 3 generalmanagers hide the existence and maintenance for later use and kept using thesame technique to the conceal $151 million in 2002 suggesting that the $150million was a los in reports.ConclusionTo conclude Neutrality and prudence are contradictory astension arise between both concepts prudence is a biased concept that ensures uncertaintyand gains are overstated and loss and liabilities are not understated comparedto neutrality provides freedom from bias means. Both concepts are requiredwithin spate circumstances when uncertainty arises prudence should the and onlybe exercised and neutrality should be demanded when a balance can be found.
Applyaccounting standards in a prudent but neutral unbiased way as neutrality can besupported by prudence.Bibliography http://www.thehindubusinessline.com/todays-paper/tp-mentor/Applying-the-concept-of-prudence-in-accounting/article20020327.ecehttp://accountingcorner.
accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-tp-prudence.pdfUSSEC Press Release (http://www.sec.
gov/news/press/2007/2007-39.htm,November 2010.1Obaidulah juan ACA, CFA2, EII Accounting directive states prudence3M.V. Kali Prasad4