According to Watts (2002) Prudence commonly referred to as conservatism is a distinction verifiability necessary for the acknowledgment in relation to gains associated to losses and expecting profits involves the identification of profits before establishing authorized and confirmable right on spawning proceeds associated to the gains. Though according to Professor Barker (2015) he differentiates that conservatism is defined as any technique in accounting that always points to book value being minimum with respect to economic worth, on the other hand, he defines prudence an ideal class conservatism emanating after cautious reaction towards improbability.
Conservatism is widely considered as the predisposition of accountants’ character of deciding to evaluate and determine appropriate course when faced with uncertain situations in order to feature minor estimate rate of assets, revenue, and expenses.Prudence may be considered rudimentary core principle, as an ideal requirement, the important theoretical idea fundamental in financial accounting. Nevertheless, it cannot be considered vast qualitative technique of data that is availed purposely for the general financial statement as stipulated in the financial report. Moreover, the pliability of prudence to denigration over a period of time as a result of its rudimentary nature as an ideal principle besides, the important function it plays in accounting methodology, the theory of unity and social practices. W. A. Paton (1916) undoubtedly presented out that an absolute underestimation in which it is conceivable to establish the definite facts is not prudence but suppression.
Conservatism in accounting apparently does not include any deliberate manipulation in the valuation of product. For instance, in USA character of accountants in establishment of concealed reserves in a prejudiced method is inconsistent with conservatism. However, I this thesis I boldly believe that the law of prudence has been the critical part of essentials of financial accounting over a long span of time especially in continental Europe.Haller (2003) urged that the concept of protection the enterprise as a foundation of revenue creation by balance sheet utility and computing taxable income, preservation concept which as a result leads to capital safeguarding of nominal justice is the rationale for the significance of conservatism.
Investigation in Germany, France, Europe, and Sweden depicts prudence remained dominant accounting for a long period. According to Hellman (2008) argues that there exists a strong link between taxation and accounting and in law established nations it tends to operate in favor or prudence and high conservatism valuations of assets and liabilities considerably reduce taxable income.The effect of prudence in accounting laws is persistent (Richard 2008).
Furthermore, the international standards for accounting at present many policies exist which illustrate prudence. Moreover, conservatism empirical research has provided ideal evidence that prudence is rudimentary characteristic of the financial report. Prudence idea, not overestimating the total of revenue realized nor underestimating the quantity of the mount of expense. Prudence tends to delay realization of revenue operation and proof expense and liabilities.Prudence is a significant thing when organizing financial report. Until 2010 conservatism was entailed in international accounting standard board (IASB) in order to make financial statement significant to members.
Effective and reliable judgment is critical in financial reporting. Organizational teams establishing estimates are subjects of several incentives that may influence either overstatement or understatement in financial performance and position. For instance, overstatement of financial presentation may avert a negative effect on management of filing poor performance. However, it has been argued prudence bias in relation to understatement in assets. Business capitalization by prudence dividend policy. According to Basu (1997) on properties of conservatism in association with other accounting principles on assets.The role of prudence in financial reporting regards to balance sheet presentation and generating profit or loss statements.
The rationale of prudence based on meaning aims at preventing experiencing apparent impending expenditure and also evade allocation of unreal gains. The recognition and evaluation played on prudence basis entailing determining only profits attained in the balance sheet, debts are recognized for example in Germany prevalence of conservatism that is evidently conventional by rule, at the perilous time of economic predicament during 1920s when preexisting accounting measures failed to fully protect the creditors from insolvency. For that reason, the principle of conservatism was established during 1937 in standard cooperation law.According to Bunea (2014) a key menace for financial information users, creditors and investors are often signified by asset overvaluation. However, in a condition of conservatism, this means changes in determining impairments of tangible and intangible assets in controlled market enhancing distributable investor trust.According to Colasse, (2009) the consecration of standard of conservatism will adversely limit the aggregate of benefit dividends which not only allows accounting negative ideal values in its practices but also certain additional values in the same methodology. The research carried out by Panjunen (2010) in Finland indicated conservatism being important in financial reporting.
This shows that conservatism is still relevant accounting norm among respondent. Prudence plays a key role in establishing whether profits can be realized in gain loss account and decision making. Earning conservatism highlights the profits and losses in accounting methodology involving instant recognition of net gains. On the other hand, balance sheet conservatism entails progressive undervaluation of total assets. Prudence needs revenue to be identified in situations where relied on principle there is no realization of profit for the case Germany and Italy are the nations identified with prudence. Moreover, in stipulations of reporting, conservatism is exhibited in identification and valuation process in which information presentation and financial statements are disclosed.
Accordingly, prudence also has an important role in the valuation of assets. Prudence is essential in accounting as it ascertains income and net assets are not overvalued and liabilities with expenses are not undervalued. For instance, constant evaluation of net assets makes sure their value does not go beyond the benefits stipulated. Since prudence is associated with risk and perception, understanding it needs a clear definition and analysis of the risk. Prudence is reflected in identification and asset evaluation through delimiting situations under which expenditure can be taken as assets. Haller (2003) argues that safeguarding company generating income leads to the emphasis on preservation, with respect to her argument, Conservatism in accounting plays a significant role.Prudence concept of conservativeness in identifying net assets and not undervaluing liabilities produces a conservatively stated financial statement and does not only give record of information of transaction but also record probable liability. Conservatism tend to delay recognition in coordinating with revenue transactions.
There has been a gradual increase in the constant review of net assets to identify if it is declining in value. Conservatism is majorly executed when setting up for instance allowance for uncertain account or reserve for outdated inventory. Consequently, accounting principle coordinates the prudence methodology in many of its principles and prudence could work in defining conceptual framework essential for financial information and phase of accounting conservatism and asymmetry retained within a limited scope. With diminishing prudence scope significance, despite being desirable effective quality of financial statement. Identifying favorable events and conservatism in anticipating no gains but avail for all losses emanate from uncertainty arising from predictions which requires cautious judgment in preparation of financial statements.
Littleton (1940) regarded prudence in association to attitude only which is to be additional during analyzing of accounting figures hence the regulation of caution is efficient by user when analyzing the outcome of accounting measurement prepared based on a rational organization of guidelineTo sum up, prudence was identified critical principle in accounting entailing traits of both existing regulation and future laws and the key role is identified in the conceptualized design. Consequently, the use of precautionary rules aid financial statements to prevent misleading optimism to users majorly investors in an uncertain scenario. Provided that the organization does not use precautionary rules to maintain revenue and offer the solid foundation for financial reporting. Furthermore, prudence is not contradicting neutrality; as a matter of fact, prudence can be rudimentary in availing neutral financial information. Conservatism is an absolute genuine, cautious reaction to vagueness, on the other hand, the “big bath” accounting aims to deliberately endeavor to deceive users in the concept of financial reports information when it is vividly clear there is no uncertainty.
W. A. Paton undoubtedly established absolute underestimation where there is potentiality determining the definite facts are not dogmatism though are suppression. Open-mindedness is prudence trait to accountants detailed in comprehension of ideal accounting regulations in association to the valuation of assets and determining the range of gains.