1.11 Conservatism

VCE Accounting Unit 3. Video of this presentation can be found on my YouTube channel here https://www.youtube.com/channel/UCf5jyuJoYwie8tWfvjEc0zg.

1. 1.11 conservatism principle

2. The Rules of Accounting Relevance Reliability Comparability Understandability Entity Historical cost Going concern Reporting period Monetary unit Conservatism Consistency Qualitative Characteristics Accounting Principles 1.11 conservatism principle

3. Conservatism Principle 1.11 conservatism principle Definition: Caution must be used when preparing financial reports Losses are recorded when they are expected to occur Gains are only recognised once they are certain to happen (i.e. they have been earned ) This is done so: Assets and revenues are not overstated (too high) Liabilities and expenses are not understated (too low)

4. Conservatism Principle Example: applying conservatism to losses . A business owns inventory that was bought for $12,000 . It has gone down in value and is now worth just $ 8,000 e.g. winter coats in January Should it recognise this loss and value the inventory at $8,000 ? Answer: yes , the loss is expected to occur Balance Sheet Non-Current Assets $ Inventory 12,000 Balance Sheet Non-Current Assets $ Inventory 8,000 Income Statement Expenses $ Stock write down 4,000 1.11 conservatism principle This is done so the value of an Asset (inventory) is not overstated (too high)

5. Conservatism Principle Example: applying conservatism to gains . A business owns a building that originally cost $500,000 . But growth in the property market means the building is now valued at $600,000 if it were to be sold. Should the firm value the building at $600,000 and record a revenue (gain) of $100,000 ? Answer: no, conservatism states that this gain should not be recorded until it is certain to occur, i.e. when the building is sold This is done so the value of an Asset (building) and a revenue are not overstated (too high) Balance Sheet Non-Current Assets $ Building 500,000 1.11 conservatism principle

6. Conservatism Principle 1.11 conservatism principle Balance Sheet Non-Current Assets $ Inventory 12,000 Balance Sheet Non-Current Assets $ Inventory 8,000 Balance Sheet Non-Current Assets $ Building 500,000 Relevant? Reliable? Balance Sheet Non-Current Assets $ Building 500,000 YES NO Relevant? Reliable? NO YES

7. TASK In-class Homework SQ24 X