Prudence concept

Prudence concept is one of the basic concepts used when the financial statements are being prepared by the accountants. It is another form of accrual accounting where expenses are recorded as and when incurred not when actually paid. Same goes for revenue where revenue is recorded when earned and not when actually received.

1. PRUDENCE as a CONCEPT in ACCOUNTING Prudence concept is fundamental to accounting and preparation of financial statements Concept mandates that financial statements shall be true and fair and figures reported must be prudent. Which means that a conservative approach will be used when reporting figures in FS specifically income and expenses On one hand it adopts a conservative approach in recording assets, income and profits while on the other Proactive approach is recording expenses, liabilities and losses Assets, profits and income are recorded once realized while expenses, losses and liabilities are recorded if anticipated

2. PRUDENCE CONCEPT A COMPANY MUST NOT OVERTSTATE ITS: REVENUES PROFITS ASSETS AS WELL AS MUST NOT UNDERESTIMATE ITS: LIABILITIES LOSSES EXPENSES

3. PRUDENCE as a CONCEPT in ACCOUNTING In simple terms the business must not overvalue its profits and assets until conclusive evidence is obtained, as well as it must not undervalue its losses and expenses and must record provisions even if any possibility of occurrence exists The concept basically urges that FS must present a realistic picture about every possible event that may impact the decision of FS users. If a company anticipates loss on execution of contract in future, prudence concept urges to record a loss. Comparing it to as asset to which the company has no title yet or has control over it, Prudence concept urges not to record it as asset until control is gain or income is realized as proceeds

4. PRUDENCE CONCEPT Illustrations Many International Accounting Standards (IAS) and GAAPs have incorporated Prudence concept. Examples are: IAS 2- Inventory is stated at lower of cost and NRV (selling price- cost to sell), so whenever there are circumstances exist that NRV of stock has fallen, the inventory will be stated at lower of these two, thus asset is overstated Provision for doubtful debts- Provision is recorded in FS for debtors that are slow moving or uncertainty exist over the recovery of amount or a %age of provision is set based on past experience. It is only a possibility for occurrence that no recovery will be made in future but prudence concept urges to decrease debtors figure in FS in order to make sure that debtors are not overstated Loss on contracts- future losses for inability of execution of contracts or outflow of uncertain amounts in future are recorded as provisions instantly