THE CONCEPT OF PRUDENCE IN THEORY AND PRACTICE

Abstract

This paper studies the concept of prudence in light of recent changes related to this accounting concept in The Conceptual Framework for Financial Reporting (CF) prepared by the International Accounting Standards Board (IASB). Accounting standards should be based on clear concepts that enable an understanding of why individual standards are stipulated in a particular way and allow the establishment of new recognition and measurement practices not yet covered by existing standards. This paper contributes to understanding the importance of clarifying the concepts underlying the preparation of mandatory financial statements, and its conclusions may be useful for regulators. The revised CF emphasizes “cautious prudence,” which supposedly supports neutrality, and neglects conservatism, or “asymmetric prudence.” First, this paper examines researchers’ perspectives on the concept of prudence and reviews the results of influential theoretical and empirical studies related to accounting conservatism, a term often used in academic literature instead of prudence. Second, the effects of more or less conservative treatments on financial reports and the usefulness of such information are analyzed based on hypothetical examples. Finally, examples of how real companies treat development costs are used to support the conclusions. The results of the analyzed studies show that the most useful information is often produced by a conservative accounting system. Hypothetical examples illustrate how conservatism influences financial reporting, and real-world examples confirm its application in practice. Therefore, the CF, as a foundation for the development of individual standards, should recognize conservatism, or “asymmetric prudence,” as being as important as neutrality.

Data:
Received: 22 Mar 2020
Revised: 5 May 2020
Accepted: 6 Jun 2020
Published: 20 Jun 2020