Prudence has been a topic for accountants as some believe prudence should not be considering as a desirable quality of financial reporting but some argue that it should be the other way.
To explain the term prudence, it means exercise caution when making a decision in uncertain condition. Prudence is a key accounting principle which makes sure that assets and income are not overstated and liabilities and expenses are not understated, the final account should be reported cautious and conservative. In this essay, I will illustrate area the prudence is commonly used and my opinions. Accounting concept has been put in order to come up with the final account, desirable qualities can help the account information to be more accurate as the should not be biased when producing a final account. The information contained in the financial statement should be free from bias and reflect the actual data without presenting the company in a good way. The qualities of Accounting Information include are divided into two: primary qualities and secondary qualities. Primary qualities of useful accounting information should be relevant and reliable.
Accounting information is reliable if the user can depend on it to represent the economic condition as the information is key to the potential stakeholders. ‘Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.’ ( IASB’s Framework 89′) when preparing the financial report the preparer has to deal with some uncertainties as you cant predict 100% accurately eg weather effecting harvest for a farm, assets or income can be overstated due to the uncertainty, therefore, Prudence concept does not have the quality of reliability. A company can benefit from the management team making a financial report as the report is what potential stakeholder looking for.
This can lead to the company either an overstatement or understatement of the financial position of the company in order to favour their company was also known as introducing bias into the account, the concept of prudent should be there to ensure there is no bias or faulty information in order to complete the basic quality of relevant information with exercise of caution when estimate. The concept of prudence should stop the management team manipulating their financial statement for the company good. The aim of prudence is to assure that the company is not being optimistic regarding their real financial position, the potential stakeholder should overview the company financial statement with confidence so they will not be investing into a company with bias in the account. With the information I have provided above, prudence concept seems key to prepare a financial report with quality, as the assets or income not overstated and understated the liabilities; Prudence concept helps the potential investor to have a better picture of the company. In my opinion, the potential stakeholder should consider investing with his own understanding of the company as well as the financial report to make the correct decision, but since the accounting information is used mostly by the investors, prudence concept became inevitably when preparing in general. The fact that prudence can only use upon uncertainties, it could cause the company understated their financial position in the short term but gains in the long term when uncertainties become certain.
Should prudence be considering as a desirable quality or in another word necessary for preparation of financial report? The concept of prudence is against the neutral concept as the data is partly uncertain meaning not accurate to meet the basic quality of being reliable. Some argue that the prudence concept is too vague when applying on reports as we don’t have a scale to measure prudence and that fact that we cannot scale it as it is all base on the auditor and with no doubt that against that the report should have no bias even though it might be relevant.In conclusion, prudence concept should not be considered as a desirable quality of financial reporting, but more like a standard level of accounting, as it goes against neutrality concept.
The prudence concept confuses with the definition similar to neutral, neutrality already existed, the concept which is similar should be disregarded in order not to lead to any further confusion. Promote the same concept of neutrality will not add on any meaning but only extra.