Question

Explain the Principle of Prudence.

What is the principle of conservatism or prudence?

Name and explain the accounting convention which says. Record all anticipated losses but ignore all anticipated gains.

Answer 1

The principle states: record all anticipated losses but ignore all anticipated gains. It is the policy of playing safe. Following are the examples of the application of the principle of conservatism or prudence:

1. Closing stock is valued at cost price or market price, whichever is less.
2. Provision for doubtful debts is created in anticipation of actual bad debts.
3. A joint life insurance policy is shown at surrender value as against the premiums paid.

However, deliberate attempt to underestimate the value of assets should be discouraged as it will lead to secret reserves which is against the principle of full disclosure.