Answer to Question #41442 in Finance for sugunah

Question

how the basic accounting principle of „prudence‟ affects the preparation of financial statements (4 marks)

Answer 1

The aim of the prudence concept is to reflect the least favourable position of a business. To those unfamiliar with the concept, it might seem strange to want to do this. After all, a healthy position can work in a business’ favour sometimes. This principle is important in facilitating faithful representation – ensuring that financial statements do not mislead or give false optimism to their various users. As such, the prudence concept is a fundamental accounting principle, with the first International Accounting Standard (IAS I) outlining its role.

The prudence concept can conflict with other fundamental concepts – like the accruals basis of accounting. Accruals recognize transactions that have not yet been completed – like a hire purchase sale or prepaid expenses. In such cases, one principle (in this case, accruals) should prevail.

Prudence, along with other fundamental principles, creates a sound platform for accounting. However, note that it is no excuse for an organisation to withhold revenue or create hidden reserves. After all, that conflicts with the principle of Fair Presentation.