1.11 conservatism
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1.11
CONSERVATISM
PRINCIPLE
Video of this presentation at…
YouTube Channel for VCE Accounting
© Michael Allison. Author’s permission required for external use.
The Rules of Accounting
Relevance
Reliability
Comparability
Understandability
Entity
Historical cost
Going concern
Reporting period
Monetary unit
Conservatism
Consistency
Qualitative Characteristics Accounting Principles
1.11 CONSERVATISM PRINCIPLE
© Michael Allison. Author’s permission required for external use.
Conservatism Principle
1.11 CONSERVATISM PRINCIPLE
Definition:
Caution must be used when preparing financial reports
• Losses are recorded when they are expected to occur
• Gains are only recognised once they are certain to happen
(i.e. they have been earned)
This is done so:
• Assets and revenues are not overstated (too high)
• Liabilities and expenses are not understated (too low)
© Michael Allison. Author’s permission required for external use.
Conservatism Principle
Example: applying conservat ism to
losses.
A business owns inventory that was
bought for $12,000. It has gone down in
value and is now worth just $8,000 e.g.
winter coats in January
Should it recognise this loss and value
the inventory at $8,000?
Answer: yes, the loss is expected to occur
Balance Sheet
Non-Current Assets $
Inventory 12,000
Balance Sheet
Non-Current Assets $
Inventory 8,000
Income Statement
Expenses $
Stock write down 4,000
1.11 CONSERVATISM PRINCIPLE
This is done so the value of an Asset
(inventory) is not overstated (too high)
© Michael Allison. Author’s permission required for external use.
Conservatism Principle
Example: applying conservat ism to
gains.
A business owns a building that
originally cost $500,000.
But growth in the property market
means the building is now valued at
$600,000 if it were to be sold.
Should the firm value the building at
$600,000 and record a revenue
(gain) of $100,000?
Answer: no, conservatism states that
this gain should not be recorded until it
is certain to occur, i.e. when the building
is sold
This is done so the value of an Asset
(building) and a revenue are not
overstated (too high)
Balance Sheet
Non-Current Assets $
Building 500,000
1.11 CONSERVATISM PRINCIPLE
© Michael Allison. Author’s permission required for external use.
Conservatism Principle
1.11 CONSERVATISM PRINCIPLE
Balance Sheet
Non-Current Assets $
Inventory 12,000
Balance Sheet
Non-Current Assets $
Inventory 8,000
Balance Sheet
Non-Current Assets $
Building 500,000
Relevant?
Reliable?
Balance Sheet
Non-Current Assets $
Building 500,000
YES
NO
Relevant?
Reliable?
NO
YES
© Michael Allison. Author’s permission required for external use.
TASK
In-class Homework
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