Prudence Concept, its applicability and examples

Accounting trades and other incidents are occasionally uncertain however in order to be relevant we must report them with time. We must make estimates needing wisdom to counter the doubt. While making wisdom we have to be mindful and wise. Prudence is an integral accounting principle making sure that resources and income aren’t overstated and liabilities and expenditures aren’t understated.

Examples

  • Many businesses have debts thus leading to creation of contra account. This account is known as debt allowance or accounts receivable account. The balance in this account is the amount of receivables which stops from creation of overstatement of resources. A cost called debt charge is also booked to avoid net gain from being overstated.
  • Liabilities are of many types like pre-paid liabilities; advance liabilities, liabilities which are contingent depending upon the occurrence and non-occurrence of events. In such cases, if these are likely to occur in future then 50% of the priced account is understated. This is done under the prudence concept.
  • Periodic assessments of assets are created to be sure their carrying value will not exceed the huge benefits likely to be produced from the asset, and when it does go beyond, the impairment of resolved asset is saved by minimizing its carrying amount.

APPLICABILITY

This principle does apply while valuing current resources such as inventories, receivables, current ventures, and so forth. Prudence also requires procedures to be produced for the likely event of the reduction such as provision for doubtful obligations.

This concept is woven into different accounting criteria, such as valuation of inventories and also in accounting for investment funds. There can be an implication of prudence in the typical on fixed property as well.

Inventories: Predicated on prudence, the accounting standard expresses that inventories should be respected for the purposes of the financial claims at cost or online realisable value, whichever is leaner. By so doing, the entity is recognising the opportunity of losing likely to happen credited to drop in the value of the product.

AS 13 coping with assets classifies ventures as current ventures and long-term assets. This standard also ropes in prudence by setting up that the existing investments be transported to the financial assertions at lower of cost or online realisable value.

Receivables

Since there is absolutely no accounting standard granted on accounting for receivables, there is absolutely no such enforceable provision; however the idea of prudence would play a substantial role.

Other circumstances: Prudence is also required while making procedures for conceivable deficits such as pending suits, says not known as debts, and so forth. Predicated on a case-to-case basis, a provision or an email by using a contingency may be needed.

Banking operations

Prudence has been contained in income popularity and provisioning for both bank and non-banking finance institutions.

The prudence strategy is merely an over-all guideline. In the end, use your very best judgment in deciding how so when to track record an accounting transfer.