Conservatism Concept

What is Conservatism Concept?

The conservatism concept is a concept in accounting which refers to the idea that expenses and liabilities should be recognised as soon as possible in a situation where there is uncertainty about the possible outcome and in contrast record assets and revenues only when they are assured to be received.

In other words, the principle of conservatism states that, if an accountant has two possible outcomes for any accounting issue, then the accountant must choose that outcome which is most conservative or has the least possible chance of profit.

In the worst case scenario, the company should report assets and revenues at understated figures while overstating the liabilities and expenses.

Impact of Conservatism concept on Financial Statements

Following are some of the impacts of conservatism concept on financial statements:

1. It states that a company must always follow the most conservative side of a financial transaction, which can be done by minimising the profits (by recording uncertain liabilities and expenses and not recognising uncertain gains)

2. In case of casual losses, doubtful debts or any such future events that are uncertain in nature, the error should be done on the side of conservatism. It means that accountants should focus on recording more of estimated expenses and less of assets.

3. This concept helps in showing a true view of the financial position and the path of the business in future.

Advantages of the Conservatism Concept

Here are some of the advantages of the conservatism concept:

1. It helps stakeholders in determining the financial position of the company.

2. It provides a positive impact on the book value of the company when compared to its market value.

3. It helps investors in measuring the performance of the company more accurately and also across different periods.

Disadvantages of the Conservatism Concept

Some of the disadvantages of the conservatism concept are as follows:

1. It underestimates the company’s future value.

2. It will result in increasing the written down value of the company.

3. It promotes revenue shifting, which means a transaction can be pushed back into the next accounting period, if it is found to be not meeting the requirements for the current reporting period.

This was all about the topic of conservatism concept, which is an important topic of Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S.