The evolution of prudence in financial reporting and its relationship to bias and conservatism
The concept of prudence and its use in financial reporting has been the subject of great concern and intense debate in recent years. Outside the accounting and legal circles, “attention”, like many other words from another era, is a dying term, if not a concept.
It’s all about making the right decisions. Intelligence and intellect depend on good character. Prudence involves considering long-term decisions and their implications, and avoiding the biases that lead us to focus on the here and now. The concept of prudence has been part of financial reporting frameworks for decades.
Until 2010, it was recognized as part of the qualitative characteristics of ‘reliability’ in the conceptual framework of the International Accounting Standards Board (IASB). I decided to replace it with the concept of neutrality. To better understand the IASB’s decision to remove prudence from its conceptual framework, let’s first look at the pre-2010 definition of the term. It was “embedding prudence in the exercise of judgment necessary to make the decisions required by regulation.” “Estimates” refer to conditions of uncertainty such as assets and income not being overstated and liabilities and expenses not being understated.
Prudence requires an open mind, a necessary quality for an accountant. While some would argue that there is nothing wrong with this definition, in practice it raises some real issues with its interpretation, especially as it can lead to a tendency towards conservatism in financial reporting. increase.
Worse yet, there are also such things. “In fact, many feel that the notion of prudence is often used as a pretext for accounting for cookie jars,” the IASB chairman said in a 2012 speech.
As professionals, we strive to remove bias from our everyday behavior. – Why is the same true in finance? Would you report something different? Prudence distorts financial reporting by introducing a degree of conservatism that deviates from an unbiased or neutral financial reporting presentation.
There is no doubt that prudence and conservatism were born in a time when perhaps more important accounting standards existed. In the absence of clear guidelines and requirements to address specific financial reporting issues, concepts and frameworks have not been well developed to alert financial reporters.
But more recently, with the introduction of accounting standards, the framework has become much more mature and the concept has become obsolete. Interestingly, there appears to be stronger support for the concept of prudence in jurisdictions where the financial reporting function is associated with the concept of ‘conservation of capital’ and creditor protection.
Focused on providing information about financial performance to help investors make sound economic decisions International financial reporting standards issued by the IASB do not share the same objectives. The meaning and interpretation of the concept of prudential in financial reporting has become so distorted over time that it may not be possible to redefine and reintroduce it, but other everyday There is no doubt that there is a place in action where its true meaning can be applied.
Prudence requires an open mind, a necessary quality for an accountant. As accountants, as strategic thinkers, as producers and insurers of information, we must be able to recognize opportunities.
We need to actively seek and promote information that goes against our own prejudices, is for the common good, and is in the public interest. .
Take, for example, the development of the Integrated Reporting (IR) Framework, an initiative I enthusiastically support and promote.
There have been examples of this over the last 20 years. Annual reports have been used as a tool to promote a company’s brand, but they are often a brazen marketing effort.
IRs aim to bring discipline to the preparation of annual reports and focus on business discussions. It analyzes the model, the risks faced by the company, value creation and value loss, all in a structured way. Some might argue that establishing such a discipline amounts to practicing wisdom.
So, I think we need to understand and accept wisdom as it is, not as it is, rather than excluding it from the toolbox of virtue. Unbiased, long-term, intelligent thinking rather than the bias and conservatism in financial reporting it was once associated with.
Source: Alex Malley, “Is prudence Still a Virtue?”, INTHEBLACK.64 >1) This article is based on evolving standards and frameworks that accountants need to pay attention to. , claims that we no longer need to accept this concept. Do you agree?
2) The UK Financial Reporting Council has argued that the essence of prudence is ‘asymmetric’ prudence. Liability and loss recognition have lower thresholds than assets and earnings, which is why the definition of prudence in the proposed framework is wrong. How do you interpret vigilance? Do you agree that “asymmetrical” precautions should be included?
3) The IASB has indicated that asymmetrical precautions are included in some accounting standards (and perhaps likely to be included), but recognizes that asymmetric precautions are not mandatory feature information. It should not be included in the conceptual framework and its use should be the exception. Some argue that these guidelines regarding when it is appropriate to use asymmetric prudence should be included in the conceptual framework.
a) Can you think of a situation where asymmetric prudence is justified?
b) The IASB applies asymmetric prudence to some accounting standards Do you think the Conceptual Framework should provide guidance if you are expecting to
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