Accounting – 7.1 Accounting principles | e-Consult

Prudence in accounting is the principle of caution and careful judgment when making accounting estimates. It dictates that when there is uncertainty about future events, accountants should be conservative in their estimates. This means that potential losses should be recognized immediately, even if the likelihood of those losses occurring is not certain. The principle aims to avoid overstating assets and income, and understating liabilities and expenses.

Two ways prudence is applied in practice are:

• Impairment of Assets: When an asset's recoverable amount is less than its carrying amount, an impairment loss is recognised. This means the asset is written down to its recoverable amount, even if the asset is still being used. This is a prudent approach as it acknowledges potential future losses.
• Provision for Doubtful Debts: Businesses often make a provision for doubtful debts, which is an estimate of the amount of money that may not be collected from customers. This provision is based on past experience and current economic conditions. Even if a customer appears creditworthy, a provision is made to account for the possibility of bad debts. This is prudent because it avoids overstating assets (accounts receivable).