What is Accounting Conservatism?
How Does Accounting Conservatism Work?
There are four widely recognizedthat guide accountants:
- Be conservative. In other words, play it safe.
- Disclose in full.
- Be consistent. In other words, use the same method for calculating and reporting similar events.
- Report everything that is important. This is also known as the materiality convention. In other words, an item or event is material (and thus should be disclosed) if knowledge of the event or item might reasonably influence the users of the financial statements.
Generally Accepted Accounting Principles (GAAP), which are updated regularly to reflect the latest and specific rules, are the definitive source of guidelines that companies rely upon when preparing their financial statements. Specific rules are sometimes subject to different interpretations, and unscrupulous companies often find a way to bend or manipulate them to their advantage. This first principle, conservatism, dictates that accountants must make cautious estimates, must not make or apply speculative interpretations of rules or, in more frank terms, play fast and loose with the rules.
Why Does Accounting Conservatism Matter?
Accounting conservatism, along with the other, provides a standardized methodology (or, more realistically, an ethical guideline) that creates reliable . In turn, accounting conservatism creates a reliable means of comparing financial results from industry to industry and from year to year.