Accounting Conservatism

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Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades.

Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers. While there, Paul authored and edited thousands of financial research briefs, was published on Nasdaq. com, Yahoo Finance, and dozens of other prominent media outlets, and appeared as a guest expert at prominent radio shows and i...

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Updated August 12, 2020

What is Accounting Conservatism?

Accounting conservatism is one of the four accounting conventions, which are standards, customs or guidelines regarding the application of accounting rules.

How Does Accounting Conservatism Work?

There are four widely recognized accounting conventions that guide accountants:

  1. Be conservative. In other words, play it safe.
  2. Disclose in full.
  3. Be consistent. In other words, use the same method for calculating and reporting similar events.
  4. 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 accounting conventions and specific rules, are the definitive source of accounting guidelines that companies rely upon when preparing their financial statements. Specific GAAP 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 accounting rules or, in more frank terms, play fast and loose with the rules.

Why Does Accounting Conservatism Matter?

Accounting conservatism, along with the other accounting conventions, provides a standardized methodology (or, more realistically, an ethical guideline) that creates reliable financial statements. In turn, accounting conservatism creates a reliable means of comparing financial results from industry to industry and from year to year.

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Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers.

If you have a question about Accounting Conservatism, then please ask Paul.

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