Question

The controller of your company says, "I want our accounting policies to be as conservative as possible." What does she mean by this?

Answer 1

In the light of the above statement, it can be derived that the controller is talking about the Conservative principle of accounting. The Conservatism principle of accounting states that in case of uncertain situations, all expenses and liabilities should be accounted for and all revenues and gains should not be recorded unless there is reasonable certainty by means of its actual receipt. It is a GAAP concept which records and recognize both certain or uncertain expenses and liabilities. It provides support in recording uncertainty and estimates.

According to the principle of conservatism, the conservative side of any financial transaction should be focussed as the basis for error. It is done by reducing profits in terms of providing for uncertain losses or expenses instead of unknown or estimated gains. It anticipates no profits and provide for all losses. It means that one should record for lowest value of assets and revenues and highest value of liabilities and expenses. For instance, in case of valuation of inventory, it should be recorded at the lower of cost or market value by providing at lower of either of its acquisition cost or market value.