| 1 | It has long been established that the idea of prudence (or 'conservatism') plays a major part in financial reporting. It is recognised in the EU Accounting Directives which were agreed in the 1970s (see paragraph 3), but its history can be traced back much further. The origins of prudence may, in part, reflect the use of financial statements in showing the amount of pro t that is available for distribution. |
| 2 | The essence of prudence is that assets and income are not overstated and that liabilities and expenses are not understated. The application of prudence ensures that gains are reported only if they are highly probable or reasonably certain (often not until realised) but that (expected) losses are recognised as soon as they are identified. Prudence also causes an asymmetry in the accounting for assets and liabilities, as it requires a higher degree of certainty before recognition of assets than of liabilities. Prudence may affect the accounting policies that determine whether transactions and events are recognised; the measurement of assets and liabilities that are recognised; and the presentation of gains and losses. It may play a role both in the development of accounting standards and, in practice, the preparation of financial statements based on these standards. |
| 3 | The Fourth EU Directive on Company Law of 1978 requires that "valuation must be made on a prudent basis" and that, in particular, only profits made at the balance sheet date may be included, whereas account must be taken of all losses related to the financial year or to a previous one. This may reflect the view that prudence is necessary to counter the over-statement of income. |
| 4 | Consistently with the objective of general purpose financial reporting set out in the IASB's Framework, this Bulletin discusses prudence in the context of financial statements, which are prepared to fulfil the needs of investors and others in making decisions about providing resources to the entity and assessing how efficiently and effectively the entity's resources have been used. It does not address financial information that may be useful for other purposes such as supervision of financial institutions or monitoring compliance with contracts. |
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