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Is it time for a return to prudence?  

8 members have voted

  1. 1. Does the IASB need to go further bringing the concept of prudence back into financial accounting?

    • No, prudence is an outdate concept that isn't necessary in IFRS
      0
    • No, the IASB has it right, prudence is about avoiding bias to ensure faithful representation
      3
    • Yes, the traditional concept of prudence needs to be reintroduced to IFRS to counter management's natural over-optimism
      5


Question

Professor Karthik Ramanna, from Oxford University’s Blavatnik School of Government, has penned (should that be typed?) an article for the Harvard Business Review entitled “Businesses Must Reclaim Prudent Accounting Principles”. He defines prudence as requiring “a higher threshold to recognizing anticipated gains relative to recognizing anticipated losses”. He believes that prudence will lead to better debt management and more “resilience” in balance sheets and therefor the economy.

"Prudence is both a regulatory principle and a managerial state of mind. To bring back prudence into accounting thus requires two layers of action. First, the U.S. Securities & Exchange Commission (and its equivalents worldwide) should mandate that any new accounting standards — and indeed any accounting standards issued since about 2000 — meet the prudence test. Put differently those standards should require objective evidence before companies can book gains (or avoid losses) on the basis of expected future profits."

Prudence has had a long and complicated history in accounting. Having been removed from the IFRS Conceptual Framework in 2010 only to be reintroduced in 2018. Chapter 2 of the Conceptual Framework has this to say:

“Prudence is the exercise of caution when making judgements under conditions of uncertainty. The exercise of prudence means that assets and income are not overstated and liabilities and expenses are not understated. Equally, the exercise of prudence does not allow for the understatement of assets or income or the overstatement of liabilities or expenses. Such misstatements can lead to the overstatement or understatement of income or expenses in future periods.”

We plan on exploring prudence in more detail in a future blog post, but for now what are your thoughts, does the IASB Conceptual Framework adequately capture the concept of prudence, or is it time to get back to a stricter definition?

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