Running head: Case 5-8 The Concept of Conservatism
Case 5-8 The Concept of Conservatism
Iva White
Liberty University
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The Concept of Conservatism2
Case 5-8 The Concept of Conservatism
Define Conservatism
Conservatism is a style of accounting in which the assets are most likely understated.
There are several definitions for conservatism accounting. Basu, Watts and Hamdan all have
given accepted definitions of conservatism. “Hamdan defined accounting conservatism as the
disclosure of the minimum values, revenues, and higher values for obligations and expenses”
[DrS15]. Or we can use the definition given to us in our text, “Simply stated, conservatism holds
that when you are in doubt, it is best to choose the accounting alternative that will be least likely
to overstate assets or income” [Sch16]. This style of accounting tends to favor the future
stockholder vs. the current stockholders. This approach to accounting delays recognition of
assets and income until there is no doubt that it has happened to ensure that the information
stated in the financial statements are a reliable representation of the true value.
Why do you believe conservatism has affected financial reporting? Explain.
Conservatism reduces the chances of overstating the profits and assets in financial
statements, but it does lack transparency to a degree. The purpose for this approach to accounting
is to reduce red flags and it is thought to represent more credible financial data. In the end, the
financial data is still skewed, albeit not in the favor of the company. This can be a problem for
current stockholders, as the value of their investment is somewhat understated. Conservatism
does impair the data, but it is not as negative as other approaches that tend to overstate the profits
and assets.
Do you believe that financial statements that recognize losses but not gains provide
information that is relevant and representationally faithful? Explain.
The Concept of Conservatism3
I do not believe that these financial statements are any more faithful than statements that
overstate the profits and assets of a company. I do believe, though that they are less harmful in
the end than the overstated financial statements. Overstated financial statements can lead a
potential investor into thinking that the company is more lucrative than it really is, while
understated financial statements can prevent a potential investor from investing. This is also a
problem. There is also a question of the data that is left out of financial statements prepare
through the conservative approach. This can lead to false representations of where a company is
financially. Even with the downfalls of this approach, conservatism does give information that is
relevant, but it fails to give an actual representation of the company’s financial standing.
Do you believe that the concept of conservatism is consistent with the physical capital
maintenance concept? Explain. Do you believe that the concept of conservatism is
consistent with the financial capital maintenance concept? Explain.
Accounting conservatism is actually compared to physical capital maintenance concept
and financial capital maintenance concept on a regular basis. Conservatism is more consistent
with the physical capital maintenance concept in the sense that the physical capacity of a
company is equivalent to the current value of the net assets that are currently creating the
earnings. It does not factor in the assets that have occurred in the current accounting period. With
financial capital maintenance, the values of assets and income at the end of the reporting period
is different and holding gains and losses are considered returns on capital and included on the
financial net income statements [Sch16]. This is not the case with conservatism. Conservatism
does misrepresent the financial standing of a company, but it can be a more accurate and reliable
representation of the financial standing of a business than other accounting methods.
Biblical Perspective
The Concept of Conservatism4
This case gives me a chance to use one of my favorite verses. Proverbs 11:1 states, “The
Lord detests dishonest scales, but accurate weights find favor with him” (NIV). We must strive to
always depict an accurate representation of the status of our “weights”. Whether in business or
life, being transparent, truthful and reliable are all important characteristics of a person that we
would like to spend time with. These characteristics hint of a more fruitful or advantageous
partnership. The same thing can be said about a business partnership. We look for the business
that is going to be honest and transparent with us. We look for reliability when it comes to stated
profits and losses.
References
Al-Sakini, D. S., & Al-Awawdeh, D. H. (2015). The effect of accounting conservatism and its impacts on
the fair value of the corporation: and empirical study on Jordanian public joint-stock industrial
companies. International Journal fo Business and Social Science, 6(7), 229-241. Retrieved from
http://ijbssnet.com/journals/Vol_6_No_7_July_2015/24.pdf
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2016). Financial Accounting Theory and Analysis (12 ed.).
Hoboken: Wiley & Sons, Inc.
The Concept of Conservatism
Case 5-8 The Concept of Conservatism
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