Accounting Concepts Definitions Part : 8 ( Prudence Concept )

Accounting Concepts Definitions Part : 8

prudence concept in accounting, prudence concept definition, prudence concept example

Prudence Concept

Accounting student and haven’t heard about prudence concept would be the most surprising thing to say. Why? The simple reason is simply because this is involved in every accounting decision, big or small.

Now, before going to how this is accompanied we should take a look what this thing really states:

“In every situation where a profit and loss scenario is involved or, where price sensitive situation is evident; the decision should go for loss side or, lower price”

It is obvious that from this definition the subject looks hazier, but, never be disheartened; because, there is more to follow. So, sit back and relax.

This concept states two different portions. They involve:

  1. Profit-loss scenario
  2. Price sensitive situation

So, these two are broken down in particles here-

  1. When you are going for a new entity’s records you may find expenses much higher than revenues. This is obviously because of the newness of the entity. For one reason, keep in mind that the entity should state all the expenses (estimated) to their highest limit and state all the revenues (estimated) to their lowest limit (But, not zero). This creates a scenario for probable loss and this is left to happen. Because, if you are in a loss making scenario and suddenly you are making profit, this will show your entity to be a viable investment option as this is swimming against losses and running into profits. If the profit is overridden then if there is profit of some lower stature, that will make it look like a losing one.
  2. It is highly evident when you are recording some or, trying to evaluate some assets or, your inventory. This provides the unique opportunity for the entity to record that thing at a price which is at their discretion. If they engage a lower price for the inventory then when they are going for the sale of that they are supposed to gain a profit (If the price is higher than the recorded ones).

The objective always remains the same and that is-

Loss Minimization

This core objective gives the purpose in which keeping the loss at its minimum is the objective. This doesn’t mean that profit should be at its highest levels rather it proposes a unique situation where putting profit and loss at the zero point maximizes the situation (No profit-no loss). For more on this topic read  Loss minimization.

So, this is the concept and now examples follow:

Physical count of inventory discovers that there is 500 pieces of that thing. Every piece has a cost of $100. Every piece has a market value of $80.

Now, what should you do?

The answer lies within the concept which is-

The inventory should be recorded at the lower of the options available. So, the value of inventory will be: ($80*500) or, $40000.

Think this explains all the alleys clearly. Don’t ever go away without reading the loss minimization article. Because, without reading that- your concept will not be fulfilled and without a complete concept you won’t be able to understand many of the other things.

10 thoughts on “Accounting Concepts Definitions Part : 8 ( Prudence Concept )

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  • mbt shoes miami says:

    Thanks for the in depth prudence concept examples :)

  • Hogan says:

    How do you relate Price sensitive situation to prudence concept?

  • Lunettes Dior says:

    I am searching more details on Profit-loss scenario.

  • Carolina Herrera Bolsos says:

    Please suggest some good books on prudence concept.

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    Where to find more details on prudence concept?

  • ray ban pas cher says:

    prudence concept definition is not clear

  • Burberry Pas Cher says:

    Give more examples on prudence concept.

  • Ray Ban Wayfarer says:

    In much the same way as personal , business credit cards often charge a yearly fee. They even give businesses the opportunity to provide employers with their own credit card for travel and expenses, which saves them filling out tedious expenses forms. So, if your employees need to book accommodation, pay for travel or food, a credit card may just come in handy.We must know prudence concept.

  • Lululemon Yoga says:

    Great explanation on prudence concept.

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