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:
So, these two are broken down in particles here-
The objective always remains the same and that is-
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.