Objective of conservatism

Conservatism is a principle of accounting that suggests that assets and income should not be overstated, and liabilities and expenses should not be understated. The objective of conservatism is to anticipate potential losses and expenses, rather than potential gains and profits.

Anticipating losses but not profits

Conservatism is an important principle for financial reporting because it helps to prevent financial statements from being misleading. By anticipating potential losses and expenses, conservatism ensures that financial statements provide a more accurate reflection of a company's financial position.

Under conservatism, assets are recorded at their lower of cost or market value, which means that assets are not overstated. For example, if a company has inventory that has decreased in value, the inventory will be recorded at its lower market value.

Similarly, liabilities are recorded at their higher of cost or market value, which means that liabilities are not understated. For example, if a company is involved in a lawsuit that could result in a significant loss, the potential loss will be recorded as a liability on the balance sheet.

Conclusion

In conclusion, the objective of conservatism is to anticipate potential losses and expenses, rather than potential gains and profits. This principle is important for financial reporting because it helps to ensure that financial statements provide a more accurate reflection of a company's financial position. By recording assets at their lower value and liabilities at their higher value, conservatism helps to prevent financial statements from being misleading.

Conservatism principal says anticipate all possible losses