Convention of conservatism

{{short description|Accounting practice of anticipating future losses but not future gains}}

{{Accounting}}

In accounting, the convention of conservatism, also known as the doctrine of prudence, is a policy of anticipating possible future losses but not future gains. It states that when choosing between two solutions, the one that will be least likely to overstate assets and income should be selected. This policy tends to understate net assets and net income, and therefore lead companies to "play safe". When given a choice between several outcomes where the probabilities of occurrence are equally likely, one should recognize that transaction resulting in the lower amount of profit, or at least the deferral of a profit.{{cite web|url=https://www.accountingtools.com/articles/2017/5/14/the-conservatism-principle|title=The conservatism principle|date=June 2022 }}{{cite book|author=Naseem Ahmed|title=Financial Accounting|url=https://books.google.com/books?id=fmiXKF8dRcIC&pg=PA23|accessdate=4 March 2013|year=2008|publisher=Atlantic Publishers & Dist|isbn=978-81-269-0993-3}}

Conservatism plays an important role in a number of accounting rules, including the allowance for doubtful debts{{Cite journal|last1=Jackson|first1=Scott B.|last2=Liu|first2=Xiaotao (kelvin)|date=2010-06-01|title=The Allowance for Uncollectible Accounts, Conservatism, and Earnings Management|journal=Journal of Accounting Research|language=en|volume=48|issue=3|pages=565–601|doi=10.1111/j.1475-679X.2009.00364.x|s2cid=154445210 |issn=1475-679X}} and the lower of cost or market rule,{{Cite web|url=http://www.accountingcoach.com/lower-of-cost-or-market/explanation|title=Lower of Cost or Market (LCM) {{!}} Explanation {{!}} AccountingCoach|website=AccountingCoach.com|access-date=2016-10-01}} which states that one should record inventory at the lower of either its acquisition cost or its current market value.