Critical Discussion on Prudence Concept and Conceptual Framework in Advance Accounting Theory

This report discusses the critical aspects of prudence concept and conceptual framework in advance accounting theory. It also provides arguments in favor and against the re-inclusion of prudence in accounting standards. The report outlines the context of change and arguments in favor and against the prudence of new CF. The final part of this report will facilitate decision/ advice with regards to re-inclusion of produce to the IASB.

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Advance Accounting Theory

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Table of Contents
Introduction......................................................................................................................................3
Part 1: Internal Audience Directors Brief........................................................................................4
Part 2: Letter to IASB AudienceED................................................................................................8
Conclusion.....................................................................................................................................12
References......................................................................................................................................13

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Introduction
This report is quite effective in the generation of theoretical knowledge about different concepts
and elements related to advance accounting theory. This report is emphasized on the critical
discussion on concept of prudence and the conceptual framework. For practical relevance of the
findings of this report, the application will be done the case scenario given in the assignment
problem. This report will focus on outlining the context of change and arguments in favor and
against the prudence of new CF. The final part of this report will facilitate decision/ advice with
regards to re-inclusion of produce to the IASB.

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Part 1: Internal Audience Directors Brief
In general, the concept of prudence can be explained as process of taking high degree of caution
by financial analysts or other authorities of companies while taking the decisions related to
making estimates in situations of uncertainty. Purpose behind use of prudence concept is to avoid
occurrence of overstatement of understatement of incomes and liabilities of the companies. But
the problem with application of prudence is that it does not allow development of excess
provisions and hidden reserves that could lead to situations of overstatement of liabilities and
understatement of assets. In addition to this, there is lack of neutrality in the financial statements
developed by companies with application of prudence (IASB, 2016). Hence there will be law
quality of reliability in financial reports of companies. Due to this, IASB has removed in chapter
3, the reference to prudence. It is also because the implementation of prudence would lead to
biasness in development of financial statements.
Australia has adopted the IFRS accounting standards in 2005. Similar to this, the Australian
systems of ASC 3 were replaced by Framework for the Preparation and Presentation of Financial
Statements. This was the accounting framework of IASB. This framework was having a specific
link to concept of prudence with regards to qualitative aspects of the financial statements
(Măciucă et al., 2015). After passing of some years, a new framework entitled as conceptual
framework for preparation and presentation of financial statements were published and
implemented across Australia in 2010. This framework has eliminated the components of
prudence and conservatism. These new frameworks or accounting standards have been adopted
in country by AASB on 1 July 2014.

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In accordance to Holt (2018), element of prudence has been removed by IASB from accounting
standards, because there were the chances of inconsistencies with neutrality concept. Prudence
concept has been removed from accounting standards because of lack of understanding about
prudence and its subjective application. The application of prudence concept can align the
shareholder’s interest as well as the interest of managers with the financial reporting in different
organizations. In the corporate sector of Australia, it has been observed that due to non-existence
of prudence concept, different financial problems were occurring. This has created the need of
re-inclusion of prudence in accounting standards for improving the estimations in the financial
reports of companies.
According to Nobes and Zeff (2016), prudence concept is important, because it creates a need for
greater caution while taking different types judgments with regards to liabilities in financial
losses in financial reporting of companies. In contrast to this, with the application of prudence
concept, there will be lower need at the time of calculation or estimation of business assets and
gains. In support of this, Ahmed and Hussainey (2017) argue that prudence concept is need in
businesses, because it can provide the persuasive evidence for supporting the ascertainment of
assets and gains than of business liabilities and the business losses. IASB has defined the concept
of prudence as process of taking greater level of caution in decision making within the situations
of uncertain conditions. In other words, it is felt by IASB that re-inclusion of prudence in the
financial reporting framework can help the business firms in achievement of neutrality in
application of different accounting policies.
The favorable comments have also been observed from draft report of IAIS (2018), with regards
to the reintroduction of prudence for betterment of financial reporting of organization. According
to report, there is expectation from different stakeholders of business entities with regards to the

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faithful and relevant representation of different financial reports and financial performance in
different statements of financial position. The reinstatement of prudence concept will allow the
regulatory bodies to continue to development of the accounting standards and conceptual
frameworks related to financial reporting. The regulatory authorities should also focus on
inclusion of notion of reporting for the situations, in which economic substances of commercial
obligations and rights are reported. There are two most important qualitative aspects of the
financial reporting such as faithful representation and the relevance of all financial items
included in different financial reports of company. This is possible through re-inclusion of
prudence concept in accounting reporting standards. It is also so because there is no any direct
relationship between measurement measures and these two qualitative aspects.
There is also a belief among the financial analysts and business experts that lack of prudence
concept in the accounting standards like IFRS has lead to emergence of financial problems in the
corporate sector at global platform. Example of such financial problems is the occurrence of
global financial crisis, which affect the economy of every country across globe (Bensadon and
Praquin, 2016). It is also so because non-existence of prudence concept has lead to emergence of
over-exuberance of expansion that is also associated with the problems of unjustified dividends
and bonuses, and the unrealized profits.
One of the arguments against the concept of prudence is that it hampers the comparability and
neutrality of financial results of companies available in the financial reports in published or
unpublished annual reports. CFA or chartered financial analysts is example of investors that like
the attribute of neutrality in actual financial results of companies. This type of companies does
not support the re-inclusion of prudence in accounting standards (Cooper, 2015). These investors
also argue that in the situations of uncertainty can be handled by organizations, if the

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organizations should make their best estimates and the required disclosures of same can be made
in the financial reports.
In context of the restraint in profit recognition, it has been argued that prudence holds back the
profits in one year that ultimately results in release of same in subsequent business years. This
often results in exaggerated financial results of the companies. The smoothing effect of prudence
was seen in case of restatement of financial profits of Daimler Benz from the German accounting
standards to GAAP of United States. In case of Spanish Bank, the concept of prudence has
masked the actual financial situation of bank at time of financial crisis and leads to delay in
remedial actions. According to people with opinions against the re-inclusion of prudence there is
no need of prudence concept (Martin, 2018). In contrast to this, there should be true and
transparent picture of the financial items within financial reports of companies. The concept of
prudence is also supported by these people because there is lack of clarity that if prudence and
how much prudence is fair and appropriate. There is also lack of clarity that how much the
companies down their bias about assets in their financial reports. It is also difficult to quantify
that how much prudence is good and how much prudence is bad.
According to Martin (2018), the concept of prudence is already included in the IFRS accounting
standards, which is evidential from different types of accounting and financial treatments. For
example, in accordance to IAS 18, the recording or recognition of revenue in financial reports of
companies can only be done if the transfer of goods and services has taken place. In other words,
it is sufficient that company has received the orders for sale of particular quantities and that
quantity of products is available in inventory of company. At the same time, IAS 37 depicts that
the treatment of contingencies between negative and positive should be done in an asymmetric
manner. It is also said in the provision that recording of a contingent asset can be done only if it

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the receipt of same is certain virtually. Similar to this, the recording of contingent liabilities
should be done only if there is greater likelihood of occurrence of the outflow of key company
resources.
According to the supporters of re-inclusion of prudence concept, conservative estimation in
different financial statements is very important for counteracting the impact of over optimistic
estimations that have been made by management of companies. At the same time, removal of
prudence can result in occurrence of those gains and assets the emergence of which in uncertain
in nature. Similar to this, it can also invite problems of recording of those liabilities and losses,
the occurrence of which is uncertain in business (AASB, 2013). Removal of prudence was also
criticized by analysts by indicating that such type of removal can result in enhancement in
application of current value measurements. Example of such measurements includes fair value
measurement approach. This type of approach is inherently unverifiable so can lead to error in
statements.
Part 2: Letter to IASB AudienceED
To,
IASB Audience ED
The concept of prudence has received support towards the reintroduction of the concept into the
conceptual framework. It is always a matter of discussion about following the concept of
‘prudence’. This letter will be providing the views and the discussions of our company towards
the re-inclusion of prudence.
The concept of prudence was having a long track record which entails towards the recording of
the incomes and the expenses. This concept was removed, it has analyzed that due to the lack of

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prudence has created over-exuberance of expansion, unrealized profits and adjustment of the
bonuses and dividends in several firms (Martin, 2018). This is the reason some of the experts of
our organization were against the decision of removing this concept. The majority of the
arguments against the concept were due to comparability and neutrality towards the outcomes of
the financial systems (Bouvier, 2016). The management wants to report the actual results to
maintain the transparency. In addition to this, when this concept was challenged towards the
desirability of moderation that may lead to changed and delayed remedial actions. At the same
time, there is also argument towards the recognition of the most of the assets at the historical cost
where as the basis concept was to record the assets at the recognized value at the time of the
determination of the value (Martin, 2018).
This indicates that the downfall in the value of asset due to depreciation or any other reason is
needed to be shown in the books of accounts form the immediate effects where as the increase in
the value of any asset will not be recognized or recorded until the asset is sold this means the
profits and gains are to be recorded on actual basis and losses or decline in the income are to be
recorded on accrual basis (Natasha, et al., 2018). This helps to maintain a balance in the
accounting due to preventing the assets to be over stated and understating the liabilities that will
lead to affects the final accounts of the company.
The concept contradicts with fair value measurement, in case of responding to the financial
stability and bank resilience arguments it can be said that the issues are not laid in the right
manner for the purpose of financial reporting. The financial reporting and the update in the
principles are mainly for the benefits of the investors and capital markets in the best possible
manner to present the true, fair and transparent picture (Bensadon and Praquin, 2016). It is also

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identified and suggested by some of the members that prudence leads to hold back the profits and
also leads to hamper the profits up to certain extent.
On the other side, the observations supporting the concept that shows the need of the
reintroduction of the concept for the improvement of the financial statements also welcomes the
same so that the reporting can be improved. Along with this, the management also identified that
the shareholders are expected to view the appropriate and accurate information in the accounts so
the financial performance can be improved through the use this concept (Martin, 2018). The
reinstatement of the approach will also lead to assure the regulatory bodies that there is
betterment of the reporting in the financial reporting. In addition to this, the core team of the
company also depicted the need of close focus on the inclusion of notion of treatment of the
various changes in the assets and other transactions that takes place in the company
(Linnenluecke, et al., 2017). It is also required to report the economic, commercial and
obligation for the purpose of indicating the qualitative frame of the accounting this leads to
faithful representation of the records of the company.
It is also identified over a long discussion, that the beliefs and sentiments towards the concepts
of the financial reporting and preparations of the financial statements are needed to be updated.
Also, there are less knowledge of the concept among the business experts and there is also some
confusions and issues about the appropriateness of the concept that leads to a situation of
collision among the staff (Martin, 2018). On the actual analysis of the financial records and
reporting it is identified that the concept of prudence is if followed properly then it will lead to
overcome the financial institutions. It is analyzed that the crisis happened in 2008 among the
financial institutions (Lim, et al., 2014). The issues happened due to the over valuation of the
properties and the financial institutions processed loans on the rates that leads to severe loss to

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the various economies. In case, the concept of prudence was continued then it might be possible
that such kind of issue will not happen again.
The other arguments that favour the concept are the confidence of the related parties towards the
true and fairness of the financial statements. It is also favoured by the accountants as there is no
clarity about the measurement of the application of the concept to depict appropriate and
correctness of the accounts (Bensadon and Praquin, 2016). This is the reason that the
management finds it useful for the companies and the institutions to accept the concept and the
organization is supporting the re-inclusion.
The other supportive comments in the re-inclusion of this are the conservative nature of the
concept that will be beneficial at the time of the crisis the global economy will have to face
various challenges at the time of recession which can possibly be avoided by the application of
the re-inclusion of prudence (IAIS, 2018). It is also clear that the companies that have applied
the principle in the books of the accounts will lead to lower profits but this helps to save tax and
in case of negative situation in the global market the firm have stable and strong position as the
devaluation of the assets will not reach to the book value at which they are recorded. on the other
side if the assets are valued at higher rates then the devaluation will lead to loss to the business
and also the share prices will also fall significantly that will lead to more problem for the
investors and other stakeholders. So, it our management team is favouring the re-inclusion due to
its benefits to the investors and stakeholders along with the companies for the preparation of the
financial statements.
Thanks
For, Big Phore Partners

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Conclusion
On the basis of above analysis, it can be concluded that prudence can be defined as the process
of taking into account high degree of caution while making any financial estimations in the
instances of uncertainty. The concept of prudence has been removed by IASB, because it was
inconsistent with the concepts of neutrality and comparability in financial reporting. In a recent
meeting it was identified that there is need of the concept of prudence for better picture of the
financial statements that has lead to more discussions and meetings among the experts in the
industry towards the re-inclusion of prudence. As per the discussion at the Big Phore Partners,
the concept is helpful to identify and indicate the true picture of the financial reporting so it
welcomes the re-inclusion of the concept.

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References
AASB (2013) A Review of the IASB’s Conceptual Framework for Financial Reporting
Comments to the AASB by 8 November 2013. [Online]. Available at:
https://www.aasb.gov.au/admin/file/content105/c9/ITC29_07-13.pdf (Accessed: 28 September
2018).
Ahmed, A.H. and Hussainey, K. (2017) Is Egyptian corporate financial reporting becoming more
conservative?. Journal of Financial Reporting and Accounting, 15(3), pp. 333-346.
Bensadon, D. and Praquin, N. (2016) IFRS in a Global World: International and Critical
Perspectives on Accounting. Germany: Springer.
Bouvier, S. (2016) IASB faces battle to reconcile divergent views on 'prudent' accounting.
[Online]. Available at: https://www.ipe.com/news/regulation/iasb-faces-battle-to-reconcile-
divergent-views-on-prudent-accounting/10012444.fullarticle (Accessed: 28 September 2018).
Cooper, S. (2015) A tale of ‘prudence’. [Online]. Available at: http://archive.ifrs.org/Investor-
resources/Investor-perspectives-2/Documents/Prudence_Investor-Perspective_Conceptual-
FW.PDF (Accessed: 28 September 2018).
Holt, G. (2018) The IASB removed the reference to prudence in the paper because of the possible
inconsistency with the concept of neutrality. [Online]. Available at:
https://www.accaglobal.com/in/en/member/discover/cpd-articles/corporate-reporting/holt-
jan16.html (Accessed: 28 September 2018).
IAIS (2018) IASB’s Exposure Draft on Conceptual Framework for Financial Reporting.
[Online]. Available at:

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https://www.IAIS_response_to_IASB_proposed_changes_to_the_Conceptual_Framework_(Nov
ember_2015).pdf (Accessed: 28 September 2018).
Lim, C. Y., Lee, E., Kausar, A., and Walker, M. (2014) Bank accounting conservatism and bank
loan pricing, Journal of Accounting and Public Policy, 33(3), pp. 260-278.
Linnenluecke, M. K., Birt, J., Chen, X., Ling, X., and Smith, T. (2017) Accounting research in
Abacus, A&F, AAR, and AJM from 2008–2015: A review and research Agenda, Abacus, 53(2),
pp. 159-179.
Măciucă, G., Hlaciuc, E. and Ursache, A. (2015) The role of prudence in financial reporting:
IFRS versus Directive 34. Procedia Economics and Finance, 32, pp. 738-744.
Martin, R. (2018) Prudence and IFRS. [Online]. Available at:
https://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-tp-
prudence.pdf (Accessed: 28 September 2018).
Natasha, R., Ak, S., and Soenarno, Y. N. (2018) THE INFLUENCE OF PRUDENCE,
COGNITIVE ABILITY, AND PERSONALITY ON RISK AVERSION, Message from the Chief
Editor, 50, pp. 43-45.
Nobes, C.W. and Zeff, S.A. (2016) Have Canada, Japan and Switzerland Adopted
IFRS?. Australian Accounting Review, 26(3), pp. 284-290.