Prudence and the Conceptual Framework

This paper discusses the arguments for and against the re-inclusion of prudence in the new conceptual framework. It highlights the concept of prudence and the benefits of this principal to the auditing process and the ways through which prudence would assist the organisation in making more money.

Running head: PRUDENCE AND THE CONCEPTUAL FRAMEWORK
Prudence and the Conceptual Framework
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1PRUDENCE AND THE CONCEPTUAL FRAMEWORK
Table of Contents
Part 1: Internal Audience Directors’ Brief.......................................................................................2
Part 2: IASB Audience ED Submission..........................................................................................5
References:......................................................................................................................................9

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Part 1: Internal Audience Directors’ Brief
To,
The Directors,
Big Phore Limited
Date: 05/10/2018
Subject: Arguments for and against the re-inclusion of prudence in the new conceptual
framework
This is to highlight the attention that contradictory opinions are prevalent among the
senior management regarding whether the principle of prudence needs to be included in the new
conceptual framework. Some members perceive that prudence is the cornerstone of accounting
and financial reporting, while the other members think that prudence might not provide crucial
information to the investors for undertaking appropriate decisions.
This paper would emphasise on the concept of prudence and the benefits of this principal
to the auditing process and the ways through which prudence would assist the organisation in
making more money. In the words of Baker and Burlaud (2015), prudence could be seen as
something, which needs to be embedded in the standards. However, the preparers need to
exercise it when those standards are applied. Moreover, this principle compels the accountants to
think on conservative lines, in which all the likely expenses and liabilities would be recognised;
however, the recognition of assets and income is made only when they are realised or assured.

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Certain arguments are put forward against the prudence principle and the main issues
include comparability and neutrality of the resulting financial reports. For instance, professional
investors like Chartered Financial Analysts (CFA) would like the management to disclose the
actual results transparently, which should free from bias and they would be neutral to good news
as well as bad news (Barker and Teixeira 2018). In the presence of uncertainties, the investors
would want the best estimate of the management supported by adequate disclosures based on
which the estimate has been prepared.
It has been identified that prudence might hold profits back in a year and this restraint
might result the release in a subsequent year due to which exaggerated results might be
published. For instance, Daimler Benz’s restatement of profit record from prudent German
accounting to US GAAP for the New York listing signify the smoothing prudence effect (Barker
2015). Moreover, the Spanish banks as well as dynamic provisioning in the crisis are depicted as
a further case, in which the prudent reserves have undermined the underlying weaknesses
temporarily due to change in condition and delayed remedial measure.
The audit process would be complex; in case, material misstatements are inherent in the
financial reports and hence, qualified auditors are needed for the audit process. The work of the
auditors would increase and if prudence is not carried out effectively, the auditors would be held
accountable for the failure of the organisation because of audit failure (Bauer, O'Brien, and
Saeed 2014). For Mr. Price, the expectation gap could not be filled completely and the auditors
would be blamed, if they undertake incorrect decision. This would impose direct threat to the
reputation of the organisation. The integrity of the managers would be questioned and the
investors might lose trust in the organisation leading to market failure (Cooper 2015).
Difficulties would be encountered by the corporate advisory group in terms of providing client

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advice, as the biasness of the financial statements would increase. Finally, there would be
additional regulations for controlling the accounting process from the end of the professional
groups and thus, micromanage situation might take place.
However, there are certain points that are put forward in favour of including prudence in
the new conceptual framework. Majority of the auditors and accountants would argue for
including the prudence principle and it is adjudged as the cornerstone of modern accounting and
financial reporting (Linsmeier 2016). This principle protects the interests of the small investors
as well as those of the overall investor community. In case, this principle is not present, there
might be realisation of uncertain income in the books of accounts and the value of uncertain
assets might be reflected in the statement of financial position.
In addition, the organisations might switch over to the window dressing techniques under
such situations and these might aggressively depict additional revenue, reflect additional assets
and hide few expenses and liabilities from the financial statements (Macve 2015). Therefore, this
might lead to loss of trust on the financial statements. For instance, if a bank provides loan to an
organisation having absence of prudence in its financial statements and following aggressive
mechanism of revenue recognition, it might pose problem for the bank. This is because the
organisation might not be able to service the debt. Hence, for maintaining the interests of the
debt service providers, minimising the chances of window dressing from the end of the company
board and investors, prudence principle is crucial (Mora and Walker 2015).
Therefore, based on the above evaluation, it could be stated that even though prudence
has certain limitations, its benefits outweigh the drawbacks. Therefore, re-inclusion of prudence

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in the new conceptual framework would enhance the financial reporting quality of the business
organisations.
Part 2: IASB Audience ED Submission
Big Phore Partners
Level 99
101 Collins
Melbourne VIC 3000
05/10/2018
Hans Hoogervorst, Chairman
International Accounting Standards Board
30 Cannon Street
London EC4M 6XH
United Kingdom
Re: Exposure Draft ED/2015/3 Conceptual Framework for Financial Reporting

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Dear Chair Hoogervorst:
On behalf of our clients and team at Big Phore Partners, we thank you for the opportunity to
provide our comments on the International Accounting Standards Board's (IASB) Exposure
Draft (ED) regarding Conceptual Framework for Financial Reporting (CF).
Big Phore Partners appreciates the opportunity of commenting on the proposals of IASB in
revising the conceptual framework in its existing exposure draft. The organisation supports the
claims of IASB to update the framework so that completeness and clarity could be applied at the
time of developing accounting policies. It is believed that the prudence is a positive leap for
future standard setting and the comments of the organisation are associated exclusively to the
below-stated question:
Chapter 2 - Qualitative Characteristics of Useful Information
Question 1-Proposed changes to Chapters 2:
Do you support the proposal to reintroduce an explicit reference to the notion of
prudence (described as caution when making judgments under conditions of
uncertainty) and to state that prudence is important in achieving neutrality;
Why or why not?
Even though Big Phore Partners emphasise on broader data sources in its evaluation, the
financial statements are considered to be valuable for financial analysis. From the perspective of
the organisation, it is necessary that the other comprehensive income statement represents a fair

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view of financial position, which is free from bias.
According to the management, if a general prudence reference is to be re-initiated into the
framework, there needs to be effective implementation examples and guidance in relation to its
practical application. In the absence of practical guidance, it is believed that asymmetrical bias
risk could be introduced by the management at the time of applying the prudence principle. This
could provide opportunities in managing financial reporting earnings (Penman 2016).
It is recognised that the prudence principle has limited and particular use in relation to financial
reporting. For instance, prudence has particular and suitable application in IAS 37 in order to
gauge and measure contingent assets and contingent liabilities and the case is similar in IAS 38
for protecting internal goodwill recognition and setting stringent criteria for realising
development costs (Sutton, Cordery and Van Zijl 2015).
However, more particularly, the prudence and neutrality principles are not compatible with each
other all the time. There could be relation between conservative accounting and prudence leading
to conservative reporting bias and this might compromise neutrality while preparing the financial
statements of the organisation (Tracey 2015). From the perspective of the organisation, the
neutrality principle needs to be overreaching, since accounting should depict the underlying
events and transactions with fair and true overview not containing any bias. Due to this reason, it
is necessary for IASB to incorporate implementation guidance with instances about the practical
prudence application, in which a particular interpretation or standard could not be applied. Thus,
the conceptual framework would be dependent on formulation of accounting policy (Van Mourik
2014).
According to the view of Big Phore Partners, this would be beneficial in assuring that the
initiation of a general principle of prudence in the framework is not violated or leads to

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asymmetrical bias. Any conservative moves for assuring solvency, which the voluntary
management intention or prudential regulation mandates, needs to be addressed ideally from the
perspective in equity. This is conducted either through developing non-distributable reserves or
application of policies related to capital management (Watts and Zuo 2016).
Moreover, Big Phore Partners is of the notion that that prudence in conceptual framework has
direct association with corporate governance. As per the opinion of the management,
conservatism and prudence are critical to the overall functions of corporate governance.
Therefore, it is essential for IFRS to rake into account these aspects in future standards of
accounting. Moreover, majority of the auditors and accountants would argue for including the
prudence principle and it is adjudged as the cornerstone of modern accounting and financial
reporting (Zhang and Andrew 2014). This principle protects the interests of the small investors
as well as those of the overall investor community. In case, this principle is not present, there
might be realisation of uncertain income in the books of accounts and the value of uncertain
assets might be reflected in the statement of financial position. Hence, the organisation supports
the re-inclusion of prudence in the new conceptual framework.
Thank you for the opportunity to provide our comments. If you have any questions, please do not
hesitate to contact me on [phone] or [e-mail]
June Coopers, FCA, PhD, AO
Executive Chair

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References:
Baker, C.R. and Burlaud, A., 2015. The historical evolution from accounting theory to
conceptual framework in financial standards setting. The CPA Journal, 85(8), p.54.
Barker, R. and Teixeira, A., 2018. Gaps in the IFRS conceptual framework. Accounting in
Europe, 15(2), pp.153-166.
Barker, R., 2015. Conservatism, prudence and the IASB's conceptual framework. Accounting
and Business Research, 45(4), pp.514-538.
Bauer, A.M., O'Brien, P.C. and Saeed, U., 2014. Reliability makes accounting relevant: a
comment on the IASB Conceptual Framework project. Accounting in Europe, 11(2), pp.211-217.
Cooper, S., 2015. A tale of ‘prudence’. Investor Perspectives, IFRS.
Linsmeier, T.J., 2016. Revised model for presentation in statement (s) of financial performance:
Potential implications for measurement in the conceptual framework. Accounting
Horizons, 30(4), pp.485-498.
Macve, R., 2015. A Conceptual Framework for Financial Accounting and Reporting: Vision,
Tool, Or Threat?. Routledge.
Mora, A. and Walker, M., 2015. The implications of research on accounting conservatism for
accounting standard setting. Accounting and Business Research, 45(5), pp.620-650.
Penman, S., 2016. Conservatism as a defining principle for accounting. The Japanese
Accounting Review, 6(2016), pp.1-16.

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Sutton, D.B., Cordery, C.J. and Van Zijl, T., 2015. The purpose of financial reporting: The case
for coherence in the conceptual framework and standards. Abacus, 51(1), pp.116-141.
Tracey, E., 2015. Discussion of ‘Conservatism, prudence and the IASB's conceptual
framework’by Richard Barker (2015). Accounting and Business Research, 45(4), pp.539-542.
Van Mourik, C., 2014. The equity theories and the IASB conceptual framework. Accounting in
Europe, 11(2), pp.219-233.
Watts, R.L. and Zuo, L., 2016. Understanding practice and institutions: A historical
perspective. Accounting Horizons, 30(3), pp.409-423.
Zhang, Y. and Andrew, J., 2014. Financialisation and the conceptual framework. Critical
perspectives on accounting, 25(1), pp.17-26.