Prudence and the Conceptual Framework

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

2PRUDENCE AND THE CONCEPTUAL FRAMEWORK
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.

3PRUDENCE AND THE CONCEPTUAL FRAMEWORK
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