Discussion Paper: Prudence

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Discussion Paper: Prudence

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Contents
Introduction.................................................................................................................................................3
Part 1: Arguments for and Against the ‘Prudence’......................................................................................3
Arguments against the ‘Prudence’ Inclusion...........................................................................................3
Arguments for Inclusion of ‘Prudence’....................................................................................................5
Part 2: Exposure draft submitted to the IASB..............................................................................................7
Summary & Recommendations.................................................................................................................10
References.................................................................................................................................................11

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Introduction
The present discussion paper is developed to be presented to the Board of Executive
Directors at Big Phore Partners in relation to the matter of prudence. The paper is aimed to
develop an understanding of the concept of prudence and to analyze its implications on the
financial reporting. This has been done for presenting a conclusive set of findings to the IASB
(International Accounting Standards Board) regarding the re-inclusion of prudence in the
Conceptual Framework (CF) of financial reporting. This has been conducted by presenting
detailed arguments for and against the re-inclusion of prudence concept in the conceptual
framework of accounting. Also, a letter has been prepared to be presented to the IASB relating to
eth discussion in reference to extent of support given by our auditing team to the inclusion of
prudence in the CF.
Part 1: Arguments for and Against the ‘Prudence’
The IASB is presently seeking comments in relation to the re-introduction of the
principle of ‘prudence’ as an essential qualitative characteristic of financial reporting in its
conceptual framework for the year 2015. The exposure draft released by the IASB has defined
prudence as a degree of caution to be used by the accountants at the time of making judgments
during conditions of uncertainty. This re-inclusion of the concept by the IASB has resulted from
the demand from the log-term investors for the presence of a degree of protection for them by
ensuring that financial information is disclose in a faithful manner. The concept of prudence was
introduced by the IASB in its framework for development and presentation of financial
statements of the year 1989. As such, the standard-setting body of Australia, AASB, when
adopted IFRS in 2005 has included the concept to be referred by the business entities during
financial reporting. It was removed from the CF by the IASB in the year 2010 that was adopted
by the AASB in the year 2014. IASB is currently emphasizing on re-introduction of prudence in
the conceptual framework and that will have a direct impact on the financial reporting of
Australian business entities. IASB is currently seeking opinions from various financial experts
about the decision of including prudence principle again as a major characteristic of financial
information (George, 2016). As such, the discussion paper has presented arguments for and
against the concept for assisting IASB in taking an adequate decision as follows:

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Arguments against the ‘Prudence’ Inclusion
The conceptual framework of the financial reporting has stated the general
objective of developing the financial statements and presented a discussion in relation to the
necessary characteristics to be presented in them for protection of investor’s interest. Prudence is
regarded as one of the major characteristics that have gained significant attention from the
investors. However, the concept was removed from the CF in the year 2010 as it is reported to be
in conflict with ‘neutrality’ and ‘faithful presentation’ principle of financial reporting. This is
because the rationale behind the use of prudence principal is that a company should not
recognize the asset at a value higher than the expected amount to be recovered from its sales. On
the other hand, it also stated that liabilities should not be presented in a lower amount that is
expected to be paid in future for meeting them. As such, the principle means that developers of
financial statements need to take caution in exercise of judgments and estimates taken for
recording the value of asset and liabilities that have uncertainties such as collection of
receivables or probable useful life of plant and equipment. This means that produce does not
allow for overstating an asset or understating the value of a liabilities. This may contradict the
faithful representation of financial information as the application of the concept can result in
restricting the depiction of real worth of an entity and therefore can lead to inaccurate decision-
making of investors (Cooper, 2015).
It has been pointed by various accounting experts that restraining profits in a
year can result in release of it in the coming period of time that can lead to depiction of the
exaggerated results of an entity. Therefore, as such it can be stated that the principle of prudence
can lead to reduced reliability of information. Also, it contradicts with the neutrality principle of
financial reporting which emphasizes on avoiding biasness during development of financial
statements. The financial information should be neutral to both good and bad news however
prudence inclusion can restrict the disclosure of financial information that has greater
measurement uncertainty. However, this may cause materialistic change in the worth of an entity
during the occurrence of good or bad situations and thus prudence fails to depict faithful
information to the investors. Thus, it can be said that re-inclusion of prudence can negatively
impact the interest of the investors as the degree of reliability of financial information will be
dependent on the accuracy of accounting estimates taken by the management during
uncertainties. As such, its inclusion can negatively impact the competitiveness of Australian