Prudence and the New Conceptual Framework in Accounting

Running head: PRUDENCE AND NEW CONCEPTUAL FRAMEWORK IN ACCOUNTING 1
Prudence and the New Conceptual Framework in Accounting
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PRUDENCE AND THE NEW CONCEPTUAL FRAMEWORK IN ACCOUNTING 2
Prudence and the New Conceptual Framework in Accounting
There has been a heated debate on the matter of prudence in financial accounting over
the recent years. Some people have argued that financial accounting is a conservative practice
that requires accountants to be cautious. Others believe that accountants should be neutral when
applying the principles of the International Accounting Standards Board (IASB) so that there is a
faithful presentation during financial reporting. There are inherently many risks attached to the
application of prudence in financial accounting. One of the main items that often fall into the trap
of prudence is the valuation of assets (Barker, 2015). It is usually common to find that the book
value of assets being less than the economic value of the same assets. Because of these
differences, there are both practical and conceptual reasons for the outcome when neutrality or
prudence concepts are applied. If an accountant uses the prudence principle to value an entity’s
assets, there would be information asymmetry bias which might lead to a conservative outcome
of the financial statements being presented (Holt, 2018). This saw the need for the update of the
IASB’s 1989 Framework for the Preparation and Presentation of Financial Statements to remove
the concept of conservatism and prudence in financial reporting. This paper seeks to make an
outline of the initial discussion paper draft for the Board of Directors of Big Phore Partners
detailing the context of the change and the arguments for and against the inclusion of the matter
of prudence in the new Conceptual Framework by IASB. This paper is also intended to prepare a
letter of the draft to be submitted to the IASB in regard to the firm's position on the issue of re-
including prudence in the Conceptual Framework.

PRUDENCE AND THE NEW CONCEPTUAL FRAMEWORK IN ACCOUNTING 3
Part 1 Internal Audience Directors’ Brief
The Context of the Change
We can all attest to the fact that financial accounting is not a subject for the neutral
measurement and recording of the economic value of items of the financial statements. We also
all know that the book value and the economic value of items are conceptually different because
of the issue of conservatism (Dichev, 2015). This issue of inherent conservatism seems to have
been overlooked by the IASB and other critics. The decision of IASB to remove prudence from
the Framework for the Preparation and Presentation of Financial Statements has sparked a lot of
criticism from practitioners and academia (Barker, 2015; Tracey, 2015). Although it can be
argued that the challenge of the new framework is being implied by adopting an agency –based,
contracting demand for prudent accounting, critics of this principle believe that the actual
problem, for the most part, does not exist.
What appears to be the truth of matters is that, most investors today, desire that the
management through the accountants of an organization will avail ‘‘the right information’’ for
them to make the right decisions. As a comment to this new Conceptual Framework, we can
suggest as a company (Big Phore Partners) to ask IASB not to re-include the principle of
prudence and conservatism as it is against the desires of most investors. But because Mr Price
(the company's executive director) believes that prudence is the cornerstone of financial
reporting, we have to look at the arguments for and against the re-inclusion of the principle of
prudence in the Framework for the Preparation and Presentation of Financial Statements during
financial reporting.

PRUDENCE AND THE NEW CONCEPTUAL FRAMEWORK IN ACCOUNTING 4
Arguments for Inclusion of the Matter of Prudence in the New Conceptual Framework
Prudence in financial accounting and reporting has had a long-established track record.
Since the prudence matter was done away in 2010, there has been a heated debate on whether to
re-include it or not. As the body mandated to review and update accounting standards and
frameworks, the International Financial Reporting Standards (IFRS) should consider these
arguments for and against the matter of prudence before making a decision on the same.
The Need to Be Cautious
There has been a general, clear and acceptable expectation that has been placed among
accountants by users of financial statements over a long time. These users have always believed
that accountants should restrain themselves from a situation of anticipated over-exuberance of
the management when it comes to the preparation and presentation of a company’s financial
statements. Some users also usually believe that the reported and audited financial statements are
usually hard and that most certainly some estimates might have been made cautiously by the
accountants during the preparation of such numbers ("Conceptual Framework", 2018). This
scenario was being referred to by the previous framework as prudence where accounting
standards supported it. The view of caution during the preparation and presentation of financial
statements is not only held by the general public but also by professional investors, accounting
researchers and organisations stakeholders. Investors are particularly interested in this area
because of the profits figure they desire for payment of dividends and bonuses.