Prudence (conservatism)
In one sentenceA principle calling for caution in making estimates, so the business does not overstate assets and revenue or understate liabilities and expenses.
Simply put
When an estimate is uncertain, choose the figure that does not flatter the picture: an expected loss is recorded, and a gain is not recorded until it is realized.
Its best-known example is measuring inventory at the lower of cost and net realizable value. Prudence does not mean hiding profits or overstating provisions.
Worked example
A clothing store has old styles costing 50,000 SAR that will sell only at a discount, so their net realizable value is 42,000 SAR.
Inventory cost50,000 SAR
Net realizable value42,000 SAR
Inventory value in the statements (the lower)42,000 SAR
Inventory write-down loss (50,000 − 42,000)8,000 SAR
Don't confuse it with
ProvisionsAn application of prudence through a reasonable estimate; they must not be inflated to reduce profit.