The Prudence Concept

Accountants are a cautious lot and where alternative accounting procedures or valuations are possible, the most pessimistic one is normally chosen. This is the prudence concept: that is, giving the most cautious representation of the financial position.

So, if you have unsold goods at the end of your financial year, in your balance sheet, they will be valued at their purchase cost (say, £100 each) rather than their sale price of £150. To value them at their sale price of £150, would mean that you had anticipated making a profit of £50 before you had actually sold them.

Also, for example, if a loss is foreseen, it should be taken into account immediately: If a business purchases stock for £1,200 but then because of a sudden slump in the market, it can only be sold for £900, then the stock should be valued at £900 in the accounts, (therefore recognising the £300 immediately.

The prudence concept basically means not counting your chickens before they’re hatched.

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4 responses to “The Prudence Concept

  1. What will be the double entry for the transaction?When we value the stock at 900 instead of 1200.

  2. You need to enter a journal to make your Profit & Loss closing stock account equal to the value of your stock (£900). The balance in the account should show a credit balance of £900.
    Your balance sheet closing stock should also then have a balance of £900, but it should show a debit amount of £900.

    TRIAL BALANCE EXTRACT:
    P&L Closing Stock a/c £900 CR
    B.S. Closing stock a/c $900 DR

    The reduction in the value of your stock will automatically reduce your profit for the period in question.

  3. Sorry, it’s taken a while to get around to this. In the meantime, it’s great that someone has answered for me!! Thanks Nilsson 🙂

    The double entry would be:
    Dr P&L £300
    Cr Stock £300

    This would then bring down the stock value.
    Then, when you close your P&L and work the balance sheet, you will have achieved the balances that Nilsson states in his comment.

  4. So what would be the entry if we dispose of an asset at original cost after it had been partly depreciated?
    As an invoice is raised as a sale the income is currently recorded in a “income” account. But how to I write down to value of current assets?