What is prudence in accounting, and why does it matter?

When financial statements are prepared, a key characteristic of the information is that it is “neutral”—being neutral means that the information is not biased and will not influence the users to act in a particular way.

What is prudence?

Prudence supports the application of neutrality. Prudence means exercising caution when making judgements under uncertain circumstances. Assets and revenue should not be overstated, and liabilities and expenses should not be understated. Prudence does not meant that assets and revenue should be understated or liabilities and expenses overstated. In the spirit of being neutral, prudence means applying the same level of caution in accounting for all elements of the financial statements. There may be instances at a standards-level when the accounting may be asymmetric, i.e. the requirements may not be the same for all the elements. There are specific reasons for these differences, but in principle these differences result in information that is deemed to be most relevant to users of the financial statements.

Why is it important?

When both the IPSASB developed, and the IASB revised, their conceptual frameworks, “prudence” was not included in either document. Several stakeholders, largely in Europe, argued that “prudence” is an important concept to ensure that elements are not overstated or understated, but are unbiased.

After much deliberation at the IASB, prudence was reinstated in the Conceptual Framework. As similar concerns were raised in the public sector, the IPSASB has proposed amendments to include prudence as an aspect to consider in applying neutrality. Neutrality, along with information being free from error and complete, is considered in applying the qualitative characteristic of “faithful representation”.

The IPSASB issued ED 81 on Conceptual Framework Update: Chapter 3, Qualitative  Characteristics and Chapter 5, Elements in Financial Statements for comment. Various changes, including prudence, are proposed to the Conceptual Framework and input is requested on these proposals

Have your say?

Comment to the IPSASB is due on 31 May 2022. As the ASB‘s Conceptual Framework is based on the IPSASB’s, any changes would need to considered by the Board. The ASB will have a series of  roundtable discussions  to discuss the proposed changes in ED 81 so that comments can be submitted to the IPSASB. ED 81 of the IPSASB has been published concurrently by the ASB as ED 197. Information about the project can be accessed using this link. If you are interested in joining the discussions, please contact E van der Westhuizen at eliznav@asb.co.za.