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+--- Thread: prudence. (/showthread.php?tid=5886)
prudence. - irfan kazim - 05-26-2009
AOA,brothers and sisters,
Plz tell me the solid reason about why prudence concept ignore expected gains and why not record this like expected loses.
- faisal_desperado - 05-31-2009
W.Salam
Mr Irfan Prudence means recognizing all losses ,which may arise in the near future, & anticipating no gains unless there isn't a great certainity that economic benefits will flow to the entity.
From The theoritical view point the said defination is sufficient,
but practically if the concept of prudence is ignored then the following results are inevitable.
It would imiginary augment the Revenue which means increaing all profitability related ratios & in this regard such a profit may neither be used as a yardstick/benchmark to compare with others (Past or other industry) nor it may be compare to any previously used benchmark.
on the other hands such a gains/profit, ( which is uncertain) if incorporated in the books then it would surely augment Asstets since they will be recorded as a receivable & resultant effect would increaase current as well as liquidity ratios, that is current assets will seem to be much on the higher side, & such an effect may result in a liquidity problem.
If any stakeholder deals with such a company , or let say any financial institute approves loan on the basis of these ratios then company will not surely be able pay its debt & as a result, it will be sued by the lender & ultimately be liquidated due to being insolvent.
besides the said reasons there are many others too, if these are insufficient for you then tell me your email address for further assistance.
- irfan kazim - 06-03-2009
AOA, i understand but why prudence concept not apply on fixed assets. whereas we revalue fixed assets. according to prudence assets and income should not be overstated. Every year we overvalue fixed assets more then thier historical cost value
- irfan kazim - 06-03-2009
AOA,
i think you are discussing short term loans that are given to business from financial institution.
- irfan kazim - 06-03-2009
My email is mc080408451@vu.edu.pk
- faisal_desperado - 06-04-2009
Irfan , your concepts regarding prudence needs rectification since prudence does not apply on the revaluation of any asset rather prudence restricts to recognize any gain, which may arise by sale of any asset in the future period of time.Furthermore, if the value of any asset is overstated or understated then it would never variate the income level. In this regard, the followings are being quoted for the purpose of revaluation purpose.
<b>As per IAS 36</b> "Impairment of Assets" Each asset needs to be cheaked for atleast once in a year that wheather it has been impaired or not , in either case, a revaluation reserve account is created & gains due to revaluation is shown in that account.
<b>As per Company Ordinance 1984</b> , if the value of any asset is revaluated then the same gain is credited to the account called "Surplus On The Revaluation Of Fixed Asset" on the equity side of the balance sheet just after "Capitl & Reserve account" & such a gain can never be treated as a part of income rather it shall be offset against the loss on the revaluation of another fixed asset, any incremental depreciation arising out of revaluation of fixed asset may also be charged to the said account, furthermore, it shall have to be shown in the same way unless fully offset as per rule specified in the ordinance.
Also note that wheather a company borrows short term loan or long term loan, in either case, liquidity position (Cash position) shall decline whenever borrower pays its obligation.
Best Ragards,
- irfan kazim - 06-05-2009
i understand. It means prudence concept just apply on the assets which are closely related with income. or only apply on current assests. Like prudence says assets and income should not be overstated.Right. PLZ faisal bhai send your mailing addrresss
- irfan kazim - 06-05-2009
Faisal bhai kia prudence concept matching concept and consistency concept k khilaf nai hy?
Because expected loses are belong to near future. While matching cencept allows us to record income and expenses that are related to each accounting period that are totally comsumed and occured. And consistency concept allows us to regulate same accountin policy year after year. While as for as inventory valuation is concerned, inventory is recorded on cost or NRV which is lower. Some times inventory is recorded on NRV and some time on Cost. Is not against the consistency concept.
- faisal_desperado - 06-06-2009
Irfan, Matching and prudence are two different things & they can in non of the case may collide each other.
however Contistency & Prudence may collide each other some times but note the following in this regard,
<b>Consistency of presentation</b>Companies are required to present the same methods consistently ineach successive period,but it also suggests to use alternative, <b>if it will be more beneficial to apply other method.</b> In such case company may also use method other than consistently used method.
Now about your question ,i agree that inventory is recorded on lower of cost or NRV/MV due to the prudence, at this moment it seems to be inconsistent for that company which records inventory at cost but started applying Lower of cost or MV/NRV ,THIS is inconsistency but companies are allowed to do so as per standards on the one hand & Prudence is having priority over other principal on the other hand.
Also in this case, i.e. MV of inventory is lower but company records it on cost basis then such a company will either sustain loss or will have lower profit than anticipation, because company will not be in a position to attain orignal profit if it anticipates profit on cost basis.
Best Regards,
Faisal Javaid
- irfan kazim - 06-08-2009
AOA, faisal bhai
I think you want to say me that prudence concept has priority over other accouting concepts that is why matching and consistency is voilated when they collide wint prudence. is it right?how can a paritcular company face lower profit or sustain loss if they record inventory at cost if MV is lower then cost? which matters can be discussed that must be consistent when we discuss the concept consistency.
- faisal_desperado - 06-13-2009
Please read the related topics in Financial Accounting by Hanif & Mukherjii / M.Y. Khan & P.K. Jain.
Best Regards,