Accounting Conventions - 2. Convention of Conservatism:

Accounting Conventions - 2. Convention of Conservatism:

     The convention of conservatism  means the convention of caution, prudence or the policy of playing safe. In other words, it means that, in the accounting records and the financial statements of a business, all the prospective losses, risks and uncertainties should be taken note of and provided for, but prospective profits should be ignored. In short, "provide for all possible losses, but anticipate no profits" is the implication of this convention. It is on account of this convention that provision for doubtful debts, provision for discount on debtors, provision for fluctuations in the prices of investments, etc., are made. Again, it is because of this convention that stock in trade is valued at cost price or market price, whichever is lower, and intangible assets like goodwill are written off.

     The significance of this convention is that the financial statements should indicate the actual position. It should neither show a rosy or better picture by window dressing nor a worse picture by creating secret reserves.