Prudence and IFRS

In this paper ACCA’s Global Forum for Corporate Reporting reviews the arguments for and against prudence in accounting standards. It summarises the debate about whether International Financial Reporting Standards, as the key global standards, should include prudence and state its importance in their conceptual framework.

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There are arguments for and against prudence in accounting standards, and these principally focus on the tension between user expectations that financial information should be a reliable record of performance and the need for them to be unbiased. There is ‘good’ and ‘bad’ prudence. What is clear is that there are many examples of prudence in existing IFRS and that these instances are widely accepted treatments. 

Given those instances, the following conclusions can be drawn. 

Prudence certainly should be discussed in the new framework when the exposure draft is produced. The previous wording is quoted above, but this seems to refer principally to the prudent application of the standards more than prudence’s role in setting the standards in the first place. 

The discussion and definition should be reconsidered as arguably the principal role for prudence in standard setting lies in robust recognition criteria for assets and liabilities, where its application is transparent. 

In measurement terms the retention of historical cost for many items will impart a proper degree of prudence to profit recognition and to asset values. Other measurement bases such as fair value need honest application of the valuation techniques, giving due recognition to the effects of uncertainty. Standards should not inject an extra element of prudence into these valuations, which will always tend to lead to an unquantified element of bias. 

Standards provide guidance but their application often involves a degree of judgement, which allows for a range of outcomes largely because of uncertainty. In exercising that judgement management should err on the side of caution and prudence.