Principle of prudence

New York Times  Sep 28  Comment 
John McDonnell, Labour’s newly appointed shadow chancellor of the Exchequer, moved to calm fears that the party would turn away from centrist economic policies of the past.
The Hindu Business Line  Aug 3  Comment 
With reference to the news that the RBI may hold repo rate cuts till September -- while the RBI advocates benign austerity, the government guns for growth through reduction of key rates. A...
The Times of India  May 25  Comment 
Reserve Bank Governor Raghuram Rajan on Monday said growth is slow in picking up even as macro economic parameters have improved, while stressing the role of state governments in improving fiscal performance.
The Economic Times  Apr 14  Comment 
The rating agency had last week raised India's outlook to 'positive' from stable and said there was a probability of a rating upgrade in the next 12-18 months.  Mar 17  Comment 
Thrifty Germans prefer economy loo roll while Italians are cutting down on luxury tissue. What does toilet paper use tell us about economic behaviour? Germany’s economic strength – premised on savings, financial prudence and staying well...
The Hindu Business Line  Mar 15  Comment 
Financial innovation and regulation have to go hand in hand for economic development, according to C Rangarajan, former Chairman, Economic Advisory Council to the Prime Minister. “Policym...
The Economist  Mar 2  Comment 
CHINESE monetary policy is rarely straightforward. This weekend’s interest cut was no exception. The third loosening move in little more than three months, it should be evident that China is now in all-out easing mode. But in describing its...
The Australian  Jan 23  Comment 
WHEN Arrium blindsided the market with a $754 million equity raising last year, its share price was smashed and its board castigated.
Equitymaster  Jan 2  Comment 
Posted by Equitymaster        The year 2014 has been a year of turn around for stock markets and overall sentiments in the economy. And while the Modi Government has shown some resolve towards reforms, the risk to reward ratio seems to...


The Principle of prudence is one of the seven principles of GAAP, and requires companies to report, on their balance sheet, the value of their assets and liabilities at their least favorable valuation. Additionally, the principle demands that income/expense recognition and projections be realistic -- i.e. revenue is not recognized unless it is certain, while expenses are recognized while they are probable.

For example, if there is a dispute about sales, the company is encouraged not to report the disputed revenue. However, if there is a lawsuit that may require the company to pay fines/fees, it has to be reported (at least in the notes).

On the other hand, investments are recorded at the value that the firm paid for it or the market value, whichever is lower. It is only after selling the position that the company recognizes any gains. Similarly, inventory of raw materials is valued at the lower of cost of purchase and market price; and inventory of finished goods are recorded at the lower of cost of production and selling price. Additionally, all real-estate assets are recorded at cost and any increase in value is not accounted for till the sale of the asset, but any significant loss of value is reported immediately. Finally, the principle requires goodwill and intangible assets to be written down gradually.

"Those with responsibility to invest money for others should act with prudence, discretion, intelligence, and regard for the safety of capital as well as income." Judge Samuel Putnum in 1830 [1] See: Prudent man rule


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