Abstract: The prudence principle, also known as the "cautiousness principle," refers to adopting a cautious stance in accounting calculations to overcome the inherent instability of commodity and market economies that bring operational risks to enterprises. Specifically, when there are multiple methods available for accounting a certain economic event, under the condition of not affecting reasonable reflection, one should try to choose an accounting treatment method that avoids overestimating income and assets and underestimating losses and liabilities. The aim is to enhance the enterprise's ability to cope with risks.
Keywords: Enterprise; Financial Management; Prudence Principle
【Paper Keywords】Enterprise; Financial Management; Prudence Principle
【Paper Abstract】The prudence principle, also known as the "cautiousness principle," refers to adopting a cautious stance in accounting calculations to overcome the inherent instability of commodity and market economies that bring operational risks to enterprises. Specifically, when there are multiple methods available for accounting a certain economic event, under the condition of not affecting reasonable reflection, one should try to choose an accounting treatment method that avoids overestimating income and assets and underestimating losses and liabilities. The aim is to enhance the enterprise's ability to cope with risks.
Japan's Corporate Accounting Standards point out: "The prudence principle" involves appropriate and sound accounting treatment in situations where adverse effects on corporate finance may occur. It requires: to avoid risks brought by uncertain futures, accounting treatment must be based on moderate and prudent judgment.
I. Objective Necessity of the Prudence Principle
1. Conflict Product of Risk and Benefit
The prudence principle is predicated on the objective existence of risk. In the ever-changing market, competition and risk are omnipresent. For profit-oriented enterprises, risk is an ever-present demon; however, companies threatened by risk can obtain sufficient rewards — benefits — through relentless efforts. Risk and benefit are closely related: the greater the risk, the greater the benefit, which serves as motivation for enterprises; the greater the benefit, the greater the accompanying risk, which serves as pressure for enterprises.
The prudence principle in accounting is precisely the remedy for resolving the conflict between "risk and benefit." Since the accounting profession itself has grown up in an environment of bankruptcies, closures, frauds, and disputes, this environment constantly fills accountants with a "strong sense of disaster," or a sense of crisis. Accountants, adhering to the prudence principle, take on the responsibility of overcoming risks without hesitation. Meanwhile, a considerable number of accounting standards and methods, though not directly derived from the prudence principle, are always influenced and governed by it.
The objective existence of enterprise operational risks and their potential losses determines the objective existence of the prudence principle in accounting. It can be said that the prudence principle serves as a "internal stabilizer" for enterprise management to some extent.
2. Constraints of Uncertainty Factors
Accounting uncertainty refers to accounting information whose ultimate outcome, whether gain or loss, can only be confirmed after the occurrence or non-occurrence of one or more uncertain future events.
Due to continuous scientific and technological advancements, rapid economic growth, and increasingly fast information dissemination, the complexity of uncertainty issues in the accounting field is growing. The causes of accounting uncertainty can be attributed to two aspects:
(1) External factors, i.e., uncertainties arising from continuous changes in the external environment of the accounting system. For example, commitments made by enterprises and credit relationships with banks, as necessary tools for financial facilitation and trade guarantees in business operations, are significant causes of accounting uncertainty. Exchange gains or losses due to differences in exchange settlement terms in foreign currency transactions, amortization of intangible assets, and the duration of contract effectiveness all lead to continuous changes in enterprise assets. In the course of production and operation, enterprises inevitably face certain risks in pursuit of excess economic benefits. Because of these risks, accounting information naturally contains uncertainty. Additionally, the survival and growth of enterprises are inseparable from the social environment, so accounting information is inevitably affected by factors such as tax rates, price change indices, and inflation, leading to continuous changes in enterprise assets.
(2) Internal factors, i.e., uncertainties caused by the information processing process within the accounting system, which leads to uncertainty in accounting information. For example, due to limitations in the professional level or ethical quality of accounting personnel during confirmation, measurement, recording, and reporting, enterprise accounting information continues to change. In summary, accounting uncertainty directly targets the quality of accounting information, and the quality of accounting information determines the inevitable existence of accounting uncertainty.
"Uncertainty," this widespread constraint factor, has become the basis for the traditional accounting concept of prudence. As generally described, the prudence concept is not an assumption in accounting, nor is it a constraint factor, but in application, it is used as a constraint factor to present less reliable relevant data. The prudence principle is a definite response of people to accounting uncertainty. Accounting is a product of the combination of economics, technology, and human beings. The existence of accounting uncertainty means the existence of risk, and the existence of risk naturally leads people to take measures, seeking a prudent way to avoid risks and protect themselves. The prudence principle in accounting work is one such method adopted by people. For example, in the face of uncertainty in accounting work, trustees, auditors, and investors, for different purposes such as reducing fiduciary duties, alleviating auditing responsibilities, and avoiding or mitigating investment risks and making accurate and reasonable decisions, require that the disclosure of accounting information must adopt the prudence principle.
II. Major Manifestations of the Prudence Principle in Corporate Accounting
The application of the prudence principle in enterprises is illustrated as follows:
1. Lower-of-Cost-or-Market Method
The end-of-period valuation of inventory and short-term investments can use the lower-of-cost-or-market method, i.e., provisions for inventory depreciation and short-term investment markdown can be extracted, and the amount below cost can be recognized as current period losses. Moreover, enterprises should regularly examine the book value of long-term investments item by item. If the market price continues to fall or the operating conditions of the invested unit change, resulting in its recoverable amount being lower than the book value of the investment, the difference should first offset the capital reserve item of that investment, and any insufficient portion should be recognized as current period investment loss.
2. Adoption of Accelerated Depreciation Method
The 1992 accounting system strictly defined the scope of application of the accelerated depreciation method, while the accounting system for joint-stock companies did not impose restrictions on the scope of application of the accelerated depreciation method. Enterprises can appropriately select the depreciation method according to the nature and consumption mode of fixed assets.
3. Amortization of Intangible Assets
Amortized over the shorter term specified by the contract or law and the operating period. If the contract or law does not specify a term, it is amortized over no more than 10 years, whereas the industry accounting system stipulates amortization over no less than 10 years. For start-up expenses, the industry accounting system stipulates amortization over no less than 5 years, while the "Accounting System for Joint-Stock Limited Companies" and specific standards changed this to amortization over no more than 5 years. If the start-up expenses are not significant, they can also be amortized all at once in the month when production and operation begin, and included in profits and losses.
4. Accounting Treatment of Investments
In "Corporate Accounting Standards - Investment," it is stipulated that the investment cost for obtaining long-term equity investments by abandoning non-cash assets should be calculated based on the fair value of the abandoned non-cash assets...