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Beyond the definition of the principle of prudential value, we must take into account that this principle is based on the idea that certain assets or transactions are complex to value. They involve in the sense of their weight but are challenging because they are subject to situations of risk or uncertainty that could change their value.
What is Prudence?
The term prudence comes from the Latin prudential, which is a quality that consists of benefits acting or speaking carefully, fairly and appropriately, cautiously, moderately, with foresight and reflection, sensibly and cautiously to avoid possible damage, difficulties, ills and inconveniences, and respect the life, feelings, and freedoms of others.
Prudence requires good sense, judgment, temperance, sanity, wisdom, discernment, poise, and caution. If you do not have good conduct or do not act prudently, for example, by driving, you put your and other people’s lives in danger or at risk.
Associated with Prudential Value
The concept of prudence link to multiple values. For example, expressing yourself in clear and appropriate language is part of prudence, especially when communicating important events or bad news. On the other hand, prudence implies respect for the feelings and lives of others. An individual with reckless behaviour is likely to endanger their existence and pose a danger to the lives of others. This occurs with those who drive recklessly, have dangerous animals in their home or celebrate by shooting into the air, among many other actions and behaviors contrary to prudence.
The Importance of Being Cautious for Prudential Value
To be prudent, to put it another way, is to be cautious. A man who wins a prize and spends all the money on parties does not stand out for his prudence: if in the future he has an unforeseen economic event, he will have no way of solving it.
It is interesting to mention that the Egyptian people used to represent prudence through a serpent with three heads (one with the appearance of a lion, another of a wolf and the other of a dog). So it is that, for them, an individual is prudent when he has the cunning of vipers, the vigour of lions, the agility of wolves and the patience of dogs.
Prudential Value in Economic Terms
In the economic sciences, a law called the “Principle of Prudence” regulates how a company’s profits and expenses must account for. In addition, it facilitates the creation of reserve funds to avoid catastrophes and anticipate unstable economic situations.
This principle is made up of the following series of rules:
- Revenue can only account for after it has been earned, regardless of when it collects;
- The losses and those possible risks that are foreseen must register under the name of «Reserves and provisions»;
- All expenses must record at the time they incur, regardless of their payment date;
- All assets that are written off must record, regardless of whether the period is negative or positive.
An example of this principle can be: we have a house that has account for 40 million dollars, but its price in the current market is much lower, about 30 million; We must account for all these numbers, including the difference between the two values, even if the house has sold.
The Principle of Prudence and the Faithful Image of the Company
The principle of prudence is not in contradiction with that of authentic image. We might think that the duty to present a representative picture of the company. A prevents us from considering possible changes in the value of the assets. This is not the case since the responsibility to represent a company’s actual. The image carries with it the idea of presenting possible risks. If we hide these risks, we will not give the company an actual photo.
Continuing with the previous example, if we grant a loan and record it as is, expecting that we will collect all of it (if we know this is not the case), we base information. Why is information biased? Because, in reality, we know it is tough to collect it.
Example of the Prudential Value Principle
To better understand the concept of the principle of prudence, we will give a slightly more developed example than serves to understand the principle of sense better. Suppose a company sells 100 computers to a customer. Each of these has a selling price of $1,000. Indeed, the billing will have been 100,000 dollars. The client does not pay at the time, and the invoice is pending payment. After a month, the client tells us that he will not be able to pay (for the moment) part of the payment.
The company must make an accounting adjustment since it may not collect the entire 100,000 euros that the client must pay. And therefore, you must order a deterioration of the customer account. This way, the customer account reduce, the risk collect, and the principle of prudence complies with it.
As a field of study, professional judgment offers the concept of prudence. Which defines the prudential criterion in accounting regulations; however, the ethical perspective. It accompanies practical reason and is relevant in the decision-making of entities contemplate. The double dimension of prudence consists of being rational and reasonable. Which implies the possibility of carrying out an activity that is the best for a specific action. The ethical discernment that accompanies the action is given by its social impact. It but what is put to the test in the prudential criterion is the ability to deliberate or rationalize. What compares to what expect to obtain from the act so that only. It the prudent man has before him the rational principle of decision.
The public accountant uses the prudential criterion to choose from several alternatives. It presented as simultaneous, In which most adequately satisfies the financial information requirements. Therefore, in case of doubt or uncertainty. It the accountant must use a criterion based on your professional judgment supported by prudence. In which allows you to adhere to the requirements established by accounting doctrine and practices.