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2.14 Which of the following statements about prudence is correct?
A Prudence requires assets to be carried at their lowest possible valuation
B When prudence is applied, income is not recognised until the cash has been received
C A prudent decision will mean lower expenditure
D Prudence does not allow for overstatement of liabilitiesthe answer is D,
but I know that, in prudence method,prudence method
don’t overestimate = Assets, income
don’t understimate= liability, expense
so how d is the answer? which prudence method says don’t underestimate liabilityI am guessing that you found this question in the Bpp Revision Kit, and it is really a play with the words.
The prudence concept does state that we should act on the side of caution, but that does not mean that it allows you to deliberately overstate liabilities. It is only if we are unsure of the liability that we should show higher liability rather than lower, but that does not mean that we should deliberately show ourselves as owing more than we actually expect to owe.
For example, if we know that we owe suppliers $1,000 then we must show $1,000 as being owing. We cannot just decide to show $1,200 as being owing 🙂
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