Prudence principle is the rule of becoming carefulness. In accounting, we can become careful from future losses. For facing the losses without tension, it is very easy to separate of profit’s some part for this. Every type of loss will increase our liability.
As per prudence principle, we should make and record all estimated future loss and forget all estimated future gains. By doing this, we have to make the provisions for future losses. For example, there is the risk of defaulting the some debtors. For tolerating this loss, it is good, if we make the provision for doubtful debt. This reserve will deduct our total profit. If this loss will happen, we can easy buy new stock through this provision.
This provision is also called principle of conservatism because this rule is not new. Every time, businessman wants to play his investment in safe side. He also wants to control every type of risk through making reserve. At that time of making of reserve, he should estimate the future loss correctly, otherwise, it will become secrete reserve and it is against the principle of full disclosure.
Examples of Prudence Principle
– Stock‘s value is calculated on the basis of cost or realizable value whichever is less.
– The provision for doubtful debts, provision for discount allowed and provision for other future losses should be made
– Fixed assets must be depreciated on the basis of correct rate of depreciation.