Definition
The financial accounting term conservatism constraint refers to an accounting constraint that states when in doubt, report information that does not overstate income or assets or does not understate expenses or liabilities.
Explanation
Constraints accounting is a financial reporting approach that is consistent with the framework outlined by the Financial Accounting Standards Board (FASB). The Conservatism constraint is used when all other accounting theory, principles, assumptions, and constraints fail to provide the accountant with guidance.
The conservatism constraint provides final guidance to an accountant when higher level concepts fail. This constraint states when in doubt, report information that does not overstate income or assets or does not understate expenses or liabilities. This is sometimes interpreted to mean assets and income should always be understated, which is not correct. When there is no doubt how to accurately account for an asset or expense, then this constraint is not applied.
Examples
One of the often cited examples of the conservative constraint has to do with the valuing of inventory. When in doubt as to its value, it's better to use the lower of market or cost. Another example would be the classification of some operating costs as a balance sheet item (asset) or an income statement item (expense).
Related Terms
The Financial Accounting Standards Board, or FASB, is an independent, non-profit organization which establishes the financial accounting standards used by companies in the preparation of financial reports.
Moneyzine EditorNovember 6th, 2024
The term cost / benefit constraint refers to an accounting constraint that states the cost of providing information must be measured against the benefit derived from the use of that same information.Moneyzine EditorJanuary 12th, 2024
The term industry practices constraint refers to an accounting constraint that states the preparation of financial statements for some industries require a departure from what would be considered standard accounting practices.Moneyzine EditorJanuary 22nd, 2024
The term materiality refers to an accounting constraint that is used to determine the relative importance or value of an item to one of the company's financial statements. If an item is not deemed significant enough to influence the decision-making process of an individual examining the company's financial statements, then that item is not considered material.Moneyzine EditorFebruary 8th, 2024
The financial accounting term lower of cost or market refers to an inventory valuation rule that states items should be valued at their original cost or their current market cost, whichever is lower.Moneyzine EditorJanuary 24th, 2024- The financial accounting term prudent cost concept refers to a process that allows accountants to place a value on an asset that is different than historical cost. The prudent cost concept applies when a company is unaware of the asset's true value and the acquisition price is too high. When this occurs, the recommended course of action is to charge a loss in the current period.Moneyzine EditorSeptember 21st, 2023
