Conservatism

The term 'conservative' in layman term means to be cautious. Similarly an accountant generally has to be cautious in recording the transactions. The principle of conservatism gives guidance to an accountant as to how he must record any uncertain events and estimates.

The principle of conservatism states that one has to be always on the safer side and must adopt a conservative approach for any transaction. Most of the time this means minimizing profits by recording uncertain losses or expenses and not recording uncertain or estimated gains.

Example : Provision for doubtful debts. Let's assume the collections team estimates that the chances of recovery of debt from a particular customer is doubtful and suggests provision of 5 %, whereas the sales team estimates it to be at 3 %. Now based on the prinicple of conservatism the enterprise must make a 5 % provision for doubtful debts.