When to Use Conservatism Principle of Accounting?
1. Provision for Bad Debts: Conservatism is evident in the creation of reserves for bad debts. This allowance recognizes potential losses from customers who may not be able to fulfill their payment obligations, ensuring a more conservative representation of accounts receivable.
2. Legal Disputes and Lawsuits: When a company is involved in legal disputes or lawsuits, conservatism guides accountants to recognize potential losses associated with these legal proceedings. This recognition occurs when the loss is probable and the amount can be reasonably estimated.
3. Asset Impairment: When assessing the value of long-term assets, such as property, plant, and equipment, conservatism dictates that if there are indicators of impairment, the assets should be tested for impairment, and any necessary write-downs should be recognized.