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Date:15^th February 2010	Compiled by: M Sathya Kumar
When to exercise prudence= = The principle of prudence = is applied mostly while valuing current assets such as inventories, receivab= les and current investments. Prudence is something which every one exercis= es in day-to-day life. Prudence, according to the Oxford Dictionary, means “careful to avoid undesired consequences, circumspect, discreetR= 21;. It implies that the person should behave carefully and diligently in such= a manner as an ordinary knowledgeable person would behave in the given circumstances. While every entity is entitled to have its own policies, these policies should be based on certain considerations. One s= uch consideration is prudence. Prudence could be used as a synonym of the concept of conservatism. Prudence is generally exercised by the entity wh= ile entering into every transaction, which remains an underlying record. Prud= ence is also exercised in determining the value at which current assets are ca= rried in the financial statements. = ACCOUNTING STANDARDS This principle is applicable mostly while val= uing current assets such as inventories, receivables, current investments, etc= ., This principle is woven into AS 2 on “Valuation of inventories”, AS 4 on “Events occurring a= fter the date of the balance sheet” and also in AS 13 on “Accounti= ng for Investments” . There is an implication of prudence in AS 10 as well. This principle is aimed at avoiding recording of unrealised gains a= nd to be on guard for losses likely to arise. Based on prudence, AS 2 states that inventori= es should be valued for the purposes of the balance-sheet at cost or net realisable value, whichever is less. By so doing, the entity is factoring= in the possibility of the loss likely to arise due to drop in the selling pr= ice of the commodity. As a matter of fact, inventories were being valued at cost or market value, since long before AS 2 has become operati= ve and later on amended to change it to net realizable value. This amendment takes the concept of prudence = to its logical end, by eliminating the further expenditure to be incurred to sell these inventories. AS 4 dealing with events occurring after the balance-sheet date requires a provision to be made for the likely losses arising out of all the adjusting events. AAS 19 requires the auditor to scrutinise all such subsequent events and use his judgment to decide if a provision is required to be made. This requirement of AS 4 and AAS 19 is a corollary to the concept of prudence. The same principle of prudence has also been adopted in AS 10 in case of fixed assets held for sale. AS 10 states that= the fixed assets discarded or held for sale should be carried in the financial statements at book value or net realisable value, whichever is less.= The difference is to be treated as a loss by writing it off through the profit and loss (P&L) account. Since the f= ixed asset is held for sale, it changes its nomenclature and is on a par with current assets. Consequently, depreciation cannot be charged on such asse= ts. AS 13 dealing with investments also ropes in prudence by requiring the current investments to be carried to the financ= ial statements at lower of cost or net realisable value. Since there is no AS issued on accounting for receivables, there is no such enforceable provision, but the concept of prudence would play a significant role. Sundry debtors should be analysed qualitatively for reporting in the financial statements. Requirement of Schedule VI to indicate debtors outstanding for more than six months is a step towards prudence being communicated to the reader of the financial statements. Care should be taken to decide whether a provision is to be made or the debt is to be written off= in the particular accounting period. The auditor should use his judgment to decide if a provision is required or the debt is to be written off. Considerations would be as under: age of the debt; credit period; conduct= of the account during the earlier period; any unforeseen circumstances; perceptions of the management and their reasoning; any legal proceedings initiated for recovery and the possibility of its recovery; and prudence = is also required while making provisions for conceivable losses.<= /span> = BANKING, NON-BANKING INSTITUTIONS The Narasimhan Committee has made several recommendations on prudential norms, which brought about a sea change in revenue recognition and provisioning in the preparation and presentation = of financial statements of financial institutions. Prudence has been incorporated in the prepara= tion and presentation of the financial statements of banking and non-banking financial institutions. They are required to classify the advances on prudential norms as standard and sub-standard assets based on the perform= ance of the assets. Where the borrower fails to service the advan= ce as per the terms of sanction and the instalment and interest remains over= due (for varying periods based on the nature of the advance), the advance is = to be classified as sub-standard asset. These assets are also referred to as non-performing assets. Since the asset is not being serviced as per = the terms, the interest on such non-performing assets is to be recognised as income only on receipt of such interest (cash basis), giving a go-by to t= he accrual concept. The financial institution is required to make= a provision for the likely eventuality of sub-standard assets turning doubt= ful and later on becoming bad debts, depending on the period for which the advance remains a non-performing asset. Banks are also required to make a nominal pro= vision on standard advances as a measure of prudence. = Article by Kali Prasad, The author is a Hyderabad-bas= ed chartered accountant<= span style=3D'font-size:10.0pt;font-family:"Verdana","sans-serif";color:maroon= '>


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