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Accounting conservatism is a principal that requires accounting rules be applied with high degrees of verification.

Accountants practicing conservatism must favor solutions that reflect the least favorably on a company’s bottom line. If an accountant has two solutions to choose from when facing an accounting challenge, the one that yields inferior numbers should be selected.

For example, accounting conservatism requires overestimating a company’s allowance for doubtful accounts and losses. If a company’s sales staff believes that a group of receivables will have a bad debt percentage of 4%, but management believes that number will be closer to 6%, then accounting conservatism goes with the 6% estimate, which is the position that records the least income and largest expense.

In accounting conservatism, losses and expenses are recorded as they’re incurred and profits require high degrees of verification before they can be claimed. Strict criteria for claiming profits are a common form of accounting conservatism.

While accounting conservatism can present a bleaker picture of a company’s financials, it encourages management to exercise greater care in its decisions. In the long run, conservatism can help a company.

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