Are You Using The Principles Of Conservatism In Your Bookkeeping?
Does your bookkeeping follow the principles of conservatism in accounting? If you're not familiar with this concept, you could be accidentally making your books less accurate and making it harder to see what your small business is really making. To help you employ conservative bookkeeping, here are the two main applications of its guiding principles.
Recognition With Confidence
The idea of being conservative in your bookkeeping is rooted in the documentation of transactions in ways that are most likely to be accurate. This means that if there is any uncertainty about a transaction, the bookkeeper attempts to record the most conservative option.
In terms of recognition — when to post income and expenses — conservatism means reporting transactions when you are most assured that they are actual, permanent, and earned. If a customer orders goods, the company doesn't have rights to that income until it ships the goods. The sale can still be cancelled. Therefore, you would record the income only when you're confident of a reasonable right to that money.
Taking the conservative approach to recording this income means less chance that you are overstating your profit. It also better matches the timing of expenses you paid in order to produce the goods.
Least Favorable Outcomes
The other guideline in conservative accounting is to opt on the side of caution when analyzing how to manage your books. If you have multiple choices about how to handle a transaction, choose the one that results in the least favorable outcome for the organization. Why? This is the option that is the most likely to be correct and would risk less over- or under-statement of your finances.
For instance, consider a purchase order specifying that a customer agrees to buy between 100 and 300 widgets. If recording this purchase order, the conservative company would err on the side of caution and record only the minimum 100 rather than the optimistic 300. This would be less favorable of an outcome, but it is more likely to be reliable. It's better to revise expectations upward later than downward.
Where to Learn More
The concepts of conservative accounting encourage accuracy and reliability, but they can be complicated. If your type of business frequently faces choices where the conservatism principles may need to be applied, start by learning more about how it works in real life. Make an appointment with an accountant or bookkeeping service in your state today to begin.