What is conservative accounting philosophy?

Answer 1

Mattessich, R.:

What is conservative accounting philosophy? Prerequisite: What is "conservative accounting? It is the practice of recording and presenting financial statements based on cautious principles such as "acquisition cost or market value whichever is lower" (instead of the presently favored "fair value", frequently based on the subjective overvaluation of assets or undervaluation of debts) and "recognizing profits only after realizing sales", etc. If "philosophy" is meant in the professional sense (i.e., not merely as an "attitude"), one comes to the following conclusion:

A "conservative accounting philosophy" is an ontology and epistemology that tries to justify conservative accounting by taking into consideration: (1) the volatility of values(in general, but particularly, of assets, equities, etc.), and (2) that these values should be represented in a "prudent" and objective rather than an "optimistic" and subjective way..

A financial value is not a property of something but a three-way relation between some (i) person(s), (ii) an object, and (iii) changeable circumstances. This implies a potential for sudden or unexpected fluctuations in value such that its representation at one moment of time may no longer correspond to the reality at another moment. This creates a dilemma. On one side, accounting and financial statements are supposed to represent "reality", on the other side, this reality is in constant flux. Hence, neither a "conservative" value nor a "fair" value satisfies the ontological quest posed by a realist ontology. One solution to this problem would be to supplement accounting values of the financial statements with some kind of error estimates (e.g., its standard deviation), or to use a "multiple value approach." Proposals of this kind have been made in the literature (e.g., in Mattessich's Accounting and Analytical Methods, 1964: 220-231) but have not been seriously considered by practitioners. However, as far as share values are concerned, financial practice often attributes a risk factor to each share price. The traditional solution to this dilemma is to accept for accounting the general principle of conservativism (according to which it is preferable to err on the cautious than optimistic side). This principle has been the pivot of accounting practice (even of most of its theories) until the last decade of the twentieth century when empirical and positive accounting theories were instrumental in promoting "fair values". But some experts may argue that this resulted in occasional overvaluations in the Stock Market with billions of dollars in losses to the public. Typical overvaluations as occurred in a series of financial scandals, such as ENRON, WorldCom, Parmalat, etc. -- and more recently in the "sup-prime mortgage scandal". However, a conservative accounting philosophy has its own disadvantages. For example, it can lead to enormous discrepancies between (unrealistically low) accounting book values and (much higher) share prices in the market. Thus, neither a philosophy of conservative nor one of aggressive accounting seems to be desirable. What is needed is a philosophy that, on one side, emphasizes the fundamental dilemma of accounting representation and, on the other side, tries to sail safely through the Skylla of conservative and the Caryptis of aggressive accounting practice by indicating when to use one and when to use the other.