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Difficulty: MediumAccounting Concepts and Conventions

A business anticipates a potential loss of ₦120,000₦120,000 from an ongoing legal dispute and immediately creates a provision for it in the financial statements. However, it refrains from recognizing an expected gain of ₦80,000₦80,000 from another pending claim until the outcome is officially finalized. Which accounting convention governs this financial treatment?

  1. A
    Business entity concept
  2. Prudence conventionAnswer
  3. C
    Consistency convention
  4. D
    Money measurement concept

Answer

Prudence convention
The prudence convention (also known as conservatism) states that accountants should exercise caution when making estimates under conditions of uncertainty, ensuring profits and assets are not overstated and all expected losses are recognized immediately.

Step-by-Step Solution

1
Analyze the financial treatment described in the scenario.
The firm provides for an anticipated loss of ₦120,000₦120,000 while excluding an expected gain of ₦80,000₦80,000.
Financial accounting mandates specific caution when handling uncertain future events.
2
Identify the accounting rule requiring cautionary reporting.
The rule that requires recording probable losses immediately while ignoring unearned gains is the prudence convention.
Prudence ensures assets and income are not overstated while liabilities and losses are not understated.

Key Concept

Prudence (Conservatism) Convention
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Topics

Accounting Concepts and Conventions

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