Conservatism in accounting part I: Explanations and implications

  • Watts R
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Abstract

This paper is the first in a two-part series on conservatism in accounting. Part I examines alternative explanations for conservatism in accounting and their implications for accounting regulators. Conservatism is defined as the differential verifiability required for recognition of profits versus losses. Its extreme form is the traditional conservatism adage: "anticipate no profit, but anticipate all losses." Despite criticism, conservatism has survived in accounting form many centuries and appears to have increased in the last 30 years. FASB attempts to ban conservatism existed and prospered for so long are likely to fail and product unintended consequences. Successful elimination of conservatism will change managerial behavior and impose significant costs on investors and the economy in general. Similarly, researchers and regulators who proposed the inclusion of capitalized unverifiable future cash flows in financial reports should consider the costs generated by their proposal's effect on managerial behavior.

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Authors

  • Ross L. Watts

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