The convention of Prudence when applied to the balance

Solution

The convention of prudence, also known as the principle of conservatism, is an accounting principle that requires businesses to err on the side of caution when recording financial information. This means that businesses should not overstate assets or profits, and should instead take a conservative approach by understating assets and profits. When applied to the balance sheet, the convention of prudence results in the understatement of assets and the overstatement of liabilities. This is because businesses are required to record assets at their historical cost, even if the fair value of the assets has increased. Additionally, businesses are required to record liabilities at their present value, even if the future cash flows associated with the liabilities are uncertain