Use Of Prudence Concept In Accounting – Discussion And Analysis

Overview of the Organization

Discuss about the Use of Prudence Concept in Accounting.

In order to carry out a business in a successful manner, it is very important for the management level authorities to ensure that there are certain factors that are maintained in a proportionate manner. This includes the estimation of the company assets as well as the losses that are likely to occur in the near future. The following report is about the different criteria of estimation that are used by managers to show in their annual reports related to their company’s performance. It has explained about the prudence concept and its usage in the sector of business and accounting. The report has considered an Australian Organization and has done the analysis of its annual report. The rises and falls that have taken place in the organization along with the different aspects of company assets that have been underestimated or overestimated. The problem statement of this report is to understand the significance of implementing the prudence concept in Accounting of Business and the various ways to do it.

The BHP Billiton is an Australian based organization that involves its activities in Metals and Mining. It was founded in 1885 in an Australian town named Broken Hill, this company was awarded to be the largest mining company in the world in 2015. The headquarters of this organization are located at Melbourne, Australia and London, UK from where the mining operations in many countries around the world are controlled and directed. The organization is currently headed by Mr. Jacques Nasser who is the current Chairman of the company. In addition to this, the firm operates with its nearly 65,000 employees and staff that work under the guidance of Mr. Andrew Mackenzie who happen to be the Chief executive officer of the organization (Bhp.com, 2017).

The Prudence concept is known as one of the most significant concept that is used in the business domain. According to Steurer et al. (2016), the basic meaning of Prudence Concept is to estimate the revenues generated or recognized by a company in a controlled manner. In simple terms, it means that the assets of any organization should never be overestimated. At the same time, the losses that are likely to happen to an organization should never be underestimated by the management level authorities. In case there is a loss that is about to happen in a company due to any particular reason, the loss must be included in the annual report of the organization.

The Prudence Concept

Marshall (2016) has also described the prudence concept to be as the concept of conservatism. This means that the business managers need to be very careful about the revenue as well as the expenses that are experienced by an organization. In case of BHP Billiton, just like many other organizations, there are certain items of revenue as well as certain items of expenses while formulating of the annual report. These items or predictions of revenue and expenses are likely to occur in the near future. While formulating the annual balance sheet for the organization, the managers of BHP Billiton make certain assumptions related to few events that might lead the company to earn some profit. As per Mutowo et al. (2016), the possible extra income for a mining company apart from the usual profit can come from the customers that were supposed to pay for some earlier debt.

The main and the central theme of strategy implementation of BHP Billiton is to operate, huge, long lasting as well as low cost installations and operations without compromising the quality of work or materials. As stated by Marabel-Romo et al. (2017), the proper balance in cost as well as quality and quantity ensures that the losses that occur due to one side of operations can be overcome by the other. Moreover, the organization has also focused in the diversification in the commodity as well as the market along with its geography. The profit is usually shared in a balanced manner by the people involved in the complete process from contract distribution to transportation of machines, raw materials and carrying out the actual operations of mining.

While closing the financial statement at the end of the year, there are certain indications that there might be some income possibility. However, Coates (2017) has argued that there is also a possibility there might be some claim that can result in an expense of a certain amount of monetary value. According to the Prudence Concept, any prospective income should not be recognized in the account books. Hence, while formulating the financial statement, balance sheets or profit and loss accounts, the prospective income should not be disclosed. This has to be done because it is always safe to play on a conservative mode as revealing every detail might lead to the distribution of prospective income or profit equally among shareholders. Hence, Chamberlain (2017) has stated that in order to keep the profit as a reserve fund for the company, it is important to neglect the prospective or predicted income in the balance sheets.

Current Strategies followed by the Organization

However, as opined by Kaste (2017), the expenses should never be underestimated. Hence, if there is an expectation that there is some expense that is likely to be incurred by the company, it should be provided in to the books of accounts. This usually happens whenever there is a claim from one of the customers of the company who claims that the quality of materials supplied to him was not as per the desired expectation. The claim that is been done by the organization is usually done in terms of monetary deductions. The provision of this claim has to be made. This is because of the fact that if the claim actually arises in the future, the company actually has to pay the expenses. The claim is usually in respect of everything that has been done till date by the organization (Denuit and Eeckhoudt, 2016).

The expenses that are likely to happen are called provisions for which the company has to include them in the Annual Reports and Balance Sheets. However, there is a particular drawback of practicing the Prudence principle. As opined by Viganò (2017), it has been observed that a lot of managers actually create some provisions that are not necessary to be made. If the provisions are shown in too much quantity, there might be a possibility that the company is showing itself in a depreciating position instead of a healthy and a growing company in the market. As cited by Beardsworth (2017), this might have a negative impact in the investment in the company operations from external sources. The BHP Billiton has stated the areas that made the company to create some provisions in its annual report. In addition, the factors that were assumed and those that actually occurred have also been mentioned in the Annual Report of the Organization.

After the publishing of Annual Report for the last year that is 2016, it was proposed by some managers of the organization that the operations should be carried out in a very sustainable and balanced manner. According to Vergara (2017), the most important significance for sustainable operations is the reduction in the amount of overall production of the organizations. In the case of BHP Billiton, there are certain reasons why the production is likely to decrease due to the change in the proposed policies of Sustainability. The work is carried out by huge machines that release too much of smoke.

Importance of Prudence Concept Implementation in Annual Reports

The most significant benefit of using the sustainable development is that the atmosphere and environment are not polluted in any manner Paglietti et al. (2017). In addition to this, the danger to the health of many species of birds, ground and amphibian creatures can be avoided by using sustainable means to dump the wastage that is released during operations. Another important aspect is that the Corporate Image of the organization is certainly going to experience a good growth. However, there is certain criticism that the management staff of some of the departments have made. As per Valentinetti (2016), the sustainable development the machines that are to be used have to be emission free. However, the machines that are environment friendly are less efficient compared to those that are made to operate on diesel. Moreover, the costs of machines that emit less or nil carbon are likely to cost very high compared to the other conventional machines.

Following is the financial statements of the BHP Billiton that has included every detail regarding the major profits and losses. Moreover, the calculations related to profits available for equity share holders and current as well as non-current assets have been included in the balance sheets.

In the financial statement of BHP Billiton, it has been found that the revenue has increased, but due to the increase in the finance cost and increase in the production cost, the company has incurred losses amounted to $ 6385 in 2016. However, in the year 2017 the company has anticipated losses and thus, according to the prudence concept, BHP Billiton will disclose the losses. The reasons behind the anticipated losses are mentioned below.

Increase in production cost

Increase in finance cost and increase in tax rate

Increase in political, environmental and social influence

Increase in competition and impact of foreign market

In addition to these, the company has also estimated that in the year 2017, the depreciation cost will rise, also the liability will be rise due to the involvement of new project to counter the competitive environment. It has also been estimated that the cashflows from operating activities will reduce due to the increase in operating expenses.

The estimated financial statement showing loss in 2017 is provided below

Following are some of the recommendations that can be followed by the recommendations while doing the investments and making the annual reports so that the values of company assets remain at a proportionate level. Moreover, there recommendations are likely to reduce the overall expenses by a tremendous level.

Proposed Updating of Conceptual Framework

To focus on the Transportation: It has been observed that the modes of transportation that are currently used to transport the raw materials and mined goods are not enough efficient as they are being hauled by road transports. Hence, the company needs to initiate the Rail network and transports its materials through railways for longer distances.

Security of materials while moving through pipelines: The oil that is transported through pipelines is likely to leak and spill out in the atmosphere. This can cause a number of havocs to the environment. The company is likely to face huge financial loss as well as cases of law. Hence, while moving the oil through pipelines, it is very important to adhere to the safety precautions.

Conclusion

After the detailed study of Prudent Concept in Accounting, it can be said that this is a very important law that needs to be implemented by every firm in order to make their respective organization grow in a better manner. The above assignment has included the different aspects of business of BHP Hamilton and the different areas that help the organization to consider its values of expenses and ignore the extra income that might help it to create some extra reserves for the firm. The importance of implementing and using prudence concept while formulating the Annual Reports has been discussed and the proposed change in the organizational framework has been evaluated. In addition to this, the possible benefits to business due to the proposed updates in the conceptual framework as well as the criticisms that are likely to arise have also been discussed.

References

Beardsworth, R., 2017. Towards a critical concept of the statesperson. Journal of International Political Theory, 13(1), pp.100-121.

Bhp.com, (2017), BHP: About Us. (Accessed on: 16/08/2017) [Retrieved from: https://www.bhp.com/our-approach/our-company/about-us]

Chamberlain, P., 2017. The Wave Narrative. In The Feminist Fourth Wave (pp. 21-44). Springer International Publishing.

Coates, R., 2017. Prudence And Conservatism In Radiation Protection: A Case Study. Radiation protection dosimetry, 173(1-3), pp.100-103.

Denuit, M.M. and Eeckhoudt, L., 2016. Risk aversion, prudence, and asset allocation: a review and some new developments. Theory and Decision, 80(2), pp.227-243.

Kaste, S.C., Metzger, M. and Shulkin, B.L., 2017. Reply: The Need for Prudence When Using 18F-FDG PET as a Reference Standard for Lymphoma Detection. Journal of Nuclear Medicine, 58(8), pp.1355-1355.

Marabel-Romo, J., Guiral, A., Crespo-Espert, J.L., Gonzalo, J.A. and Moon, D., 2017. Fair value accounting in the absence of prudence in accounting standards: an illustration with exotic derivatives. Spanish Journal of Finance and Accounting/Revista Española de Financiación y Contabilidad, 46(2), pp.145-167.

Marshall, A., 2016. Pareto and the missing concept of prudence. Il Pensiero Economico Italiano, 24(2), pp.61-77.

Mutowo, P., Bento, A.P., Dedman, N., Gaulton, A., Hersey, A., Lomax, J. and Overington, J.P., 2016. A drug target slim: using gene ontology and gene ontology annotations to navigate protein-ligand target space in ChEMBL. Journal of biomedical semantics, 7(1), p.59.

Paglietti, P., 2016. Exploring the role of accounting history following the adoption of IFRS in Europe. The case of Italy. De Computis-Revista Española de Historia de la Contabilidad, 6(11), pp.83-115.

Steurer, E., Manatsgruber, D. and Jouégo, E.P., 2016. Risk Clustering as a Finance Concept for Rural Electrification in Sub-Saharan Africa to Attract International Private Investors. Energy Procedia, 93, pp.183-190.

Valentinetti, D., Rea, M.A. and Basile, C., 2016. Differences between national reporting practices and IFRS for SMEs presentation and disclosure requirements: Evidence from Italy. International Journal of Accounting and Financial Reporting, 6(2), pp.146-174.

Vergara, M., 2017. Precautionary saving: A taxonomy of prudence. Economics Letters, 150, pp.18-20.

Viganò, E., 2017. Not just an inferior virtue, nor self-interest: Adam Smith on prudence. Journal of Scottish Philosophy, 15(1), pp.125-143.

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