Welcome back! Remember our theoretical framework from our first session? Today we're exploring another key principle: conservatism.

Conservatism guides accountants when facing uncertainty. It says: when in doubt, choose the option that's less likely to overstate assets or income.

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Why might being cautious with uncertain estimates protect investors?

Think of conservatism as accounting's built-in safety margin. When estimating asset values or future cash flows, accountants lean toward being slightly pessimistic rather than overly optimistic.

This isn't about being negative - it's about managing the risk of misleading stakeholders.

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Can you think of a situation where overestimating income could harm investors?

Here's conservatism in action: if your inventory could be worth $100,000 or $80,000 (market uncertainty), conservatism says record it at $80,000.

This "lower of cost or market" approach prevents overstating assets when future values are questionable.

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How does this protect lenders who rely on asset values for loan decisions?

Conservatism also affects expense recognition. When facing uncertainty about future costs, accountants tend to recognize expenses sooner rather than later.

For example: estimate higher warranty costs rather than lower ones, recognizing the expense earlier to avoid future surprises.

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How does early expense recognition connect to our matching principle from last time?

But conservatism isn't about being unreasonably pessimistic. The goal is balanced caution - protecting against overstatement while still providing reasonably accurate information.

Too much conservatism creates its own bias, understating true performance and misleading users in the opposite direction.

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