premise: The prudence rule, which is sometimes known as conservatism, arises out of the need to make a number of estimates in preparing periodic accounts. Managers and owners are often naturally over-optimistic about future events. As a result, there is a tendency to be too confident about the future, and not to be altogether realistic about the organisation s prospects. There may, for example, be undue optimism over the credit-worthiness of new customers. Insufficient allowance may therefore be made for the possibility of bad debt. In turn, this might have the effect of overstating profit.
hypothesis: Accountants should avoid making estimates when preparing periodic accounts.