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Conservative Bias - benefits

Hi all, 

(I have checked and did not find a post on this topic)

How should I understand one of the benefits of conservative bias as

“…in protecting the interests of those who have less complete information than company management, such as buyers of the company’s debt.”?

(Page 284, bottom of the KAPLAN Schweser notes, Book - Financial Reporting version 2019).

Thanks heaps!

Hugo

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xiaoke20009, are you referring to conservatism bias? It’s a level III topic within behavioral finance and it’s not tested in level I. You don’t need to worry about that for Lvl I. It refers to a bias where someone is not open to adjusting prior beliefs after having received new market information. For example you initially believe that diet soft drinks do not make you fat. New evidence is presented that ties diet drink ingredients to weight gain. However you have conservatism bias and you do not want to weigh the new information, therefore you still believe that diet soft drinks do not contribute to making people fat. 

Analyst0718 wrote:
xiaoke20009, are you referring to conservatism bias?

No.

He’s referring to a conservative bias in accounting methods: recognizing less net income today but (likely) more net income in the future.

Simplify the complicated side; don't complify the simplicated side.

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xiaoke20009 wrote:
Hi all,

Howdy.

xiaoke20009 wrote:
(I have checked and did not find a post on this topic)

That makes you rare amongst posters here.  And all the more welcome.

xiaoke20009 wrote:
How should I understand one of the benefits of conservative bias as

“…in protecting the interests of those who have less complete information than company management, such as buyers of the company’s debt.”?

(Page 284, bottom of the KAPLAN Schweser notes, Book - Financial Reporting version 2019).

A conservative bias recognizes less net income in the current period (using methods that recognize revenues late or expenses early) and, likely, more net income in future periods.  If current (actual) earnings are higher than reported, there is a built-in cushion for providers of capital, such as bondholders.

xiaoke20009 wrote:
Thanks heaps!

My pleasure.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

Hello S2000magician

Thanks for your detailed explanations. I now fully understand the concept. 

Sorry for the late response. Was busy going through notes materials and failed to log in for a couple of times for some reason. 

Upon completion of round one reading (expected date 1st Sep) I will come back to the site more often:)

Have a good evening!

Hi Analyst0718 - thanks for your help and the magician was right - I was referring to the bias in relation to being conservative about the current year earnings:)

You are welcome.  Understood.  :)