Conservatism Q

CFA Level I
#1

Which of the following actions would be least likely to be viewed as conservative? a Company increases its estimated provision for bad debts b Company uses FIFO inventory method when inventory prices are declining c Company discloses contingency losses in the footnotes to the financial statements d Company uses the completed contract method for recognising revenue for long term contracts

#2

C?

#3

C

#4

yeah its C, but i thought tossing between disclosing and not disclosing the contingency meant that disclosing the contingency is more conservative…

#5

Could someone give an explanation please?

#6

you can get to the answer **** in 20/20 hindsight **** by elimination. Accounting for bad debt – is conservative. Using FIFO in a period of falling prices means COGS would be higher, so you are reporting less income --> conservative. Completed contract – is conservative because you do not book any profits till project is done. Based on that C would be the choice to go with – because question asks for Least Likely.

#7

cpk123, I would put good $ on you passing this weekend.

#8

cpk123 Wrote: ------------------------------------------------------- > you can get to the answer **** in 20/20 hindsight > **** > by elimination. > > Accounting for bad debt – is conservative. > > Using FIFO in a period of falling prices means > COGS would be higher, so you are reporting less > income --> conservative. > > Completed contract – is conservative because you > do not book any profits till project is done. > > Based on that C would be the choice to go with – > because question asks for Least Likely. So the rule of thumb for conservatism is to overstate liabilities, expenses and understate assets, revenues when faced with uncertainty? But wouldn’t a contingent loss reduce income as well?

#9

Contingent as the name suggests is not confirmed. It could be a pending lawsuit which would not affect ur FS.

#10

I guess the conservative thing to do would be to recognize the contingent liabilities on the FS (rather than just the footnotes). (They are recognized on the FS only when they are reasonably likely and you can estimate the liability)