An example of where the prudence assumption leads to a reduction in the valuation of an asset is:
A) valuing inventory at the lower of cost and net realisable value.
B) taking an upward revaluation of an asset to a reserve rather than including it in the profit calculation.
C) development expenditure capitalised as an asset rather than written off as an expense.
D) All are examples.

Question

Quizplus · Accepted Answer

The prudence assumption requires that assets should not be overstated and liabilities should not be understated. Valuing inventory at the lower of cost and net realisable value is a way to ensure that the inventory is not overstated on the balance sheet, therefore reducing its valuation. Options B and C are not examples of the prudence assumption leading to a reduction in valuation of an asset, as taking an upward revaluation of an asset to a reserve and capitalising development expenditure are both ways to increase the valuation of assets. Therefore, D is also not the correct answer.

An Example of Where the Prudence Assumption Leads to a Reduction