How might differences in the extent to which countries apply the accounting concept of conservatism (some countries are more conservative than others) affect profit margins, debt-to-equity ratios, and returns on equity

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31 August, 11:04

How might differences in the extent to which countries apply the accounting concept of conservatism (some countries are more conservative than others) affect profit margins, debt-to-equity ratios, and returns on equity

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Madeline Morales · Answer 1

Conservatism in Accounting refers to the policy of being more pessimistic than optimistic. This policy believes that future losses should be anticipated over future gains as future losses are more damaging and probable. It is essentially 'Playing Safe' Accounting. This leads to Income and Assets being understated and Expenses and Liabilities being overstated.

Profit Margins.

As the policy allows for the anticipation and recognition of expenses more than gains, Profit margins will be lower in this type of accounting as Revenue will be less but Expenses will be more.

Debt-to-Equity Ratios

Debt to Equity ratios will be higher because this policy calls for a speedier recognition of Liabilities as well. With the formula for Debt to Equity being Debt over Equity, a larger recognition of debt will mean this equation will yield higher figures. Also a component of Equity is Retained Earnings which comes from Net income and as already stated, this will be less under this policy thus decreasing the denominator of this equation as well.

Returns on Equity.

Return on Equity is calculated by dividing the Net Income by Equity. This figure will be smaller but not by much because this policy as already shown will reduce the both the Net income and the Equity but the Net Income will likely suffer a greater hit than Equity.