China Accounting System

In accounting literature, the notion of conservatism is to employ a less optimistic attitude towards handling accounting transactions or events when varied alternatives are present. The basic implication of the convention was traditionally to anticipate not profits but all losses. Therefore, a series of accounting procedures based on conservatism have been developed to account for provisional expenses and potential losses in accounting practice, such as allowances for doubtful accounts, reserves or provisions for inventory price-drops, lower of cost or market (LCM) for inventory valuation, accelerated depreciation, write-off of research and development expenditures, and so on. A widely accepted merit of the convention is thus to avoid an overstatement of assets or income in the financial statements or to provide a buffer for potential losses that may possibly occur in business operations with inherent uncertainty or risks. Overstatement in financial position or operating results led to business failures eventually and caused substantial losses to investors, creditors and other users. Responding to criticisms from the beneficiaries of financial statements, a conservative attitude emerged in practice and led to the conservatism accounting convention that has been widely accepted by accounting profession and business community since the 1930s.
The conservatism convention is, however, not without flaw. The main limitations of this convention are as follows. First, there is a lack of objective criteria for its application. Abuses are not uncommon and might be difficult to prevent. For instance, some firms may manipulate accounting numbers through arbitrary and inconsistent determination of allowances or provisions for potential losses, resulting in incomparability of accounting numbers over different periods within a firm or among different companies. Second, the traditional practices of conservative accounting would anticipate only the potential expenses or losses and