The correct answer is: C. understatement of assets.
The convention of conservatism is a principle of accounting that states that assets and income should be conservatively stated, while liabilities and expenses should be conservatively stated. This means that assets should be recorded at their lower of cost or market value, and liabilities should be recorded at their estimated amount.
The convention of conservatism is based on the idea that it is better to err on the side of caution when reporting financial information. This is because investors and creditors are more likely to be harmed if a company’s financial statements are overstated than if they are understated.
Understating assets can help to protect investors and creditors from losses. This is because if a company’s assets are understated, then its liabilities will also be understated. This means that the company’s net worth will be lower, which will reduce the amount of money that investors and creditors can lose if the company goes bankrupt.
The convention of conservatism is not without its critics. Some people argue that it can lead to companies understating their assets and income, which can make it difficult for investors and creditors to get an accurate picture of a company’s financial health. However, the convention of conservatism is still widely used in accounting, and it is likely to continue to be used in the future.
Here is a brief explanation of each option:
- A. Overstatement of assets: This would not be in line with the convention of conservatism, which states that assets should be conservatively stated.
- B. Overstatement of liabilities: This would also not be in line with the convention of conservatism, which states that liabilities should be conservatively stated.
- C. Understatement of assets: This is the correct answer, as it is in line with the convention of conservatism.
- D. Understatement of liabilities: This would not be in line with the convention of conservatism, which states that liabilities should be conservatively stated.