Some Informational Aspects of Conservatism

When two value estimates are about equally likely, conservatism dictates reporting the less optimistic one (e.g. Lower of Cost or Market). We use an analytical model to investigate informational implications of this dictum, and identify types of environments where the conservative accounting treatment is more informative than a predetermined choice. The bias induced by the conservative choice is found to be adequately moderate, never excessive. It benefits users of the financial statements that take the reported figures at face value whenever upside errors are more costly (possibly only slightly more costly) than similar downside errors. Sophisticated users, who know how to give the reports the best possible interpretation, benefit from the lower variability, not from the bias. These latter benefits are least ambiguous when upside errors and downside errors are about equally costly.