4 Major Accounting Conventions
Accounting conventions were established with a motive to bring uniformity in the books of accounts at the time of preparing them. Conventions are like customs/traditions that help the accountant to communicate clear accounting picture. In other words, accounting convention sets the guideline for the accountant that in turn helps him/her to prepare accounting statements and reports. Now lets us see the important accounting conventions:
As per the Conservatism convention at the time of recording any financial transaction, you should recognize no profit but provide for all possible losses. This is the most important convention as it depends upon the theory that the future is uncertain. For instance, the value of inventory is recorded at cost or market price whichever is less. In a similar way, the provision for doubtful debts is also created. However, conservatism impacts current assets and liabilities.
Nowadays the conservatism convention is being criticized as it conflicts with full disclosure convention. As through this convention, there are possibilities that an accountant may create secret reserves such as depreciation provisions. And due to this, the financial statements do not show a true and fair view of a business.
Convention of Full Disclosure
Full disclosure convention helps the user in the proper interpretation of the financial statements of the company. As per this convention at the time of preparing records, full disclosure of financial information shall be made by the accountant.
Full disclosure can be made in two ways:
- Either in the body of the financial statements, or
- In notes accompanying such financial statements
However, in case if there are any financial events that occur between the balance sheet preparation date and its publication. Then in such a case, the relevant information about such event shall also be disclosed.
In a nutshell, full disclosure of every single accounting record is a need so as to make such record helpful. So through this, we can conclude that the convention of full disclosure is a very significant convention.
According to the convention of consistency once the company has decided to follow a method of accounting then it shall consistently follow the same method throughout. Along with this, changing the accounting method often would make the comparison of its own financial statements of different period difficult for the company.
Moreover, the convention of consistency helps the management to analyze the financial statement of different periods and ensure that corrective decisions are taken, if needed. However, if a change is necessary for the accounting method then there shall be a sound reason for such change.
Through the above statements, we can conclude that consistency convention helps in
- Promoting accuracy
- Enhancing comparability
- Decision making
Moreover, it does not bar any accounting method change but if there is any change, then such change shall be disclosed in the financial statements.
Accounting Convention of Materiality
As per the accounting convention of materiality, an item is material if it can influence the decision of users of the financial statements. This convention is related to the significant importance of any event or item. Moreover, the materiality of an item depends on its amount and an events materiality depends upon its nature.
The materiality convention enables the users to ignore all such events or items that are not relevant or material. For instance, most companies publish their financial statements in round figures and do not include paise. Such omission is irrelevant or immaterial when figures are in crores or lakhs.
Therefore we can conclude that all relevant information should be disclosed as per the convention of materiality that may help the user to understand the financial statements clearly.