What is Accounting Conventions?
As the name suggests, Accounting Convention is a practice adopted by an entity based on a general agreement between the accounting agencies and assisting the accountant during the preparation of the Company’s financial statements.
To improve the quality of financial information, international financial institutions may alter or modify any accounting conventions. The following essential accounting conventions are presented below:
- Convention of Consistency: The financial statements can only be matched if the company consistently follows the accounting policies during the period. However, modifications can be carried out in exceptional circumstances.
- Convention of Disclosure: This policy states that the financial statements should be qualified to disclose all relevant information to users to assist them in making informed decisions.
- Conservatism: The conference says the firm should not expect income and profit but provide for all costs and losses.
- Important: The concept of accounting conventions differ from the specific disclosure conventions which state that only those disclosed in the financial statements have a significant economic impact.
Four major accounting conventions
Accounting Conventions were instituted to bring similarities to the books of account during the preparation period. Arrangements are similar to the customs/traditions that help the auditor articulate a clear accounting picture. In other words, the accounting conventions set out an accountant’s guide, which assists him in preparing statements and reports. Now let’s look at the essential accounting conventions:
Consent of Conservatism
According to Conservatism Conventions, you should not only allocate profit against any financial transaction but also allocate the possible losses. Conservatism is a crucial convention as it is based on the premise that the future is uncertain. For example, inventory value is recorded at cost or a market price any less. In the same way, the provision of questionable loans is also being developed.
Convention of disclosure
The entire disclosure agreement assists the user to interpret the company’s financial statements correctly. According to the conventions, during the preparation of the records, the accountant is required to fully disclose the financial information.
The entire disclosure can be made in two ways:
- In the body of the financial statements
- Notes accompanying such financial statements.
However, in the event of a financial incident occurring between the date of preparation of the balance and its publication. In such a case, the relevant details of the event will also be disclosed.
When a company decides to follow a particular accounting method, it must always follow the same procedure everywhere. In line with this, changing the accounting system can often make comparisons of different financial statements difficult for an entity.
In addition, consolidation helps managers analyze the financial statements for the various periods and ensure that adjustment decisions are made, if necessary.
Hence, we can conclude that the consistency convention is helpful in promoting accuracy, improves comparisons, and decision making. The accounting conventions do not include inconsistencies, wrong calculations, other accounting mistakes, etc.
In addition, it does not prevent any changes in accounting, but if there is a change, that change will be disclosed in the financial statements.
Financial Reporting Agreement
As a rule of thumb for accounting materiality convention, an item is essential to influence users’ decisions of financial statements. This convention is related to the great importance of any event or object. In addition, the inclination of an object depends on its size, and the availability of events depends on its nature.
The convention of materiality enables users to disregard all events that are incompatible or immaterial objects. For example, many companies publish their financial statements in circular figures and omit paise, and such omissions are insignificant or insignificant when the figures are in crores or lakhs.
Therefore, we can conclude that all relevant information should be disclosed regarding factors that can help the user better understand financial statements.
Accounting conventions with examples
If the company created a plant worth Rs 250,000, 10 years ago, it should remain the same book value today.
The company’s revenue is recorded after a reasonable certainty exists for the receipt, while costs, losses, and contingent liabilities are recorded as soon as they occur. It also includes convention of materiality example.
- Reliability: Financial statements prepared according to accounting conventions and accounting standards are considered reliable and very accurate. The following methods present the relevant details, and it increases investor confidence.
- Planning and Resolution: Provides sufficient information regarding financial data.
- Accessible to Compare: Convention of accounting ensures that most companies report transactions in the same way as described. Thus it makes it easier for investors, lenders, and analysts to compare the performance of companies.
- Efficiency: Accounting standards and provide efficiency in the reporting process, making it easier for the auditor.
- Management Decisions: It helps managers make some critical decisions that affect the business. For example, the concept of prudence ensures that revenue is recorded when available, but liabilities and expenses are recorded as soon as they occur.
- Minimize Fraud: They are the guidelines for a particular business transaction, fully defined by monetary values. While not legally binding, conventions of accounting make sure that the financial statements provide the correct information in a certain way.
- Uncertainty: Many accounting conventions do not fully define concepts or transactions recorded in the financial statements. Thus, it makes it easier for managers to apply specific accounting calculations.
Accounting Conventions are designed to address the problem of specific activities through guidelines, which are not adequately addressed by financial standards. These conventions help many companies while accurately reporting their financial data. At the same time, it ensures that the financial statements have all the necessary information for the benefit of investors.