Accounting Convention

Accounting Conventions:

Conventions in accounting have been evolved and developed to bring about uniformity in the maintenance of accounts. Conventions denote customs or traditions or usages which are in use since long.

To be clear, these are nothing but unwritten laws. The accountants have to adopt the usage or customs, which are used as a guide in the preparation of accounting reports and statements.

Following are the important accounting conventions in use:

1. CONVENTION OF DISCLOSURE

This convention requires that accounting statements should be honestly prepared and all significant information should be disclosed therein. That is, while making accountancy records, care should be taken to disclose all material information. Here the emphasis is only on material information and not on immaterial information.

This convention assumes greater importance in respect of corporate organisations where the management is divorced from ownership. That is why forms of Balance Sheet and Profit and Loss accounts are prescribed in Schedule VI of the Companies Act, 1956; so that significant information may not be left out to be disclosed.

The purpose of this convention is to communicate all material and relevant facts of financial position and the results of operations, which have material interests to proprietor, creditors and investors.Sometimes, there may be time gap between the preparation of Balance Sheet and its publication and if there are material events — bad debts, destruction of plant or machinery etc., which occurred in the time gap, may also be known to users proprietors, creditors etc.:

2.Convention of Consistency:

In short, full disclosure of all relevant facts in accounts is a necessity in order to make accounting record useful. Therefore, full disclosure is a very healthy convention, and is important.2. Convention of Consistency:

Rules and practices of accounting should be continuously observed and applied. In order to enable the management to draw conclusions about the operation of a company over a number of years, it is essential that the practices and methods of accounting remain unchanged from one period to another. Comparisons are possible only if a consistent policy of accounting is followed.

If there are frequent changes in the treatment of accounts there is little or no scope for reliability. Comparison of accounting period with that in the past is possible only when the convention of consistency is adhered to.
According to Anthony, “the consistency requires that once a company had decided on one method, it will treat all subsequent events of the same character in the same fashion unless it has a sound “reason to do otherwise.”

This convention plays its role particularly when alternative accounting practice is equally acceptable. Moreover, consistency serves to eliminate personal bias. But if a change becomes desirable, the change and its effect should be clearly stated in the financial statements. Accounts should lend themselves easily to comparisons and contrasts.

This convention increases accuracy and comparability of accounting information for prediction or decision making. This convention does not prohibit changes. If there is any change, its effect should be clearly stated in the financial statements.

3. CONVENTION OF CONSERVATISM

“Anticipate no profit and provide for all possible losses” is the essence of this convention. Future is uncertain. Fluctuations and uncertainties are not uncommon. Conservatism refers to the policy of choosing the procedure that leads to understatement as against overstatement of resources and income.

“Anticipate no profit and provide for all possible losses” is the essence of this convention. Future is uncertain. Fluctuations and uncertainties are not uncommon. Conservatism refers to the policy of choosing the procedure that leads to understatement as against overstatement of resources and income.

The consequences of an error of understatement are likely to be less serious than that of an error of overstatement. For example, closing stock is valued at cost or market price whichever is lower. This is a convention of caution or playing safe and is adhered to while preparing financial statements. Showing a position better than what it is, is not permitted. Moreover, it is not proper to show a position substantially worse than what it is.

Following are the examples:

(a) The value of an asset should not be overestimated.

(b) The value of a liability should not be underestimated.

(c) The profit should not be overestimated.

(d) The loss should not be underestimated.

Such conservatism is generally accepted to present a true and fair value of business in the financial statements.

4. CONVENTION OF MATERIALITY

American Accounting Association defines the term materiality as “An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investor.” It refers to the relative importance of an item or event. Materiality of an item depends on its amount and its nature.

Theoretically, all items, large or small, should be treated alike. Materiality convention implies that the economic significance of an item will to some extent affect its accounting treatment.

Materiality in its essence is of relative significance. In the sense that some of the unimportant items are either left out or included with other items.

For instance, acquisition of items like fountain pen, stapler, pin cushion, punching machine etc., can be treated as part of assets, when considering their durability and span of life. But, it is not necessary to maintain separate ledgers. Such low cost items can be treated as expense for the period.

Therefore, unimportant items are either left out or merged with other items. The reason for this different treatment lies in the magnitude of their amount. The dividing line between material and immaterial varies according to the company, the circumstances of the transactions and economic significance. It should also be noted that an item considered to be material for one business firm, may be immaterial for another firm.

Similarly, an item of material in a year may not be material in the subsequent years. Similarly, most of the companies publish their financial statements in whole rupees round figures, by ignoring paise.

Omission of paise is immaterial, i.e., insignificant when figures appear in lakhs. In short, all material information should be disclosed that is necessary to make the financial statements clear and understandable.. These conventions are also known as doctrine.