In this post, we’ll go through accounting conventions in-depth, including their explanation, five key conventions, and much more.
What is Accounting Convention?
Accounting convention is the practice of accounting that ensures the proper conduct of accounting functions and the accurate, simple, fluent, and meaningful presentation of financial statements (income statement and financial position) and their information to interested parties.
Accounting conventions have long served as a guide for preparing financial statements that are consistent with socioeconomic norms.
They may have options, but they do not implement them because of time, cost, habits, and practical benefits.
Accounting conventions have evolved through time and are subject to change when financial conditions change.
Accounting conventions are not recognized by international law. It is entirely dependent on the country’s political, social, and economic circumstances. It is impossible to determine why it is used.
What are the 5 Important Accounting Conventions?
The 5 important accounting conventions are as follows:
Convention of Conservatism
In accounting, conservatism is a defensive principle. There’s an adage that says you should think about loss first and profit second.
The real meaning is that it is preferable to make a profit, but it is necessary to look first to ensure that no losses occur.
According to this principle, in order to assess profit, you must be conservative, i.e., assume no profit and account for all possible losses.
It suggests that if there is a chance of loss in the future, a provision should be made, but anticipated profit should not be considered until it is achieved.
The accountant carefully examines the income and expenditure of the year when preparing a detailed income statement at the end of the year.
When reviewing the expenditure categories, the accountant looks to see if any year-end expenses have been ignored.
When auditing income, on the other hand, he keeps a close eye on whether there is any income in the year in which the income was taken that is not supposed to come in this year.
In other words, if any income is deducted during account preparation, it will not be a problem, but if any expenses are deducted, it will be a problem.
For example, due to the conservative policy, when valuing a closing stock product, the lower price between the purchase price and the market price is taken into account, and bad debt reserves are created on the debtor to protect against possible losses.
Convention of Consistency
Accounting is a practical science. As a result, in order to maintain proper accounting, the practical principles of different eras must be consistent.
Every year, according to this principle, businesses make and maintain the books of accounts using the same process. This is due to inter-organizational and year-to-year comparisons and analyses.
Otherwise, it is impossible to obtain the true financial picture of the businesses.
Exceptions to this rule will not be consistent with the results of one year’s business and the results of the following year’s business.
It is necessary to follow this policy when it comes to accounting. However, it is frequently necessary to change policy in order to improve business policy.
For example, for the past few years, a company has followed the FIFO (First in First out) policy when regarding the issue of goods. However, if the LIFO (Last in First out) policy is preferable due to the needs of the business or the nature of the goods, the consistency policy is altered.
In all of these cases, businesses present the policy change’s results in the financial statements.
The consistency convention aids in the accuracy of financial accounts and assists management and accounting users in making good judgments.
Convention of Materiality
In accounting, the materiality principle is very important. When recording all business information, it’s important to double-check the materiality of this information.
If a piece of information has no effect on the decisions of accounting users, it isn’t deemed material.
The accountant’s expertise, experience, and intellect are used to record transactions under this principle.
At the time of documenting the transaction, the accountant examines the transaction’s materiality or immateriality.
For example, stationery items such as calculators, office files, staple machines, and punch machines are purchased for long-term use in business, but because of their low cost, they are not treated as assets, and the cost is not distributed over the useful life; instead, they are treated as expenses for the year and shown in the comprehensive income statement.
The policies and procedures a business entity will use to prepare accounting and financial statements and how it will present accounting data are determined by the policies and methods used by other businesses in the industry to prepare and present accounting and financial statements.
It allows for the comparison of judgments made by different business organizations in the same industry.
Accounting depends on what information a business provides or what information it stores and maintains. The cost of creating and storing data is related to the benefits of that information.
Suppose the benefits derived from such information outweigh the costs of storing and compiling the data. In that case, all that information is created and stored in accounting.
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