What are accounting
conventions? Explain important accounting conventions.
The term "conventions"
includes those customs or traditions which guide the accountants while
preparing the accounting statements. The following are the important
Convention of Materiality
Convention of Consistency
Convention of Conservatism
The disclosure of all
significant information is one of the important accounting conventions. It
implies that accounts should be prepared in such a way that all material
information is clearly disclosed to the reader. The term disclosure does not
imply that all information that any one could desire is to be included in
accounting statements. The term only implies that there is to a sufficient
disclosure of information which is of material in trust to proprietors,
present and potential creditors and investors. The idea behind this
convention is that any body who want to study the financial statements
should not be mislead. He should be able to make a free judgment. The
disclosures can be in the way of foot notes. Within the body of financial
statements, in the minutes of meeting of directors etc.
It refers to the relative
importance of an item or even. According to this convention only those
events or items should be recorded which have a significant bearing and
insignificant things should be ignored. This is because otherwise accounting
will be unnecessarily over burden with minute details. There is no formula
in making a distinction between material and immaterial events. It is a
matter of judgment and it is left to the accountant for taking a decision.
It should be noted that an item material for one concern may be immaterial
for another. Similarly, an item material in one year may not be material in
the next year.
This convention means that
accounting practices should remain uncharged from one period to another. For
example, if stock is valued at cost or market price whichever is less; this
principle should be followed year after year. Similarly, if depreciation is
charged on fixed assets according to diminishing balance method, it should
be done year after year. This is necessary for the purpose of comparison.
However, consistency does not mean inflexibility. It does not forbid
introduction of improved accounting techniques. If a change becomes
necessary, the change and its effect should be stated clearly.
This convention means a
caution approach or policy of "play safe". This convention ensures that
uncertainties and risks inherent in business transactions should be given a
proper consideration. If there is a possibility of loss, it should be taken
into account at the earliest. On the other hand, a prospect of profit should
be ignored up to the time it does not materialise. On account of this
reason, the accountants follow the rule 'anticipate no profit but provide
for all possible losses'. On account of this convention, the inventory is
valued 'at cost or market price whichever is less.' The effect of the above
is that in case market price has gone down then provide for the 'anticipated
loss' but if the market price has gone up then ignore the 'anticipated
profits.' Similarly a provision is made for possible bad and doubtful debt
out of current year's profits.
Critics point out that
conservatism to an excess degree will result in the creation of secrets
reserves. This will be quite contrary to the doctrine of disclosure.