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The term
'accounting conventions' includes those customs or traditions
which guide the accountant while communicating the
accounting information. Important
accounting conventions are:
- Conservatism
convention
- Full
disclosure
- consistency
- Materiality
These accounting conventions are explained below:
According to this
convention, accounts follow the rule "anticipate no
profit but provide for all possible losses", while
recording business transactions. In other words, the
Accountant follows the policy of "playing safe". On
account of this convention, the inventory is valued
at cost or market price whichever is less! Similarly
a provision is made for possible bad and doubtful
debts out of current year's profits. This concept
affects principally the category of current assets.
The convention of
conservation has been criticized these days as it
goes against the convention of full disclosure. It
encourages the accountant to create secret reserves
(e.g. by creating excess provision for bad and
doubtful debts, depreciation etc.), and the
financial statements do not show a true and fair
view of state of affairs of the business.
According to this
convention the users of financial statements
(proprietors, creditors and investors) are informed
of any facts necessary for the proper interpretation
of the statements. Full disclosure may be made
either in the body of financial statements, or in
notes accompanying the statements. Significant
financial events occurring after the balance sheet
date, but before the financial statements have been
issued to outsiders require full disclosure.
The practice of
appending notes to the financial statements (such as
about contingent liabilities or market value, of
investments or law suits against the company is in
pursuant to the convention of full disclosure.
This convention
states that once an entity has decided on one
method, it should use the same method for all
subsequent events of the same character unless it
has a sound reason to change methods. If an entity
made frequent changes in the manner of handling a
given class of events in the accounting records,
comparison of its financial statements for one
period with those of another period would be
difficult.
Consistency, as
used here, has a narrow meaning. It refers only to
consistency over time, not to logical consistency at
a given moment of time. For example fixed assets are
recorded at cost, but inventories are recorded at
the lower of their cost or market value. Some people
argue that this is inconsistent. Whatever the
logical merits of this argument, it does not involve
the accounting concept of consistency. This
convention does not mean that the treatment of
different categories of transactions must be
consistent with one another but only that
transactions in a given category must be treated
consistently from one accounting period to the next.
The term
materiality refers to the relative importance of an
item or an event. An item is "material" if knowledge
of the item might reasonably influence the decisions
of users of financial statements. Accountants must
be sure that all material items are properly
reported in the financial statement.
However, the
financial reporting process should be cost-effective
- that is, the value of the information should
exceed the cost of its preparation. In short, the
convention of materiality allows accountants to
ignore other accounting principles with respect to
items that are not material. An example of the
materiality convention is found in the manner in
which most companies account for low-cost plant
assets, such as pencil sharpness or wastebaskets.
Although the matching concept calls for depreciating
plant assets over their useful life, these low-cost
items usually are charged immediately to an expense
account the resulting "distortion" in the financial
statement is too small to be of any importance. |
