Question

List out definitions and different types of accounting conventions.

Answer 1

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:

1. Conservatism:

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.

2. Full Disclosure:

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.

3. Consistency:

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.

4. Materiality:

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.