Accounting conventions are standards, customs or guidelines associated with the practical application of accounting principles, and are aimed at bringing about consistency in the maintenance of accounts. Accounting conventions are generally accepted principles and are not considered legally binding. Here are some common accounting conventions along with examples:
Conservatism Convention: This convention suggests that accountants should be cautious and conservative when recording transactions and estimating values. It encourages the recognition of potential losses as soon as they are anticipated, but only recognizing gains when they are realized.
Example: A company estimates that a certain percentage of its accounts receivable may become uncollectible due to customer credit risk. To apply the conservatism convention, the company records an allowance for doubtful accounts to reflect the potential loss in value.
Consistency Convention: This convention requires that accounting methods and practices used by an entity should be consistent from one period to another. Changes in accounting policies should only be made if required by new accounting standards or if they lead to a more accurate presentation of financial information.
Example: A company consistently uses the straight-line depreciation method for all its assets in one reporting period and continues to use the same method in subsequent periods, maintaining consistency.
Full Disclosure Convention: This convention mandates that all relevant information and details about an entity’s financial position and performance should be disclosed in the financial statements or accompanying notes. This ensures transparency and helps users of financial statements make informed decisions.
Example: In the notes to the financial statements, a company provides detailed information about its significant accounting policies, contingent liabilities, related-party transactions, and other material events.
Historical Cost Convention: Under this convention, assets and liabilities are initially recorded at their historical cost (original transaction price) rather than their current market value. This provides a verifiable and objective basis for recording transactions.
Example: A company purchases a piece of machinery for Rs10,000. Under the historical cost convention, the machinery would be recorded on the balance sheet at its original cost of $10,000.
Materiality Convention: This convention suggests that only information that is significant and has the potential to influence decision-making needs to be included in the financial statements. Immaterial information can be omitted to avoid cluttering the financial statements.
Example: A company has a large number of office supplies with low individual values. Instead of listing each individual item, the company aggregates the total value of office supplies under a single line item in the balance sheet.
Objectivity Convention: This convention emphasizes the use of objective and reliable evidence to support financial transactions and events. It encourages accountants to rely on verifiable data and avoid personal opinions or estimates.
Example: A company records sales revenue only when a sales transaction is supported by a sales invoice and delivery confirmation, ensuring that there is objective evidence of the sale.
