Accounting Convention - Explained
What is an Accounting Convention?
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Table of ContentsWhat is an Accounting Convention?How are Accounting Conventions Used?Types of Accounting ConventionsImportance of Accounting Conventions
What is an Accounting Convention?
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. These principles assist businesses in establishing procedures to record business transactions that have not yet been fully addressed by accounting standards.
Back to: ACCOUNTING, TAX, & REPORTING
How are Accounting Conventions Used?
Accounting conventions are vital to the accounting profession, since they bring about uniformity in the process of recording transactions by multiple organizations. Such uniformity makes it possible to reliably compare the financial results, financial position, and cash flows of different organizations.Accounting conventions typically support concepts such as relevance, reliability, materiality and comparability, which goes a long way in helping to standardize the financial reporting process.
Types of Accounting Conventions
Accounting conventions can be classified into four main types; they are:
- The Convention of Disclosure: The convention of disclosure advocates the full disclosure of all material information, whether favorable or otherwise, in the accounting statements of a business enterprise. This convention mandates that all relevant information pertaining to financial position as well as the results of operations, that is deemed to be of material value to proprietors, creditors and debtors must be disclosed, and that all accounting statements must be prepared honestly. The convention of disclosure holds greater importance in the case of businesses where the ownership is separate from the management. Material events that can significantly affect a business include bad debts, destruction of plant or machinery, etc.
- The Convention of Consistency: This convention advocates the continuous observation and application of the rules and practices of accounting. The uniformity and consistency of accounting rules is vital to profit and loss calculations as well as comparisons of company performance. Frequent changes in the treatment of accounts will, most definitely, make such accounts inconsistent, and hence, less reliable. In other words, for accounting information to be accepted as reliable, it must be truthful, accurate and complete.
- The Convention of Conservatism: The convention of conservatism essentially anticipates an uncertain future and as such, regards profit improbable while providing for all possible losses. In other words, for every two available values of a transaction, the convention of conservatism records the lower value. As such, application of these principles almost always results in an understatement of resources and income.
- The Convention of Materiality: The convention of materiality advocates the recording of all material facts, while eliminating insignificant information. Material facts are those pieces of information that can potentially influence the decision of informed investor. Although theoretically all information should be treated alike, the convention of materiality places great emphasis on the economic significance of an item as a determinant of its importance in accounting. It should be noted that any item deemed material by a business can be treated as unimportant by another business. In the same way, an item that is considered material during a particular period may be treated as unimportant in subsequent periods of time.
Importance of Accounting Conventions
Over the years, accounting conventions have successfully addressed the shortcomings of established accounting standards by helping govern specific situations for which there exists no specific guidelines in the accounting standards. Accounting conventions are an important component of the accounting process since they offer an accurate and reliable means of comparing financial performance from industry to industry as well as from year to year. Several businesses corresponding to different industries have utilized accounting conventions to regulate the preparation of quarterly balance sheets, income statements, and annual reports.