What are Accounting Conventions?
Accounting conventions are ‘general rules of practice’ formulated out of customs, usages and traditions as guiding principles for accounting. The accounting follows these rules on a conviction that the accounting practices should be consistent, the financial statements should be prepared on a conservative basis to mitigate the risk of loss and the vital information relating to accounting should be disclosed.
Below are the accounting conventions.
1. Conventions of consistency
This convention affirms that a business unit should be consistent in its accounting practices so that the users of information are able to make comparison of accounting statements over a period or between different enterprises. This consistency should b the nature of general acceptability. That means, accounting practices should remain unchanged unless the change is necessarily warranted. However, consistency does not prevent the introduction of innovative methods of accounting. But it is essential that such a change is incorporated and its effect clearly stated so that the decision-makers are not misled. For example, there is a change in the depreciation policy, i.e., from the straight-line method to the diminishing balance method. this aspect should be clearly disclosed along with financial statements.
2. Convention of Conservatism
Generally, financial statements are drawn on the convention of conservatism following the maxim ‘anticipate no profit but provide for all possible losses’. This practice prevents accountants to prepare financial statements with ‘prejudice using personal judgment’. Window dressing is not permitted according to this convention. For example, the general practice followed to value stock is, ‘cost or market price whichever is lower’. Suppose, the accountant has been valuing the stock consistently at cost price only without taking the lower market price into consideration, then the accountant has not followed the principle of conservatism, which is completely against this convention.
3. Convention of material disclosure
Material disclosure means, ‘the disclosure of vital information’ relating to the preparation of financial statements. What is material or significant information depends on the circumstances and discretion of the accountant. Discretion does not mean personal judgment but judgment based on facts. This does not also mean that every minute detail should be provided. It means the accountant should use his/her discretion only to distinguish between significant and insignificant information and disclose all significant information in the form of footnotes, references, using parentheses, etc., so that the financial statements are understood properly by users. For example, in addition to the asset values, the mode of valuation should also be stated. If there is any change in the accounting policy between the previous years and the current year, it should be stated in the footnote.
Thus, GAAP, acts as the basic tenets to be followed in accounting to provide quality and user-friendly information.