Accounting Conventions :
The term ‘convention’ denotes custom or tradition or practice based on general agreement between the accounting bodies which guide the accountant while preparing the financial statements. It is a guide to the selection or application of a procedure. In fact financial statements, namely, the profit and loss account and balance sheet are prepared according to the following accounting conventions:
(i) Consistency: The consistency convention implies that the accounting practices should remain the same from one year to another. The results of different years will be comparable only when accounting rules are continuously adhered to from year to year. For example, the principle of valuing stock at cost or market price whichever is lower should be followed year after year to get comparable results. Similarly, if depreciation is charged on fixed assets according to diminishing balance method, it should be done year after year. The rationale behind this principle is that frequent changes in accounting treatment would make the financial statements unreliable to the persons who use them.
The consistency convention does not mean that a particular method of accounting once adopted can never be changed. When an accounting change is desirable, it should be fully disclosed in the financial statements along with its effect in terms of rupee amounts on the reported income and financial position of the year in which the change is made.
(ii) Disclosure: Apart from statutory requirements good accounting practice also demands all significant information should be fully and fairly disclosed in the financial statements. All information which is of material interest to proprietors, creditors and investors should be disclosed in accounting statements. This convention is gaining more importance because most of big business units are in the form of joint stock companies where ownership is divorced from management. The Companies Act makes ample provisions for disclosure of essential information so that there is no chance of any material information being left out.
(iii) Conservatism: Financial statements are usually drawn up on a conservative basis. There are two principles which stem directly from conservatism.
(a) The accountant should not anticipate income and should provide for all possible losses, and
(b) Faced with the choice between two methods of valuing an asset the accountant should choose a method which leads to the lesser value.
Examples:
– Making provisions for bad debts in respect of doubtful debts.
– Amortizing intangible assets like, goodwill, patents, trade marks, etc. as early as possible.
– Valuing the stock in hand at lower of cost or market value.
(iv) Materiality: According to the convention of materiality, accountants should report only what is material and ignore insignificant details while preparing the final accounts. The decision whether the transaction is material or not should be made by the accountant on the basis of professional experience and judgment.
An item may be material for one purpose while immaterial for another. For the items appearing in the profit and loss account, materiality should be judged in relation to the profits shown by the profit and loss account. And for the items appearing in the balance sheet, materiality may be judged in relation to the groups to which the assets or liabilities belong e.g. for any item of current liabilities, it should be judged in relation to the total current liabilities.