ACCOUNTING CONVENTIONS

ACCOUNTING CONVENTIONS
1. Convention of Materiality. Materiality concept states that items
of small significance need not be given strict theoretically correct treatment.
Infact, there are many events in business which are insignificant in
nature. The cost of recording and showing in financial statement such events
may not be well justified by the utility derived from that information. For
example, an ordinary calculator costing Rs. 100 may last for ten years.
However, the effort involved in allocating its cost over the ten year period
is not worth the benefit that can be derived from this operation. The cost
incurred on calculator may be treated as the expense of the period in which
it is purchased. Similarly, when a statement of outstanding debtors is prepared
for sending to top management, figures may be rounded to the nearest
ten or hundred
This convention will unnecessarily overburden an accountant with
more details in case he is unable to find an objective distinction between
material and immaterial events. It should be noted that an item material for
one party may be immaterial for another. Actually, there are no hard and
fast rule to draw the line between material and immaterial events and hence,
It is a matter of judgement and common sense. Despite this limitation, It is
necessary to disclose all material information to make the financial statements
clear and understandable. This is required as per IAS-1 and also reiterated
in IAS-5. As per IAS-1, materiality should govern the selection and
application of accounting policies.

2. Convention of Conservatism. This concept requires that the accountants

must follow the policy of ‘’playing safe” while recording business

transactions and events. That is why, the accountant follow the rule

anticipate no profit but provide for all possible losses, while recording the

business events. This rule means that an accountant should record lowest

possible value for assets and revenues, and the highest possible value for

liabilities and expenses. According to this concept, revenues or gains should

be recognised only when they are realised in the form of cash or assets

(i.e. debts) the ultimate cash realisation of which can be assessed with reasonable

certainty. Further, provision must be made for all known liabilities,

expenses and losses, Probable losses regarding all contingencies

should also be provided for. ‘Valuing the stock in trade at market price or

cost price which ever is less’, ‘making the provision for doubtful debts on

debtors in anticipation of actual bad debts’, ‘adopting written down value

method of depreciation as against straight line method’, not providing for

discount on creditors but providing for discount on debtors’, are some of

the examples of the application of the convention of conservatism.

The principle of conservatism may also invite criticism if not applied

cautiously. For example, when the accountant create secret reserves,

by creating excess provision for bad and doubtful debts, depreciation, etc.

The financial statements do not present a true and fair view of state of

affairs. American Institute of Certified Public Accountant have also indicated

that this concept need to be applied with much more caution and care

as over conservatism may result in misrepresentation.

3 Convention of Consistency. The convention of consistency requires

that once a firm decided on certain accounting policies and methods

and has used these for some time, it should continue to follow the same

methods or procedures for all subsequent similar events and transactions unless it has a sound reason to do otherwise. In other worlds, accounting

practices should remain unchanged from one period to another. For example,

if depreciation is charged on fixed assets according to straight line method,

this method should be followed year after year. Analogously, if stock is

valued at ‘cost or market price whichever is less’, this principle should be

applied in each subsequent year.

However, this principle does not forbid introduction of improved

accounting techniques. If for valid reasons the company makes any departure

from the method so far in use, then the effect of the change must be

clearly stated in the financial statements in the year of change. The application

of the principle of consistency is necessary for the purpose of comparison.

One could draw valid conclusions from the comparison of data drawn

from financial statements of one year with that of the other year. But the

inconsistency in the application of accounting methods might significantly

affect the reported data.