What is Accounting Convention? Definition, Types, Pros vs Cons

The accepted guidelines and standards followed while recording business transactions are known as accounting conventions. These conventions are not legalized practices set in stone but are commonly followed when dealing with situations not clearly in the purview of accounting standards.

Accounting conventions are practical solutions to problems in forming financial statements. In the absence of specific guidelines for a given situation, these conventions help to maintain a degree of uniformity.

Accounting is such an area that there can be several grey areas in practice. The theory may not be fully equipped to deal with common problems arising from situations, depending on various issues such as comparability and reliability. In these cases, accounting conventions help to determine the best way to record such transactions.

Key Takeaways

1. Accounting is the process of recording, classifying, and summarizing financial transactions to provide information for decision-making purposes.
2. Individuals, businesses, and organizations use accounting to track financial performance, prepare financial statements, and comply with regulatory requirements.
3. Accounting involves several key principles, including double-entry bookkeeping, the accrual accounting method, and the Generally Accepted Accounting Principles (GAAP).

Basic Points of the Concept

1. Accounting conventions are mutually understood and agreed-upon terms that establish uniformity concerning how books of accounts are kept (such as taking inventory).
2. The scope of these conventions continues to both expand and reduce over time. If guidelines are set regarding an issue formerly addressed by an accounting convention, then the convention is overruled.
3. However, the conventions too change and evolve with time and changes in the economy and include more and more conditions under its scope.

Types of Accounting Conventions

1. Conservatism Convention – This is one of the most basic conventions based on the premise that the future must be considered. While estimating assets and recording transactions, losses are to be recorded rather than profits. Whenever there is a conflict between two available values, the lower one should be factored in to make leeway for future financial setbacks.
2. Full Disclosure Convention – Every detail of financial transactions should be plain and recorded to interpret financial statements accurately.
3. Convention of Consistency – A particular manner of accounting must be decided at the outset, and this is the format that should be followed throughout. This maintains uniformity and enables better decision-making.
4. The Convention of Materiality requires that all material items be included in the accounts if they are involved in transactions.

Advantages of Accounting Conventions

1. It ensures that different businesses record their transactions following the same standards. This makes it easier for investors to contrast and compare performances.
2. Being flexible and accommodative, accounting conventions change over time to suit the situations.
3. Conservative accounting conventions ensure that financial statements are prepared to the greatest detail. This makes smarter business decisions possible as accounting conventions allow uniformity of representation even in those transactions where accounting standards do not function.

Disadvantages of Accounting Conventions

1. Because there are no rigid guidelines, there is ample room for error and data manipulation.
2. Such large-scale errors could cause disastrous economic consequences, bringing about inflations or deflations.
3. Corporate failures have been known to happen due to frequent alterations of ways of representation and too many assumptions.

References

1. https://www.jstor.org/stable/2352032?seq=4#metadata_info_tab_content
2. https://www.sciencedirect.com/science/article/abs/pii/S0263237387800579