The generally 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 certain problems that may arise in forming financial statements. In the absence of specific guidelines for a given situation, these conventions help to maintain a degree of uniformity.
Accounting itself 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 which can arise out of 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.
- Accounting is the process of recording, classifying, and summarizing financial transactions to provide information for decision-making purposes.
- Individuals, businesses, and organizations use accounting to track financial performance, prepare financial statements, and comply with regulatory requirements.
- 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
- Accounting conventions are like mutually understood and agreed upon terms that establish uniformity with respect to how book of accounts are kept (such as taking inventory).
- The scope of these conventions continues to both expand and reduce over time. If guidelines are set regarding a certain issue formerly addressed by an accounting convention, then the convention is overruled.
- However the conventions too change and evolve with time and changes in economy and include more and more conditions under its scope.
Types of Accounting Conventions
- Conservatism Convention – This is one of the most basic conventions based on the premise that the future must be kept in mind. 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.
- Full Disclosure Convention – Every single detail of financial transactions should be made plain and recorded for accurate interpretation of financial statements.
- 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.
- Convention of Materiality – This requires that all material items be also included in the accounts if they are involved in transactions.
Advantages of Accounting Conventions
- It ensures that different businesses record their transactions following the same standards. This makes it easier on the part of investors to contrast and compare performances.
- Being flexible and accommodative, accounting conventions change over time to suit the situations.
- Conservative accounting conventions ensure that the financial statements prepared to the greatest details. 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
- Because there are no rigidly established guidelines there is ample room for error and data manipulation.
- Such large scale errors could cause disastrous consequences to the economy, bringing about inflations or deflations.
- Corporate failures have been known to happen due to frequent alterations of ways of representation and too many assumptions.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.