Accounting conventions refer to common practices which are universally followed in recording and presenting accounting information of the business entity. These are followed like customs or traditions. Accounting conventions are evolved through the regular and consistent practice over the years to facilitate uniform recording in the books of accounts.
Accounting conventions help in comparing accounting data of different business units or of the same unit for different periods. These have been developed over the years. The most important conventions which have been used for a long time are:
- Convention of Consistency
- Convention of Materiality
- Convention of Conservatism
1. Convention of Consistency
The convention of consistency means that same accounting principles should be used for preparing financial statements year after year. A meaningful conclusion can be drawn from financial statements of the same enterprise when there is a comparison between them over a period of time. But this can be possible only when accounting policies and practices followed by the enterprise are uniform and consistent over a period of time.
If different accounting procedures and practices are used for preparing financial statements of different years, then the result will not be comparable. Generally a businessman follows the same general practices or methods year after year, for preparing the books of accounts.
As per this convention the same accounting methods should be adopted every year in preparing financial statements. But it does not mean that a particular method of accounting once adopted can never be changed. Whenever a change in method is necessary, it should be disclosed by way of footnotes in the financial statements of that year.
Significance of Convention of Consistency
- It facilitates comparative analysis of the financial statements.
- It ensures uniformity in charging depreciation on fixed assets and valuation of closing stock.
2. Convention of Materiality
The convention of materiality states that, to make financial statements meaningful, only material fact, important and relevant information should be supplied to the users of accounting information. The materiality of a fact depends on its nature and the amount involved. Material fact refers to the information that will influence the decision of its user.
For example, a businessman is dealing in electronic goods. He purchases T.V., Refrigerator, Washing Machine, and Computer for his business. In buying these items he uses larger part of his capital. These items are significant items and should be recorded in books of accounts in detail. At the same time to maintain day to day office work he purchases pen, pencil, match box, and other items. For this he will use very small amount of his capital. These items are insignificant items and hence they should be recorded separately. Thus, the items that are significantly important in recording the details are termed as material facts or significant items. The items that are of less significance are immaterial facts or insignificant items.
Significance of Convention of Materiality
- It helps in minimizing errors in calculation.
- It helps in making Financial Statements more meaningful.
- It saves time and resources.
3. Convention of Conservatism
This convention is based on the principle that “Anticipate no profit, but provide for all possible losses”. It provides guidance for recording transactions in the books of accounts. It is based on the policy of playing safe in regard to showing profit. The main objective of this convention is to show minimum profit. Profit should not be overstated.
If more profit is shown than the actual, it may lead to distribution of dividend out of capital. This is not a fair policy and it will lead to the reduction in the capital of the enterprise.
- It helps in ascertaining actual profit.
- It is useful in the situation of uncertainties and doubts.
- It helps in maintaining the capital at its real value.