Accounting Convention Methods

Accounting conventions are guidelines used to assist businesses in determining how to track certain business transactions that are not fully addressed by accounting standards. These processes and principles are not legally binding, but accounting bodies generally accept them. They are primarily intended to promote consistency and assist accountants in overcoming practical issues that may arise when preparing financial statements.

Understanding an Accounting Convention

In some cases, the accounting standards that regulate a specific situation do not provide a definitive guideline. Accounting conventions can be used in such cases. Accounting is littered with assumptions, concepts, standards, and conventions. Accounting conventions that help to standardise the financial reporting process frequently support concepts such as relevance, reliability, materiality, and comparability. In a nutshell, accounting conventions fill in the gaps left by accounting standards. If an oversight organisation, such as the ICAI (Institute of Chartered Accountants of India), issues guidelines that address the same topic as the accounting convention, the accounting convention becomes obsolete.

Accounting standards’ scope and detail continue to expand, leading to fewer accounting conventions that can be used. Accounting conventions are also not set in stone. They can, on the other hand, keep evolving over time to reflect new thoughts and opinions on the best way to record transactions.

Accounting conventions are important because it ensures that transactions are recorded consistently across multiple companies. Having a standardised methodology makes things simpler for investors to compare the financial results of different companies, such as competitors in the same industry.

Accounting conventions, however, are far from perfect. They are sometimes vaguely defined, giving companies and their accountants the opportunity to bend or manipulate them to their advantage.

Methods of Accounting Convention

Accounting conventions are divided into four categories to assist accountants:

Conservatism: It is both an accounting principle and a convention to play it safe. It instructs accountants to err on the side of caution when estimating assets and liabilities. That is, when two transaction values are available, the lower one should be preferred. The general idea is to consider the worst-case scenario for a company’s financial future.

Consistency: A company’s accounting principles should be applied consistently across all accounting cycles. Once it has decided on a method, it is urged to stick with it in the future, unless there is a compelling reason to do otherwise. Without this convention, it is much more difficult for investors to make a comparison and assess how the company is performing from one period to the next.

Full disclosure: All potentially important and relevant information must be disclosed, irrespective of whether it is detrimental to the company.

Materiality: This convention, like full disclosure, encourages companies to lay all of their cards on the table. If an item or event is material, or important, it must be disclosed. The idea here is that any data that could influence a person reading the financial statement’s decision must be included.

Accounting Conventions Applicable Areas

Inventory valuation can benefit from accounting conservatism. When deciding the reporting value of inventory, conservatism dictates that the monetary value be the lower of historical cost or replacement cost.

Accounting conventions also state that line-item adjustments should not be made for inflation or market value. As a result, book value may occasionally be below market value. For example, if a building costs Rs.50,000 when purchased, it should be recorded as such, regardless of whether it is now worth more.

The conservatism convention is also used in estimates of uncollectible accounts receivable and casualty losses. If a company expects to win a lawsuit, it cannot report the gain until all revenue recognition principles are met. However, if a litigation claim is assumed to be lost, an estimated economic impact must be included in the notes of the financial statements. Contingent liabilities, such as royalties or unearned revenue, must also be disclosed.

Conclusion 

Accounting conventions are guidelines that assist businesses in determining how to record business transactions that are not completely covered by accounting standards. Accounting bodies generally accept them, but they are not legally binding. If an oversight organisation issues a guideline on the same subject as the accounting convention, the accounting convention is no longer applicable. Accounting conventions are divided into four categories: conservatism, consistency, full disclosure, and materiality.