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Conventions
The term "conventions" includes those customs or traditions which guide the accountants while preparing the accounting statements. The following are the important accounting conventions.
1. 2. 3. 4.
of of of of
Convention of Disclosure:
The disclosure of all significant information is one of the important accounting conventions. It implies that accounts should be prepared in such a way that all material information is clearly disclosed to the reader. The term disclosure does not imply that all information that any one could desire is to be included in accounting statements. The term only implies that there is to a sufficient disclosure of information which is of material in trust to proprietors, present and potential creditors and investors. The idea behind this convention is that any body who want to study the financial statements should not be mislead. He should be able to make a free judgment. The disclosures can be in the way of foot notes. Within the body of financial statements, in the minutes of meeting of directors etc.
Convention of Materiality:
It refers to the relative importance of an item or even. According to this convention only those events or items should be recorded which have a significant bearing and insignificant things should be ignored. This is because otherwise accounting will be unnecessarily over burden with minute details. There is no formula in making a distinction between material and immaterial events. It is a matter of judgment and it is left to the accountant for taking a decision. It should be noted that an item material for one concern may be immaterial for another. Similarly, an item material in one year may not be material in the next year.
Convention of Consistency:
This convention means that accounting practices should remain uncharged from one period to another. For example, if stock is valued at cost or market price whichever is less; this principle should be followed year after year. Similarly, if depreciation is charged on fixed assets according to diminishing balance method, it should be done year after year. This is necessary for the purpose of comparison. However, consistency does not mean inflexibility. It does not forbid introduction of improved accounting techniques. If a change becomes necessary, the change and its effect should be stated clearly.
Convention of Conservatism:
This convention means a caution approach or policy of "play safe". This convention ensures that uncertainties and risks inherent in business transactions should be given a proper consideration. If there is a possibility of loss, it should be taken into account at the earliest. On the other hand, a prospect of profit should be ignored up to the time it does not materialise. On account of this reason, the accountants follow the rule 'anticipate no profit but provide for all possible losses'. On account of this convention, the inventory is valued 'at cost or market price whichever is less.' The effect of the above is that in case market price has gone down then provide for the 'anticipated loss' but if the market price has gone up then ignore the 'anticipated profits.' Similarly a provision is made for possible bad and doubtful debt out of current year's profits.
Concepts:
The term concepts includes those basic assumptions or conditions upon which accounting is based. The following are the important accounting concepts:
1. 2. 3. 4. 5. 6. 7. 8.
Business Entity Concept Going Concern Concept Money Measurement Concept Cost Concept Duel Aspect Concept Accounting Period Concept Matching Concept Realisation / Realization Concepts
the business has a separate legal entity than the shareholders. The coming and going shareholders don not affect the entity of the business. Thus, the distinction between owner and the business unit has helped accounting in reporting profitability more objectively and fairly. It has also led to the development of 'responsibility accounting' which enables us to find out the profitability of even the different sub-units of the main business.
Cost Concept:
This concept is closely related to the going concern concept. According to this concept, an asset in ordinarily recorded in the books at the price at which it was acquired i.e., at its cost price. This cost serves the basis for the accounting of this asset during the subsequent period. The 'cost' should not be confused with 'value'. It must be remembered that as the real worth of the assets changes from time to time, it does not mean that the value of such an asset is wrongly recorded in the books. The book values of the assets as recorded do not reflect their real value. They do not signify that values noted therein are the values for which they can be sold. Though the assets are recorded in the books at cost, in course of time, they are reduced in value on account of depreciation charges. The idea that the transactions should be recorded at cost rather than at a subjective or arbitrary value is known as cost concept. With the passage of time, the market value of fixed assets like land and buildings vary greatly from their cost. These changes in the value are generally ignored by the accountants and they continue to value them in the balance sheet at historical cost. The principle of valuing the fixed assets at cost and not at market value is the underlying
principle in cost concept. According to them the current values alone will fairly represent the cost to the entity. The cost principle is based on the principle of objectivity. There is no room for personal assessment in showing the figures in accounting records. If subjectivity is flowed in records the same assets will be valued at different figures by different individual. Every body will have his own views about various assets. The cost concept is helpful in making truthful records. The records becomes more reliable and comparable.
= =
The term 'assets' denotes the resources owned by a business while the term 'equities' denotes the claims of various parties against the assets. Equities are of two types. They are owners equity and outsiders equity. Owner's equity (or capital) is the claim of the owner's against the assets of the business while outsiders equity (liabilities) is the claim of outside parties against the assets of the business. Since all assets of the business are claimed by someone (either owners or outsiders), the total of assets will be equal to total of liabilities. Thus:
Equities OR Liabilities
= +
Suppose if the business borrows $5000 from a bank, dual aspect of this transaction will be
Assets
15,000
Thus the accounting Equation states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of owner's equity and outsider's liabilities. As a mater of fact the entire system of double entry accounting is based on this concept.
Matching concept:
The aim of business is to earn profit. In order to ascertain the profit the costs (expenses) are matched to revenue. The difference between income from sales and costs of producing the goods will be the profit. When business is taken as a going concern then it becomes necessary to evaluate the performance periodically. A correct statement of income requires a distinction between past, present and future expenditures. A distinction between capital and revenue expenditure is also necessary. The revenues and costs of same period are matched. In other words, income made by the business during a period can be measured only when the revenue earned during a period is compared with the expenditure incurred for earning that revenue. The question when the payment was received or made is irrelevant.
Realisation Concept:
This concept emphasises that profit should be considered only when realised. The question is at what stage profit should be deemed to have accrued? Whether at the time of receiving the order or at the time of execution of the order or at the time of receiving the cash? For answering this question the accounting is in conformity with the law and Recognises the principle of law i.e., the revenue is earned only when the goods are transferred. It means that profit is deemed to have accrued when property i goods passes to the buyer, viz., when sales are made.