Conventions Applied to Accounting

What exactly are these “accounting conventions,” though?

Customs, usages, and traditions are the foundation from which accounting conventions, which are broad standards of practice, are derived. The accounting profession relies on these norms as its primary set of guiding principles.

These standards are followed by accountants because it is generally believed that accounting processes ought to be consistent, that financial statements ought to be prepared on a conservative basis in order to reduce the risk of loss, and that essential accounting information ought to be reported.

1. Consistency in Conventional Practice

Users of accounting information are able to compare accounting statements across time or between different businesses thanks to this convention, which emphasizes that a business unit should be consistent in the accounting processes it employs.

The nature of universal acceptability need to be consistent with this consistency. This indicates that accounting procedures should continue as they have in the past unless there is compelling evidence to support a change.

The rule of consistency does not restrict the introduction of innovative accounting techniques. However, it is crucial that any changes be included, and the impact of such changes should be expressed explicitly, so as to ensure that decision-makers are not mislead in any way.

For instance, if there is a change in the depreciation policy (for instance, from the straight-line technique to the decreasing balance method), this change should be stated in a clear and understandable manner together with the financial statements.

2. The Conservative Party’s Convention

In most cases, the preparation of financial accounts adheres to the conservative practice of following the adage “anticipate no profit but provide for all possible losses.” This is done in accordance with the convention of conservatism. The preparation of financial statements with “prejudice using personal judgment” is rendered impossible for accountants as a result of this measure.

According to the guidelines of this convention, window dressing is not allowed. For instance, the standard method for determining the value of a company’s shares is to determine “cost or market price, whichever is lower.”

Therefore, if an accountant continually values a stock at the cost price without taking into consideration the lower market price, then they have violated the convention of conservatism and are being less cautious than they should be.

3. The Convention on the Disclosure of Material

Disclosure of information that is material necessitates the disclosure of information that is essential to the compilation of financial statements. The circumstances and the accountant’s judgement both play a role in determining what information should be considered relevant or noteworthy.

It’s important to note that having discretion does not entail making decisions based on your own personal judgment.

This does not imply that each and every detail, irrespective of how insignificant they may be, had to be presented. It means that accountants should only use their discretion to differentiate between information that is significant and information that is not significant.

To ensure that consumers correctly comprehend financial statements, accountants should make sure to disclose any and all relevant information by including it in the form of footnotes, references, parenthetical citations, and any other appropriate format.

For instance, in addition to the values of assets, an accountant needs to reveal the method that was used to value those assets. A footnote ought to be added to the report in the event that there was a change in the accounting policy implemented between the prior year and the current year.

In light of this, the Generally Accepted Accounting Principles (GAAP) serve as the fundamental guidelines that accountants are required to adhere to in order to guarantee the delivery of information that is consistent, of high quality, and easy to understand.

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