What are Accounting Conventions - Accounting Basics

What are the different Accounting conventions?

The different accounting conventions are as follows:

Convention of Consistency

The accounting rules, principles and conventions need to follow consistently and continuously to compare the results of different years. Frequent changes in the accounting treatment may affect the reliability of the financial statements. For instance if the firm selects cost or market price whichever is lower method for evaluating the stock and written down value method for depreciation, the same methods should be followed consistently and continuously.

The change and the effect of change on the profit and loss and on the financial position of the company are to be clearly mentioned.

Convention of Disclosure

According to the Companies Act of 1956, financial statements are to be prepared in a specified format. Each and every company which come under the Companies Act of 1956 should follow this practice. The financial statements are prepared by using various provisions. The provisions are provided to disclose all the important information such that the financial statements should be true and fair.

Convention of Materiality

If the disclosure or non-disclosure of information influence the decision of the users of financial statements, such information should be disclosed.

For better understanding, please refer to General Instruction for preparation of Statement of Profit and Loss in revised scheduled VI to the Companies Act, 1956:

  • A company shall disclose by way of notes additional information regarding any item of income or expenditure which exceeds 1% of the revenue from operations or Rs 1,00,000 whichever is higher.
  • A Company shall disclose in Notes to Accounts, share in the company held by each shareholder holding more than 5% share specifying the number of share held.

Conservation or Prudence

This convention is to play safe. As a policy of conservatism, provisions for losses are provided but profits are not anticipated. The provisions are made for doubtful debts, contingent liability.

For instance, If A purchases 1000 items @ Rs 80 per item and sells 900 items out of them @ Rs 100 per item when the market value of stock is (i) Rs 90 and in condition (ii) Rs 70 per item, the profit is calculated as follows:

Sale Value (A) (900x100)
Less - Cost of Goods Sold
Less - Closing Stock
Cost of Goods Sold (B)

The stock is evaluated by using the ‘Cost or market prices whichever is lower’ method.

By understanding the profits or by overstating the losses, the creation of hidden reserve is not permitted by Prudence.

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