What are accounting concepts and conventions?
In this blog, we have discussed the difference between concepts and conventions of accounting.
Very often, accounting is called the language of business because it is through accounting that a business communicates with the outside world. To make this language uniform and commonly understood by all, it must be based on certain scientifically laid down procedures and standards. These are called accounting principles that enable sound accounting practices & procedures to be followed in reporting the financial status and performance of a business.
Accounting principles are categorized into two: Accounting concepts and accounting conventions.
Breaking down accounting concepts
Accounting concepts are basic assumptions based on which the financial statements of a business are prepared. They act as a foundation to establish various methods and procedures for recording and presenting transactions of a business.
The important accounting concepts are as follows:
1. Business entity concept: According to this concept, every business (be it a proprietorship, partnership or joint stock company) is treated as an entity separate from its owners. Accounts are maintained from the point of view of the business as distinguished from the person(s) owning it.
2. Money measurement concept: The money measurement concept holds that only those transactions and events are recorded that can be interpreted in terms of money. Transactions that cannot be expressed in monetary terms do not find a place in the books of account.
3. Cost concept: As per this concept, all assets of a business must be recorded at the costs actually spent for acquiring them. Such costs become the basis for all subsequent accounting. However, it doesn’t mean that the assets shall always be recorded at their original costs. Their value should be systematically reduced by charging depreciation.
4. Going concern concept: The going concern concept holds that business transactions are recorded on the assumption that the business will continue for a long time and there is no intention to liquidate the business in the coming future.
5. Dual aspect concept: This concept is based on the double-entry system of book-keeping. Every transaction is recorded in two aspects: debit and credit in such a manner that the total amount debited shall always be equal to the total amount credited. Hence, at any point in time, the total assets of a business are always equal to its total liabilities.
6. Realisation concept: According to this concept, revenue is recognized only when a sale is made. No income can be recorded in the books unless cash has been received or the customer has assumed a legal obligation to pay. This concept prevents businesses from inflating their profits by recording expected incomes that are likely to accrue.
7. Accrual concept: Transactions in business are recorded on an accrual basis of accounting. It means they are recorded as and when they occur and not when the related payments are received or made. Thus, even if there isn’t an immediate settlement in cash, accrued incomes and expenses are recognized as and when they are earned and incurred.
8. Accounting period concept: For analyzing the results of a business, its life is normally divided into appropriate intervals. Each such interval is known as an accounting period. It is usually composed of 12 months at the end of which financial statements are prepared to know the entity’s performance during the year.
9. Revenue match concept: Based on the accounting period concept, the matching concept says that to determine the profit or loss of a particular period, the expenses of the period must be matched with the incomes of the same period.
Breaking down accounting conventions
Conventions denote customs, traditions or practices. They are developed through implied accounting practices followed by entities over time. Usually, there is a general agreement between the accounting bodies to accept the conventions in practice. These conventions guide an accountant in the selection or application of accounting methods & procedures while preparing financial statements.
Financial statements, i.e., profit and loss account and balance sheet are prepared using the following accounting conventions:
1. Consistency: The convention of consistency implies that the accounting treatment should remain the same year after year. The results of several years would be comparable only if the same accounting practices are continuously adhered to from year to year. For example, if depreciation is computed using the diminishing balance method, then the same method should be followed for all years.
2. Disclosure: According to this convention, all significant information should be fully and fairly disclosed in financial statements. All material information of a business entity is required to be disclosed so as to meet the interests of both internal and external stakeholders. Moreover, the Companies Act 2013 also has ample provisions for specifying the requirement of disclosure of essential information.
3. Conservatism: Financial statements are usually drawn up on the principle of conservatism. It says that an accountant should not anticipate income but he should provide for all possible losses. Further, if there are two possible ways of valuing an asset, the accountant should choose the one that leads to a lesser value. Some examples of conservatism are making provisions for bad debts in respect of doubtful debts and valuing stock in hand at the lower of cost or market price.
4. Materiality: The convention of materiality states that while presenting financial statements, accountants should only report what is deemed material and ignore all insignificant details. Material items are those whose inclusion or exclusion is likely to have an impact on the decision-making of users of financial information. Financial statements must be complete in all material aspects so that they can give an accurate picture of the state of affairs of the entity.
Difference between the two
The following points will summarize the difference between accounting concepts and accounting conventions:
Accounting concepts are ideas or notions that have a universal application. They are widely accepted in accounting to give a unifying structure and logic to the accounting process. Financial transactions are interpreted in the light of accounting concepts.
On the other hand, accounting conventions denote customs or traditions followed in accounting. These are guidelines that support accountants in the preparation and reporting of financial statements.
While accounting concepts lay the foundation for formulating various methods and procedures for recording transactions of a business, accounting conventions guide the accountants in the selection or application of various procedures.
Accounting concepts are developed by the accounting bodies of the country and they are in line with internationally accepted accounting policies. On the other hand, accounting conventions are developed through accounting practices adopted by various organizations over a period of time. They are derived by usage and practice.
Dependency on each other:
Accounting concepts are not based on conventions but accounting conventions are fundamentally based on accounting concepts.
While accounting concepts put more emphasis on the recording and interpretation of business transactions, accounting conventions are more concerned with the preparation and presentation of financial statements.
There is no role of personal judgment in the adoption of accounting concepts. But personal judgment plays a crucial role in the adoption of accounting conventions. For instance, an accountant uses his professional experience and skill to determine whether a transaction is material or not.
Accounting concepts are uniformly applied in different organizations. They form the foundation for recording and presenting transactions of a business. Whereas the manner in which accounting conventions are applied may be different in different organizations. For example, depreciation may be computed using the straight line or diminishing balance method. Similarly, an item that may be material for one organization may not be material for the other. A customer who defaults in payment of Rs. 1,000 to a company having a net worth of 500 crores is immaterial. But the same may be material for a smaller company and might have an impact on it.
The overall objective of both accounting concepts and conventions is to ensure that financial information is easily understood by all in the same manner and that the results of a business become comparable from year to year.
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