Accounting For Managers - Basics of Accounting
Accounting Conventions
Convention Of Conservatism: It is a world of uncertainty. So it is always better to pursue the policy of playing safe. This is the principle behind the convention of conservatism. According to this convention the accountant must be very careful while recognizing increases in an enterprise’s profits rather than recognizing decreases in profits. For this the accountants have to follow the rule, anticipate no profit, provide for all possible losses, while recording business transactions. It is on account of this convention that the inventory is valued at cost or market price whichever is less, i.e. When the market price of the inventories has fallen below its cost price it is shown at market price i.e. The possible loss is provided and when it is above the cost price it is shown at cost price i.e. The anticipated profit is not recorded. It is for the same reason that provision for bad and doubtful debts, provision for fluctuation in investments, etc., are created. This concept affects principally the current assets.
Convention Of Full Disclosure:
the emergence of joint stock
company form of business organization resulted in the divorce between ownership
and management. This necessitated the full disclosure of accounting information
about the enterprise to the owners and various other interested parties. Thus
the convention of full disclosure became important. By this convention it is
implied that accounts must be honestly prepared and all material information
must be adequately disclosed therein. But it does not mean that all information
that someone desires are to be disclosed in the financial
statements. It only implies that there should be adequate disclosure of
information which is of considerable value to owners, investors, creditors,
government, etc. In sachar committee report (1978), it has been emphasized that
openness in company affairs is the best way to secure responsible behaviour. It
is in accordance with this convention that companies act, banking companies
regulation act, insurance act etc., have prescribed proforma of financial
statements to enable the concerned companies to disclose sufficient
information. The practice of appending notes relating to various facts on items
which do not find place in financial statements is also in pursuance to this
convention. The following are some examples:
(a) contingent
liabilities appearing as a note
(b) market
value of investments appearing as a note
(c) schedule
of advances in case of banking companies
Convention
Of Consistency:
According to this concept it is essential that accounting procedures,
practices and method should remain unchanged from one accounting period to
another. This enables comparison of performance in one accounting period with
that in the past. For e.g. If material issues are priced on the basis of fifo
method the same basis should be followed year after year. Similarly, if
depreciation is charged on fixed assets according to diminishing balance method
it should be done in subsequent year also. But consistency never implies
inflexibility as not to permit the introduction of improved techniques of
accounting. However if introduction of a new technique results in inflating or
deflating the figures of profit as compared to the previous methods, the fact
should be well disclosed in the financial statement.
Convention
Of Materiality:
The implication of this convention is that accountant should attach
importance to material details and ignore insignificant ones. In the absence of
this distinction, accounting will unnecessarily be overburdened with minute
details. The question as to what is a material detail and what is not is left
to the discretion of the individual accountant. Further, an item should be
regarded as material if there is reason to believe that
knowledge of it would influence the decision of informed investor. Some
examples of material financial information are: fall in the value of stock,
loss of markets due to competition, change in the demand pattern due to change
in government regulations, etc. Examples of insignificant financial information
are: rounding of income to nearest ten for tax purposes etc. Sometimes if it is
felt that an immaterial item must be disclosed, the same may be shown as
footnote or in parenthesis according to its relative importance.
