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what are concepts and conventions of accounting
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Answer Posted / kanakaiah.salla
In drawing up accounting statements, whether they are
external "financial accounts" or internally-
focused "management accounts", a clear objective has to be
that the accounts fairly reflect the true "substance" of
the business and the results of its operation.
The theory of accounting has, therefore, developed the
concept of a "true and fair view". The true and fair view
is applied in ensuring and assessing whether accounts do
indeed portray accurately the business' activities.
To support the application of the "true and fair view",
accounting has adopted certain concepts and conventions
which help to ensure that accounting information is
presented accurately and consistently.
Accounting Conventions
The most commonly encountered convention is the "historical
cost convention". This requires transactions to be recorded
at the price ruling at the time, and for assets to be
valued at their original cost.
Under the "historical cost convention", therefore, no
account is taken of changing prices in the economy.
The other conventions you will encounter in a set of
accounts can be summarised as follows:
Monetary measurement:
Accountants do not account for items unless they can be
quantified in monetary terms. Items that are not accounted
for (unless someone is prepared to pay something for them)
include things like workforce skill, morale, market
leadership, brand recognition, quality of management etc.
Separate Entity This convention seeks to ensure that
private transactions and matters relating to the owners of
a business are segregated from transactions that relate to
the business.
Realisation With this convention, accounts recognise
transactions (and any profits arising from them) at the
point of sale or transfer of legal ownership - rather than
just when cash actually changes hands. For example, a
company that makes a sale to a customer can recognise that
sale when the transaction is legal - at the point of
contract. The actual payment due from the customer may not
arise until several weeks (or months) later - if the
customer has been granted some credit terms.
Materiality An important convention. As we can see from the
application of accounting standards and accounting
policies, the preparation of accounts involves a high
degree of judgement. Where decisions are required about the
appropriateness of a particular accounting judgement,
the "materiality" convention suggests that this should only
be an issue if the judgement is "significant" or "material"
to a user of the accounts. The concept of "materiality" is
an important issue for auditors of financial accounts.
Accounting Concepts
Four important accounting concepts underpin the preparation
of any set of accounts:
Going Concern Accountants assume, unless there is evidence
to the contrary, that a company is not going broke. This
has important implications for the valuation of assets and
liabilities.
Consistency Transactions and valuation methods are treated
the same way from year to year, or period to period. Users
of accounts can, therefore, make more meaningful
comparisons of financial performance from year to year.
Where accounting policies are changed, companies are
required to disclose this fact and explain the impact of
any change.
Prudence Profits are not recognised until a sale has been
completed. In addition, a cautious view is taken for future
problems and costs of the business (the are "provided for"
in the accounts" as soon as their is a reasonable chance
that such costs will be incurred in the future.
Matching (or "Accruals") Income should be
properly "matched" with the expenses of a given accounting
period.
Key Characteristics of Accounting Information
There is general agreement that, before it can be regarded
as useful in satisfying the needs of various user groups,
accounting information should satisfy the following
criteria:
Criteria What it means for the preparation of accounting
information
Understandability :
This implies the expression, with clarity, of accounting
information in such a way that it will be understandable to
users - who are generally assumed to have a reasonable
knowledge of business and economic activities
Relevance :
This implies that, to be useful, accounting information
must assist a user to form, confirm or maybe revise a view -
usually in the context of making a decision (e.g. should I
invest, should I lend money to this business? Should I work
for this business?)
Consistency:
This implies consistent treatment of similar items and
application of accounting policies
Comparability:
This implies the ability for users to be able to compare
similar companies in the same industry group and to make
comparisons of performance over time. Much of the work that
goes into setting accounting standards is based around the
need for comparability.
Reliability:
This implies that the accounting information that is
presented is truthful, accurate, complete (nothing
significant missed out) and capable of being verified (e.g.
by a potential investor).
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