Accounting Concepts and

Conventions

Dr. Avijit Roychoudhury

Inspector of Colleges
Vidyasagar University
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 term “Accounting Conventions” refers to the customs
or traditions which are used as a guide in the preparation
of accounting reports and statements. The conventions
are derived by usage and practice. The accountancy
bodies of the world may charge any of the convention to
improve the quality of accounting information accounting
conventions need not have universal application.

Historical cost
This is the most commonly encountered 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 this convention, therefore, no account is taken of
changing prices in the economy.
Convention of Consistency
According to this convention the accounting practices
should remain unchanged from one period to another. For
example, stock should be valued in the same manner every
year. Similarly depreciation is charged on fixed assets on
the same method year after year. If this assumption is not
followed, the fact should be disclosed together with
reasons.
The principle of consistency plays its role particularly when
alternative accounting methods is equally acceptable. In
case of valuation of stocks if the company applies the
principle “at cost or market price whichever is less” and if
this principle accordingly result in the valuation of stock in
one year at cost and the market price in the other year,
there is no inconsistency here. It is only an application of
the principle.
Convention of Conservatism
It takes into consideration all prospective losses but leaves
all prospective profits. Financial statements are usually
drawn up on a conservative basis. Anticipated profit are
ignored but anticipated losses are taken into account
while drawing the statements.

Examples :
(i) Making the provision for doubtful debts and
discount on debtors.
(ii) Valuation of the stock at cost price or market price
which ever is less.
(iii) Charging of small capital items, like crockery to
revenue.
(iv) Showing joint life policy at surrender value as
against the actual amount paid.
(v) Not providing for discount on creditors.
Convention of Disclosure
Apart from statutory requirement, good accounting
practice also demands that significant information should
be disclosed in financial statements. Such disclosures can
also be made through footnotes and through the contents
of balance sheet and profit and loss account. The practice
of appending notes relative to various facts and items
which do not find place in accounting statements is in
pursuance to the convention of full disclosure of material
facts.
The convention of disclosure also applies to events
occurring after the balance sheet date and the date on
which the financial statement are authorized for issue.
Such events are likely to have a substantial influence on the
earnings and financial position of the enterprises. Their
not-disclosure would affect the ability of the users for
evaluations and decisions.
Convention of Materiality:
According to this convention, the accountant should
attach importance to material detail and ignore
insignificant details in the financial statement. In
materiality principle, all the items having significant
economics effect on the business of the enterprises should
be disclosed in the financial statement.
The term materiality is the subjective term. It is on
the judgment, common sense and discretion of the
accountant that which item is material and which is not.
For example stationery purchased by the organization
though not used fully in the concept. Similarly
depreciation small items like books, calculator is taken as
100% in the year if purchase through used by company for
more than one year. This is because the amount of books
or calculator is very small to be shown in the balance
sheet. It is the assets of the company.
ACCOUNTING CONCEPTS
Entity Concept:
Entity Concept says that business enterprises is a separate
identity apart from its owner. The concept of accounting
entity for every business or what is to be excluded from the
business books. So the concept of separate entity is
applicable to all forms of business organization.
Money Measurement Concept:
Since money in the medium of exchange and the standard
of economic value, this concept requires that these
transactions alone that are capable of being measured in
terms of money be only to be recorded in the books of
accounts. For example, health condition of the chairman of
the company, working conditions of the workers, sale
policy etc. do not find place in accounting because it is not
measured in terms of money.
Cost Concept:
By this concept, the value of assets is to be determined on
the basic of historical cost. Transaction are entered in the
books of accounts at the amount actually involved. The
cost concept does not mean that the assets will always be
shown at cost. The assets may be recorded at the time of
purchase but it may reduce its value for charging
depreciation.
Many assets do not have acquisition cost. Human assets of
an enterprises are an example. The cost concept fails to
recognize such assets although it is a very important assets
of any organization.
Going Concern Concept:
According to this concept the financial statements are
normally prepared on the assumption that an enterprises
is a going concern and will continue to operate in the
foreseeable future. Transaction are therefore recorded in
such a manner that the benefits likely to accrue in future
from money spent. It is because of this concept that fixed
assets are recorded at their original cost and depreciation
in a systematic manner without reference to their current
realizable value.
Dual aspect Concept:
This concept is the core of double entry book-keeping.
Every transaction or event has two aspect. Every
transaction is bound to have two effect. If X starts a
business with a capital of Rs. 50,000, it means on the
other hand the business has to pay Rs. 50,000 to the
proprietor which is taken as proprietor’s Capital.
Realization Concept:
It closely follows the cost concept. It states that any change
in value of assets is to be recorded only when the business
actually realize it. i.e. either cash has been received or a
legal obligation to pay has been assumed by the customer.
It prevents business firm from inflating their profit by
recording sale and income that are likely to accrue, i.e.
anticipated income or gain are not recorded.
Accrual Concept:
Under accrual concept the effect of transaction and other
events are recognized on mercantile basis. When they
accrue and not as cash or a cash equivalent is received or
paid, they are recorded in the accounting record and
reported in the financial statements of the periods to
which they relate. Financial statement prepared on the
accrual basis inform users not only of past events
involving the payment and receipt of cash but also of
obligation to pay cash in the future and of resources that
represent cash to be received in the future. For Example:-
Mr. Kumar bought clothing of Rs. 50,000, by paying cash
Rs. 20,000 and sells at Rs. 60,000 for which customer paid
only Rs. 40,000. So his revenue is Rs. 60,000, not Rs.
40,000 cash received. So the accrual concept based profit
is Rs. 10,000 (Revenue- Exp.)
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 (they are
"provided for" in the accounts" as soon as there 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.
Understandability
This calls for clear expression 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 revise an
observation - usually in the context of making a decision.
Consistency
This connotes 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).
Objectivity
This implies that accounting information is prepared and
reported in a "neutral" way and not biased towards a
particular user group or vested interest.