Accounting Concepts and Conventions

Accounting Concepts
In Organisation, along with organising the book-keeping processes, when accounting concepts are
implemented effectively, it encourages businesses to integrate and interpret financial transactions
into meaningful accounting processes.

It is always important for business accountants and owners to clearly understand the basic
accounting concepts. Such understanding helps in integrating uniformity and consistency within the
business accounting processes.

Both accounting concepts and principles are important to implement within the organisation as they
help to analyse different financial rules, theories and situations and make financial decisions based
on them.

Types of Accounting Concepts

1. Going concern concept

According to the going concern concept, a firm will continue to operate indefinitely. This assumption
has an impact on financial statement preparation, allowing accountants to represent long-term
assets at their historical cost and giving stakeholders a more realistic picture of a company's financial
health in the long run.

2. Business entity concept

In terms of the business entity concept, a business is a distinct economic entity from its owners. This
identity guarantees that personal and corporate money are kept separate, allowing for transparent
financial reporting. It facilitates measuring the success of the firm independent of its owners'
financial actions, resulting in openness and accountability.

3. Accrual concept

The accrual concept directs that revenues and costs be recognised as they are received or spent,
regardless of financial movements. This idea improves financial statement accuracy by matching
them with the economic content of transactions and giving stakeholders a more complete
knowledge of a company's financial status.

4. Money measurement concept

According to the money measurement concept, only monetary transactions should be documented
in accounting. This approach makes quantification and comparison easier, ensuring that financial
statements contain relevant and comparable information for decision-making.

5. Accounting period concept

The accounting period concept separates a company's economic existence into discrete periods,
often a fiscal year, for financial reporting. This approach enables timely and consistent reporting,
assisting stakeholders to evaluate a company's performance and make correct decisions at precise
intervals.

6. Dual aspect concept

According to the dual aspect concept, every financial transaction includes two components: a debit
and a credit. This double-entry technique keeps the accounting equation (Assets = Liabilities +
Equity) balanced, allowing for a systematic approach to documenting and assessing financial
transactions.
7. Revenue realisation concept

As to the income realisation concept, income should be recognised when it is earned, regardless of
when payment is received. This concept prevents revenue from being recognised prematurely,
aligning financial statements with the actual delivery of goods or services and improving the
trustworthiness of reported revenues.

8. Historical cost concept

The historical cost concept assesses assets at their original cost, giving financial reporting a solid and
objective foundation. This concept improves dependability by minimising subjective values and
guaranteeing that financial statements accurately represent the cost of the assets.

Examples of Accounting Concepts in Practice

Some examples of each accounting concept are as follows.

 Going concern concept

In the case of this concept, when valuing its machinery and equipment on the balance sheet, a
manufacturing firm expects it will be used for a lengthy period of time, based on the idea that the
business would continue operations indefinitely.

 Business entity concept

If the proprietor of a small firm buys a personal laptop, the business entity concept guarantees that
this personal spending is not reported in the company's financial records, maintaining a clear
boundary between personal and business operations.

 Accrual concept

The accrual concept is used by a consulting business that provides services, for example, service is
provided in December but receives payment in January. The revenue is recognised in December
when the service is delivered, regardless of the actual cash received.

 Money measurement concept

When a corporation registers the acquisition of a new piece of machinery in monetary terms, this
transaction is recorded since its value is measurable. If a company spends money on employee
training, only the expense on the course and materials is recorded where in the Employee skills and
morale is not recorded as it is not measurable in terms of money. This concept ensures that only
transactions which are measurable of its monetary worth are included in the financial statements.

 Accounting period concept

A corporation that prepares quarterly financial statements follows the accounting period concept by
disclosing its financial performance and position every three months, giving stakeholders timely
insights into the company's growth.

 Dual aspect concept

When a company borrows money from a bank, the dual aspect concept guarantees that both the
liability (the loan) and the matching asset (cash) are recorded, keeping the basic accounting equation
balanced.
  Revenue realisation concept

A software firm recognises revenue if a consumer purchases a software licence, regardless of when
the payment is made. This use of the revenue realisation concept corresponds to completing the
revenue-generating process.

 Historical cost concept

If a corporation buys a building, the historical cost concept requires the asset to be recorded at its
original purchase price, giving a solid and objective foundation for the value of the financial
statement.

Importance of Accounting Concepts

The importance of accounting concepts

The importance of implementing the accounting concepts makes the accounting concepts more
clear

 Consistency and comparability

Accounting principles are important because they provide uniformity and comparability in financial
reporting. For example, the going concern concept, believes that a firm will continue to exist
indefinitely. This assumption enables financial statements to be prepared with a long-term
perspective, allowing for meaningful comparisons over numerous accounting periods.

 Risk management

The principle of conservatism in accounting promotes a careful approach in financial reporting. This
approach helps firms in risk management it emphasizes anticipating the potential losses and
liabilities while delaying the recognition of gains and revenues until they are virtually certain it means
‘anticipate no profit but provide for all losses’ it helps in identifying the possible losses immediately
but recognising rewards only after when they are realised.

This approach aids firms in risk management. Setting up provisions for possible bad debts based on
past trends, for example, demonstrates a responsible approach to risk management.

 Support in decision-making

Accounting principles give organisations a standardised framework for keeping track of financial
transactions, allowing them to produce accurate information quickly. A more accurate presentation
of a company's financial situation is provided by the accrual concept, which recognises revenues and
costs as they are generated or spent. Because accurate financial reporting gives stakeholders a
comprehensive picture of a company's profitability and financial health, it facilitates effective
decision-making.

 Credibility

Applying accounting principles strengthens financial statements' legitimacy and promotes

stakeholder trust. By matching revenues with their associated expenditures, the matching concept
keeps profits from being manipulated by ensuring that income aligns with the spending required to
produce it. This trust among creditors, investors, and other stakeholders who depend on financial
statements to evaluate its health and sustainability.

What are Accounting Conventions?

Accounting conventions, are known to be principles that act as restrictions regarding organisational
transactions that are unclear or complicated. Even though accounting conventions do not act as
legally binding, these are considered generally accepted principles helping to maintain consistency
within the financial statements of a company.

The standard financial reporting system processes the information and uses accounting conventions
to compare the different aspects of the transaction, along with analysing its relevance, application
and full disclosure in the financial statements. The accountants in a company adopt the use of these
conventions so that they act as a guide while preparing accounting statements and reports.

Accounting conventions provide financial experts and stakeholders with a unified language. They
provide a common knowledge of how financial data is recorded and reported, which allows a correct
interpretation. This understanding is critical for decision-making because it enables users to analyse
financial information and make educated decisions based on a set of standardised rules.

Types of Accounting Conventions

Similar to accounting concepts, accounting conventions also have different types that help
implement the concept in business financials efficiently.

1. Convention of conservatism

One of the most important accounting conventions that accountants apply in the business is the
conservatism principle. This principle suggests that if two values are associated with a specific
transaction, the lowest must be recorded on the asset or income side of the financial statement. In
this case, the possibility of loss is taken care of.

This accounting convention aims to understate profits and assets while dealing with business losses.
Such practice mostly helps in enhancing the overall reliability of company stakeholders on the
financial statements.

2. Convention of materiality

This accounting convention is related to all the relative information available for an item or event of a
company's financial transactions. An item is generally considered material with respect to the
influence it has on an investor's decisions. The aspect of materiality differs from one organisation to
another.

For instance, in the case of a small company, certain information can be material but the same
information may not be material for a large organisation. Hence, the application of materiality
convention entirely depends on the context of analysis.

3. Convention of consistency

Consistency convention implies that the same principles of accounting must be implemented to
prepare the business financial statements, year after year. From the prepared financial statements, it
is important to draw a meaningful conclusion of the same company when a comparison is made of
the statements over a period.

Such financial comparisons can only be made if the same accounting practices and principles are
followed uniformly by the firm over a period of time. In the case of different accounting policies
implemented every year, the comparison will not be useful, and the result can also impact financial
decisions.

4. Convention of full disclosure

The principle of full disclosure helps in the comprehensive revelation of all related details in financial
statements. This helps a thorough, impartial, and ample disclosure of accounting information.
‘Adequate’ denotes a satisfactory amount of information to be shared, ‘fair’ implies equitable
treatment for users, and ‘full’ demands a complete and detailed presentation. Consequently, the
convention stress or emphasize the necessity for financial statements to fully disclose all related
information.

Examples of Accounting Conventions in Practice

 Conservatism

Suppose in December 2023, Sam agrees to purchase a car from Tata Motors Inc., which will be
delivered to him in January 2024. From the point of view of Tata Motors Inc., it stands as good news.
But it is possible that in future due to certain unforeseen circumstances, the deal gets broken.

Hence, according to the convention of conservatism, the revenue earned from the sale of the car is
not recognised in the books until the actual delivery of the same happens.

 Materiality

Let us take into account that a large organisation has incurred a loss of Rs.150,000 due to a certain
customer. The net worth of the business is around Rs.300,000,000. Hence, the loss of 0.05% can be
considered immaterial for the business.

However, if a small organisation with a net worth of Rs.250,000, a loss of Rs.150,000 will be
considered as a loss of material information. Therefore, the situation and context define the
application of materiality for both businesses.

 Consistency

An organisation must use the same depreciation calculating method for all their fixed assets for all
financial years. This helps maintain consistency in the results of depreciation over time.

 Full Disclosure

For a business, disclosure of information, such as assets that are pledged as collateral for loan tends
to be given a full disclosure. Another example of full disclosure of information by a business is letting
the stakeholders know the reason for changing the application of accounting principles or methods.

Importance of Accounting Conventions

 Different entity

Accounting norms are critical in dealing with various entities in the financial environment. These
conventions guarantee that companies, regardless of their type of business, adopt standardised
practices for documenting financial transactions by setting consistent criteria. This consistency is
critical for establishing a level playing field, facilitating fair comparisons across companies, and
developing a thorough knowledge of financial statements among stakeholders.

 Understanding

Accounting conventions provide financial experts and stakeholders with a unified language. They
provide a common knowledge of how financial data is recorded and reported, which allows a correct
interpretation. This understanding is critical for decision-making because it enables users to analyse
financial information and make educated decisions based on a set of standardised rules.

 Impact on money

One of the paramount aspects of accounting conventions is their direct impact on representing
monetary values in financial statements. These conventions provide a controlled and standardised
method of measuring and documenting financial transactions, assuring the accuracy and precision
with which an entity's monetary situation is reflected.

 Reliable

The foundation of financial reporting is reliability, and accounting conventions play a critical role in
maintaining this vital quality. Financial statements correctly reflect the financial status and
performance of a business when standards are used consistently. To make wise decisions,
stakeholders—including creditors and investors—depend on the accuracy of financial data.

 Comparison

Comparing various entities in a meaningful way is made possible by uniform accounting rules. This
comparability is essential for investors, analysts, and other stakeholders looking to assess the
financial standing and performance of different companies. It makes benchmarking easier and helps
spot market trends, which leads to better decision-making.

Key Differences Between Accounting Concepts And Conventions

Now that you are clear about what accounting concepts and conventions are regarding a business
financial perspective let us look below to understand the difference between the two:

Basis Accounting Concept Accounting Conventions

Meaning The accounting concept is known to be a Accounting conventions are known to be

process that helps prepare and record the such principles that act as restrictions
financial transactions in an organisation, along regarding organisational transactions that
with organising the bookkeeping processes. are unclear or complicated.

Based On It is based on reason, logic and evidence. Conventions are based on custom, tradition
and judgement.

Consistency Remains consistent as well as stable over a May change throughout the period, for
period of time. instance, if changes in accounting
regulations and standards happen.

Applicabilit The accounting concept applies to all entities. Applicability of accounting conventions may
y change as a power region or country.

Disclosure Has to be disclosed in the company’s financial It may be disclosed in the financial
statements. statements of a firm to make it easy to
compare and understand.