Major Accounting Concepts and Convention

This overview will walk through some of the major accounting concepts and conventions. Understanding these core concepts is crucial because they determine how accountants analyze, record, and report financial transactions. We’ll explore the meaning behind these terms in plain English and see how they are applied.

Overview of Accounting Concepts and Conventions

Accounting Concepts and conventions serve as the foundation for recording financial transactions and carrying out firm-related functions. When working as an accountant, it is critical to comprehend accounting concepts and conventions in order to follow all necessary procedures and guarantee that all accounting information is consistent and correct. Understanding each phrase and the distinction between the two will help you enhance your skills as an accountant.

What are Accounting Concepts

Accounting concepts are the basic assumptions and rules that underlie the preparation and presentation of financial statements. An accounting concept is an assumption used to prepare final accounts and record company transactions. It is a language designed to convey information that an accountant must record, categorize, summarize, and provide to their stakeholders.

Accounting concepts are abstract ideas that can be used to structure the operation of accounting situations and processes. They outline the parameters and limits that govern how an accounting firm functions. Accountants form their ideas over time, based on their experiences. They’re the pillars of the accounting world.

Major Accounting Concepts

The key concepts you need to know include the following:

Going Concern Concept

As an accountant, you assume the business will continue to operate. This means you value assets at cost, not liquidation value. Pretty straightforward, but important.

Accrual Basis

Revenue and expenses are recorded when incurred, not when cash is exchanged. So if you sell a widget in March but don’t get paid until April, you record the sale in March. Likewise, if you incur an expense in March but don’t pay until April, you accrue the liability in March. The accrual method provides a more accurate picture of the business’s financial performance during a period.

Consistency

Apply the same accounting methods and principles from year to year. If not, comparability is lost, and financial statements become useless. Of course, as accounting standards change, so must a company’s methods, but disclosure of the changes is critical. Consistency is key.

Prudence

When in doubt, be conservative. Don’t overstate assets or revenues, or understate liabilities or expenses. But also, don’t be overly pessimistic. Find the proper balance, that’s the accountant’s challenge. The result should be financial statements that investors and creditors can rely on.

Matching Concept

Expenses are matched with revenues in the period incurred. For example, the cost of goods sold is matched to sales revenue. This provides an accurate income statement.

Economic Entity Concept

The business is accounted for separately from the owners and other businesses. Only transactions that directly affect the business are included.

Monetary Measurement

Accounting only captures transactions in monetary terms. Non-monetary items like human resources are not directly captured.

Unit of Account

This concept requires determining whether an accounting transaction or event should be recorded as a whole or whether its components should be recorded separately. This helps in measuring the accounting elements accurately.

Dual aspect Concept

This concept states that every transaction has a dual effect and results in an equal change in assets, liabilities or equity.

Cost Concept

This concept states that assets and liabilities are recorded in the books of accounts at their actual purchase price. The assets and liabilities are not adjusted in the books of accounts for changes in market value.

Why are Accounting Concepts Important?

Accounting concepts and conventions are the fundamental assumptions upon which the accounting principles are based. These help in recording and reporting the accounting information.

Accounting concepts establish a common approach that all accounting businesses can use to ensure consistency and logic in decision-making for tasks like budget planning.

These ideas are important for the following reasons:

• They establish accounting rules for a corporation.
• They provide a foundation for resolving accounting issues that may arise.
• They verify an accountant’s recorded information in a timely manner.
• They ensure that enterprises and organizations do not cheat when filing their financial reports.

The concepts ensure financial information is relevant, reliable, and comparable. They provide structure to the accounting world so readers of financial statements get an accurate view of a company’s financial position and performance.

What are Accounting Conventions?

An accounting convention is a set of principles that help businesses decide how to manage certain business transactions that accounting standards do not completely address. While these standards are not legally obligatory, most accounting bodies recognize them as a means of communicating the same concept to others.

Accounting conventions are the rules and guidelines that accountants follow when preparing financial statements. They’re part of generally accepted accounting principles (GAAP) and help ensure consistency and comparability between companies.

Accounting bodies employ accounting conventions to ensure consistency, clarity, and solve practical difficulties that arise when generating financial accounts. Accounting practices create new accounting conventions as new financial products, concerns, and developments emerge.

Major Accounting Conventions

Accounting conventions refers to the customs and traditions which guide the accountants while recording the accounting transactions and preparing the financial statements. These conventions help to make the accounting information meaningful and comparable.

The major accounting conventions are:

Consistency

The convention of consistency means that the accounting policies and methods should be applied consistently from one accounting period to another. Any change in the method should be clearly stated along with its impact. This helps in making the financial statements comparable over different periods.

Conservatism

The convention of conservatism means that the accountant should exercise caution while recording the transactions and preparing the financial statements. The revenue should not be overstated and expenses should not be understated. This convention leads to showing the minimum possible profit or maximum possible loss.

Materiality

The convention of materiality means that only material or significant information should be disclosed in the financial statements. Immaterial items need not be disclosed. Materiality depends upon the size and nature of the item under consideration.

Full Disclosure

The convention of full disclosure means that all material and significant information should be fully and fairly disclosed in the financial statements. This helps the users to understand and interpret the financial statements properly.

Accounting conventions provide guidance to accountants and help standardize how financial information is recorded and reported. Following these conventions helps produce financial statements that are reliable, comparable, consistent and useful to users.

Why are Accounting Conventions Important?

Accounting conventions refer to the rules and practices adopted by accountants universally while recording and presenting accounting information. Accounting conventions enable businesses to develop their own operating practices.

Here are some major advantages of accounting conventions:

• They provide a standardized, all-inclusive methodology that any company can employ.
• They make comparing financial periods easy to understand.
• They ensure that accounting bodies report transactions in the same manner.
• They simplify the process of comparing a company to a competitor because they all use the same procedures.

Accounting conventions promote consistency, prudence and transparency in financial reporting. They enable meaningful analysis and comparison of financial statements over time and between entities.

Accounting Concepts vs. Conventions: What’s the Difference?

Accounting concepts and conventions refer to the assumptions and rules that are used to prepare financial statements. The main difference between them is that concepts are fundamentals and conventions are practices followed by accountants based on accounting concepts.

Follow-through

Accounting conventions are less restrictive because they are theoretical, and not all firms adhere to them. Accounting concepts, on the other hand, are established methods that accountants adhere to. It  provide a fair and accurate view of a financial statement.

Uniform adaptation

Different businesses agree to apply accounting concepts uniformly. Accounting conventions, however, are not uniformly used by businesses and differ from one another.

Legal recognition

Accountants legally recognize concepts but do not explicitly acknowledge accounting conventions. The accounting concepts are governed by the Generally Accepted Accounting Principles (GAAP), which are accounting standards adopted by the United States Securities and Exchange Commission.

Bias

Accounting concepts are universal and free of bias, but accounting standards are highly susceptible to bias. This is because different accounting practices create accounting conventions based on their views and personal judgments.

Priorities

Accountants employ accounting concepts when maintaining accounts, and accounting conventions when preparing a financial statement at the end of an accounting cycle.

Following these concepts allows companies to paint an accurate picture of their financial health and performance over time. Deviating from them would make it difficult for investors and analysts to understand and compare companies.

Conclusion

Accounting concepts and conventions refer to the rules and guidelines that companies follow to record business transactions. They establish standards and ensure consistency in how financial statements are prepared.

Following these concepts, conventions and principles helps ensure accounting information is reliable, relevant, and meaningful for business stakeholders.