ACCOUNTING CONCEPTS AND CONVENTIONS
Accounting is a business language, which is used to communicate financial information to the company’s stakeholders, regarding the performance, profitability and position of the enterprise and help them in rational decision making. The financial statement is based on various concepts and conventions.
Accounting is full of assumptions, concepts, standards, and conventions. Concepts such as relevance, reliability, materiality, and comparability are often supported by accounting conventions that help to standardize the financial reporting process.
Accounting concepts which is also referred to as principles and fundamental accounting postulate are rules adopted as guides to actions in the preparation of accounting statements.
Accounting concepts are the fundamental accounting assumptions that act as a foundation for recording business transactions and the preparation of final accounts.
- Entity Concept: This concept draws a distinction between the business and the owner. This concept states that the business is a personality of its own, which can sue and be sued in its own name and not in the name of the owner.
- Going Concern: This is an assumption that an organization will exist forever (at least in the force able future) except otherwise proved. This concept is the authority behind the recording of assets in the books where values of properties are extended into the future especially as concerning their benefits.
- Money concept: This states that all financial transactions must be expressed with the currency in use in that location. The currency used in recording the financial data can be translated into other currency using the convertible nature of money.
This concept believes strongly that only financially oriented transactions should be given effect.
- Historical cost concept: This states that the cost values of the financial transaction should be used in recording such a transaction instead of fair current market values e.g. where Olu purchased a “Honda Car” latest series for N2million in Lagos while his friend Musa bought the same brand of Honda Car at the sum of N1.5million in Togo. It is expected that Olu should record his vehicle based on N2million and not otherwise while Musa do as N1.5 million and not otherwise.
- Matching concept: (Revenue vs. Expenses). This is otherwise known as accrual concept which states that the income of a period should agree with the expenditure of the same period. Consequently, the relevant cost incurred in fetching a particular income should be matched together in arriving at the actual profit or loss of the concern.
- Periodicity Concept: This is also known as time interval concept which states that financial records and statements should be prepared for a period of twelve calendar months as agreed to by the users of financial statements and the accounting world in general.
- Double Entry concept: This states that in any transaction. i.e. a financial event, there must be a debit and a corresponding credit entry. The total debit side must be equal or agree with the credit side which is the reason behind the agreement of the balance sheet.
- Realization Concept: This states that the income and expenditure of a concern must be objectivity determined i.e. income earned by an organization should be based on the services rendered, received and receivables in line with the reality of the transaction. For instance, the income received from a contract award should be used on the cost of work incurred.
- Dual Aspect Concept: It is the primary rule of accounting, which states that every transaction effects two accounts.
- Accrual Concept: The concept states that revenue is to be recognized when they become receivable, while expenses should be recognized when they become due for payment.
Accounting convention is used in resolving conflicts arising out of the application of the concepts. Accounting conventions, therefore, provide the way out, or better still, to resolving all identifiable conflicts and puzzles emanating from the application of concepts.
Accounting conventions imply the customs or practices that are widely accepted by the accounting bodies and are adopted by the firm to work as a guide in the preparation of final accounts.
The accounting conventions are as follows:
- Consistency: This convention simply states that accountants and financial practitioners’ are free to choose from alternative policies and such a policy so taken must be strictly followed without deviations. This, by implication, portrays accountants as reliable, dependable, trustworthy and forthright in their professions. The job of an accountant demands transparency as a basis of building trust.
- Prudency: This convention is also known as conservatism which states that accountants and book keepers should not anticipate future profit but future loss. This convention portrays the accountant as a person that is pessimistic and not optimistic.
- Materiality: The term materiality is relative. i.e. what is material to one person is immaterial to the other. The essence of Materiality is to assess the significance of an item in relation to the whole and such item will be treated based on its size or monetary significance.
- Objectivity: This states that financial records should be prepared in line with verifiable evidence i.e. whatever is considered as income or expenditure should be supported with documentary evidence and facts.
Accounting Conventions Applicable Areas
Inventory valuation can benefit from accounting conservatism. When determining the reporting value of inventory, conservatism dictates that the monetary value be the lower of historical cost or replacement cost.
Accounting conventions also state that line-item adjustments should not be made for inflation or market value. As a result, book value may occasionally be less than market value. For example, if a building costs $50,000 when purchased, it should be recorded as such, regardless of whether it is now worth more.
Differences Between Accounting Concept and Convention
The Key difference between accounting concepts and conventions are presented in the points given below:
- The accounting concept is defined as the accounting assumptions that the accountant of a firm follows while recording business transactions and preparing final accounts. Conversely, accounting conventions imply procedures and principles that are generally accepted by the accounting bodies and adopted by the firm to guide at the time of preparing the financial statement.
- The accounting concept is nothing but a theoretical notion that is applied while preparing financial statements. On the contrary, accounting conventions are the methods and procedures which are followed to give a true and fair view of the financial statement.
- While accounting concept is set by the accounting bodies, accounting conventions emerge out of common accounting practices, which are accepted by general agreement.
- The accounting concept is basically related to the recording of transactions and maintenance of accounts. As against, the accounting conventions focus on the preparation and presentation of financial statements.
- There is no possibility of biases or personal judgment in the adoption of accounting concepts, whereas the possibility of biases is high in the case of accounting conventions.