Accounting conventions are part of accounting principles and guidelines used to help companies determine how to record certain business transactions that have not yet been fully addressed by accounting standards. These procedures and principles are not legally binding but are generally accepted by accounting bodies. Basically, They are designed to promote consistency and help accountants overcome practical problems that can arise when preparing financial statements.
1. Convention of Disclosure: The Companies Act, 1956, prescribed a format in which financial statements must be prepared. Every company that fall under this category has to follow this practice. Various provisions are made by the Companies Act to prepare these financial statements. The purpose of these provisions is to disclose all essential information so that the view of financial statements should be true and fair. However, the term ‘disclosure’ does not mean all information. It means disclosure of information that is significance to the users of these financial statements, such as investors, owner, and creditors.
2. Convention of Consistency: This convention plays its role particularly when alternative accounting practice is equally acceptable. Moreover, consistency serves to eliminate personal bias. But if a change becomes desirable, the change and its effect should be clearly stated in the financial statements. Accounts should lend themselves easily to comparisons and contrasts. This convention increases accuracy and comparability of accounting information for prediction or decision making. This convention does not prohibit changes. If there is any change, its effect should be clearly stated in the financial statements.
3. Convention of Conservatism: This is a convention of caution or playing safe and is adhered to while preparing financial statements. Showing a position better than what it is, is not permitted. Moreover, it is not proper to show a position substantially worse than what it is.
4. Convention of Materiality: American Accounting Association defines the term materiality as “An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investor.” It refers to the relative importance of an item or event. Materiality of an item depends on its amount and its nature. Materiality in its essence is of relative significance. In the sense that some of the unimportant items are either left out or included with other items.
Therefore, unimportant items are either left out or merged with other items. The reason for this different treatment lies in the magnitude of their amount. The dividing line between material and immaterial varies according to the company, the circumstances of the transactions and economic significance. It should also be noted that an item considered to be material for one business firm, may be immaterial for another firm.