ACCOUNTING CONVENTIONS AND STANDARDS

Accounting conventions (or assumptions) are the basic rules of accounting which have become acceptable procedures over time. Accounting standards are laws for members of the professional bodies to follow.

Together the conventions and standards form a set of rules which allow accounting records and reports to be prepared in a similar fashion, regardless of the type of business or the form of ownership. The more important conventions are as follows:

The accounting entity convention is the basic principle that the personal transactions of the owner(s) should be kept separate from those of the business. The business is always viewed as a separate entity, regardless of whether the firm is a sole trader, a partnership, or a company.

The historical cost convention  states that all transactions are recorded at their original value, and adjustments are not made for inflation. This means that assets are not valued at what they could be sold for at the present time. All items stay in the accounting records at their historical or original price. This method is quite objective, as it relies on document evidence such as invoices and receipts. There are some exceptions to this rule, such as land purchased. Unlike most assets which lose value over time, land normally appreciates in value and may be revalued in some circumstances.

The going concern assumption conceives that a business will continue as a ‘going concern’ for an indefinite period. By following this rule, accountants can report long-term assets in a balance sheet. Otherwise all costs would have to be written off in their year of purchase. The going concern rule also allows accountants to cater for transactions which overlap over two consecutive years. This is a common occurrence for many credit transactions.

The accounting period convention shows how a business is performing in terms of profit, year on year. The continuous life of a business is divided into equal periods in order to calculate profit or loss. These arbitrary periods are known as accounting periods. The length of an accounting period may be a week, a month, a quarter, or a full year, but must not be any longer due to taxation requirements.

The matching principle is used to calculate a profit or loss figure for an accounting period by matching revenue for that period with the expenses over the same period of time. There are two basic methods of applying the matching principle:

1.    Cash accounting, where profit is calculated by matching revenue received with expenses paid.

2.    The accrual method where profit is determined by matching revenue earned with expenses incurred.

The consistency principle requires that the accounting methods used are applied consistently over consecutive accounting periods. Using the same accounting techniques allows the business to compare performance over time.

Verifiability is the concept that evidence should be available whenever possible to verify or check the details of financial transactions. Business documents such as invoices, receipts and cheque butts are the tools of verifiability.

Conservatism (prudence). Accounting can sometimes involve a degree of estimation. It is generally accepted that when trying to predict the future, it is better to err on the safe side. There is a tendency to allow for all possible losses and to recognise gains if reasonably certain that they will occur.

General Accounting Concepts

In addition to accounting conventions and assumptions, accounting is also influenced by several underlying concepts.

• Reliability. Accounting reports influence a wide range of financial decisions and need to contain reliable information.
• Materiality. All significant items must be reported in accounting reports. This allows for immaterial amounts to be omitted.  An item is deemed significant if its’ omission would influence financial decision-making.
• Comparability. Accounting reports are used to track changes in a firm’s performance over consecutive accounting periods. Users of reports must be able to compare results from different years.
• Relevance. Accounting information needs to relevant to the entity under examination. Only events relevant to the business entity are recorded and reported.

Accounting Standards

As economies grew, companies became bigger and more complex. The need arose for a set of commonly applied and accepted standards which could be followed by accountants. These standards were established in many countries during the 20^th century. The adoption of international standards has allowed countries to align their accounting practices, easing the bookkeeping processes where companies are selling their products or services in multiple locations or contracting workers across international borders. 

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