Accounting conventions are 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.
There are four main conventions in practice in accounting: conservatism; consistency; full disclosure; and materiality.
- Convention of consistency: The convention of consistency provides that the business shall follow the same accounting principles and methods for upcoming accounting periods. Consistency helps the users of accounting to make conclusions and draw comparisons between financial statements of different accounting periods. The financial statements between two or more accounting periods can be only compared when the accounting convention of consistency is followed. The convention of consistency helps to make financial statements more accurate and helps the management as well as users of accounting to make effective decisions.
- Convention of conservatism: This convention is based on being prudent. The business shall record all the expenses and liabilities when it sees uncertainty of incurring loss or liability. The business shall take into consideration the worst possible scenarios and provide for those scenarios in the financial statements. If the business is certain of realizing the revenue, only then it shall record as such in the books of accounts. The convention of the conservatism of accounting advises to provide for all the losses and liabilities and understate the profits and assets.
- Convention of materiality: The convention of materiality states that business shall include all the relevant and material facts separately in the financial statements. Material information refers to facts, if those are being left out or interpreted in any other way other than what it is in the financial statements, it could lead to influencing the decisions of users of financial statements. If any information does not influence the decisions of users of accounting, then that information is not considered material in nature.
- Convention of full disclosure: It provides that all the relevant and material information shall be properly disclosed in the preparation and presentation of financial statements. Financial statements are analyzed by various stakeholders as management, employees, debtors, creditors, governments, banks, etc. Hence, management needs to be concerned about the performance of the business and plan the accounting policies accordingly. Banks and creditors are concerned about the well-being of the business and important ratios as liquidity ratios and interest coverage ratios. The management and employees are concerned that the business shall be on the right trajectory to achieve its medium- and long-term objectives related to growth. The business shall also appropriately disclose all the information that takes place between the date of the balance sheet and the date of publication of the balance sheet.