Question

Explain the accounting conventions.

Answer 1

These principles are exceptions to the basic accounting principles stated above. These modifying principles are as under.

1. Principle of Materiality: This principle is an exception to the principle of full disclosure. According to this principle, items having an insignificant effect or irrelevant to the user need not be disclosed. American Accounting Association defines materiality thus: "An item should be regarded as material if there is reason to believe that knowledge of it would influence decision of informed investor."
2. Principle of Consistency: This principle states that accounting procedures and methods should remain consistent from one year to another. These should not be changed from year to year as otherwise the net profits of different years will not be comparable. For example, a firm can choose any one of the several methods of depreciation. But the method once chosen should be followed consistently year after year.
3. Principle of Conservatism or Prudence: According to this principle, record all anticipated losses but ignore all anticipated gains. Conservatism is thus, the policy of playing safe. The principle of conservatism should be applied carefully. Otherwise, it may result in the creation of secret reserves, which is against the principle of full disclosure.
4. Principle of Timeliness: Financial statements provide useful information on the basis of which users take important decisions. If the statements contain old and late information they are of little use. Therefore, this principle states that the financial statements should be prepared quickly at the end of the accounting period. They should be made available to the users at the earliest possible time. To ensure timely information, the Companies Act requires companies to report quarterly results of their operations.
5. Principle of Industry Practice: Sometimes the peculiar nature of an industry may require departure from the basic accounting principles. There may be a long standing accounting practice in an industry. For example, a particular method of valuation of stock may be prevailing in an industry. While preparing its financial statements every firm in that industry must follow the prevailing accounting practice of that industry. Otherwise the results of the firm will not be comparable to those of other firms.