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
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
General Accounting Concepts
In addition to accounting conventions and assumptions, accounting is
also influenced by several underlying concepts.
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 20th 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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