All About Accounting Concepts and Conventions With Examples

Accounting is an important part of a business, providing an organised and systematic way to record the financials. However, to implement the accounting processes efficiently, it is important to follow certain principles pointed out in the form of accounting concepts and conventions. If you follow the accounting concepts and principles accurately, it will help you make informed business decisions to grow your company.

In this article, we will dive deeper into the details of accounting concepts and conventions, along with their types, examples and differences.

What are Accounting Concepts?

The accounting concept is a process that helps prepare and record the financial transactions in an organisation, along with organising the bookkeeping processes. When you implement accounting concepts effectively, it encourages businesses to integrate and interpret financial transactions into meaningful accounting processes.

It is always important for business accountants and owners to clearly understand the basic accounting concepts. Such understanding helps in integrating uniformity and consistency within the business accounting processes. 

Both accounting concepts and principles are important to implement within the organisation as they help analyse different financial rules, theories and situations and make financial decisions based on them.

Importance of Accounting Concepts

You can understand the aspects of accounting concepts clearly once you understand why knowing and implementing accounting concepts is important for you, which are as follows:

• Consistency and comparability

Accounting principles are important because they provide uniformity and comparability in financial reporting. For example, the going concern notion believes that a firm will continue to exist indefinitely. This assumption enables financial statements to be prepared with a long-term perspective, allowing for meaningful comparisons over numerous accounting periods. 

• Risk management

The prudence concept promotes a cautious approach to financial reporting. This approach aids firms in risk management by recognising possible losses immediately but only recognising rewards when they are realised. Setting up provisions for possible bad debts based on past trends, for example, demonstrates a responsible approach to risk management. 

• Support in decision-making

Accounting principles give organisations a standardised framework for keeping track of financial transactions, allowing them to produce accurate information quickly. A more accurate depiction of a company's financial situation is provided by the accrual concept, which recognises revenues and costs as they are generated or spent. Because accurate financial reporting gives stakeholders a comprehensive picture of a company's profitability and financial health, it facilitates effective decision-making.

• Credibility

Applying accounting principles strengthens financial statements' legitimacy and fosters stakeholder trust. By matching revenues with their associated expenditures, the matching concept keeps profits from being manipulated by ensuring that income aligns with the spending required to produce it. This fosters trust among creditors, investors, and other stakeholders who depend on financial statements to evaluate its health and sustainability.

Types of Accounting Concepts

Here is a list of different types of accounting concepts that you can implement in your business as per the requirements and situations of the company:

1. Going concern concept

According to the going concern concept, a firm will continue to operate indefinitely. This assumption has an impact on financial statement preparation, allowing accountants to portray long-term assets at their historical cost and giving stakeholders a more realistic picture of a company's financial health in the long run.

2. Business entity concept

In terms of the business entity concept, a business is a distinct economic entity from its owners. This notion guarantees that personal and corporate money are kept separate, allowing for transparent financial reporting. It facilitates measuring the success of the firm independent of its owners' financial actions, fostering openness and accountability.

3. Accrual concept

The accrual concept mandates that revenues and costs be recognised as they are received or spent, regardless of financial movements. This idea improves financial statement accuracy by matching them with the economic content of transactions and giving stakeholders a more complete knowledge of a company's financial status.

4. Money measurement concept

According to the money measurement concept, only monetary transactions should be documented in accounting. This approach makes quantification and comparison easier, ensuring that financial statements contain relevant and comparable information for decision-making.

5. Accounting period concept

The accounting period concept separates a company's economic existence into discrete periods, often a fiscal year, for financial reporting. This approach enables timely and consistent reporting, assisting stakeholders to evaluate a company's performance and make educated decisions at precise intervals.

6. Dual aspect concept

According to the dual aspect concept, every financial transaction includes two components: a debit and a credit. This double-entry technique keeps the accounting equation (Assets = Liabilities + Equity) balanced, allowing for a systematic approach to documenting and assessing financial transactions.

7. Revenue realisation concept

As to the income realisation concept, income should be recognised when it is earned, regardless of when payment is received. This notion prevents revenue from being recognised prematurely, aligning financial statements with the actual delivery of products or services and improving the trustworthiness of reported revenues.

8. Historical cost concept

The historical cost concept assesses assets at their original cost, giving financial reporting a solid and objective foundation. This notion improves dependability by minimising subjective values and guaranteeing that financial statements accurately represent asset purchase costs.

Examples of Accounting Concepts In Practice

To understand the above-discussed types of accounting concepts, you need to have a practical understanding so as to implement the same. Here are some examples of each accounting concept you read above.

• Going concern concept

In the case of this concept, when valuing its machinery and equipment on the balance sheet, a manufacturing firm expects it will be used for a lengthy period of time, indicating the notion that the business would continue operations indefinitely.

• Business entity concept

If the proprietor of a small firm buys a personal laptop, the firm entity concept guarantees that this personal spending is not reported in the company's financial records, preserving a clear boundary between personal and business operations.

• Accrual concept

The accrual concept is used by a consulting business that provides services, for example, in December but receives payment in January. The revenue is recognised in December when the service is delivered, regardless of the actual cash received.

• Money measurement concept

When a corporation registers the acquisition of a new piece of machinery in monetary terms, it ensures that only transactions with quantifiable monetary worth are included in the financial statements.

• Accounting period concept

A corporation that prepares quarterly financial statements follows the accounting period concept by disclosing its financial performance and position every three months, giving stakeholders timely insights into the company's growth.

• Dual aspect concept

When a company borrows money from a bank, the dual aspect concept guarantees that both the liability (the loan) and the matching asset (cash) are recorded, keeping the basic accounting equation balanced.

• Revenue realisation concept

A software firm recognises revenue if a consumer purchases a software licence, regardless of when the payment is made. This use of the revenue realisation concept corresponds to completing the revenue-generating process.

• Historical cost concept

If a corporation buys a building, the historical cost concept requires the asset to be recorded at its original purchase price, giving a solid and objective foundation for the value of the financial statement.

What are Accounting Conventions?

Accounting conventions, also known as doctrine, are known to be principles that act as restrictions regarding organisational transactions that are unclear or complicated. Even though accounting conventions do not act as legally binding, these are considered generally accepted principles helping to maintain consistency within the financial statements of a company. 

The standard financial reporting system processes the information and uses accounting conventions to compare the different aspects of the transaction, along with analysing its relevance, application and full disclosure in the financial statements. The accountants in a company adopt the use of these conventions so that they act as a guide while preparing accounting statements and reports.

Importance of Accounting Conventions

To have a clear understanding of what accounting conventions are, it is necessary for you to understand their importance. Let us check below to get a clear idea of the importance of accounting conventions in a business:

• Different entity

Accounting norms are critical in dealing with various entities in the financial environment. These conventions guarantee that companies, regardless of their type of business, adopt standardised practices for documenting financial transactions by setting consistent criteria. This consistency is critical for establishing a level playing field, facilitating fair comparisons across companies, and developing a thorough knowledge of financial statements among stakeholders.

• Understanding

Accounting conventions provide financial experts and stakeholders with a unified language. They provide a common knowledge of how financial data is recorded and reported, which allows a correct interpretation. This understanding is critical for decision-making because it enables users to analyse financial information and make educated decisions based on a set of standardised rules.

• Impact on money

One of the paramount aspects of accounting conventions is their direct impact on representing monetary values in financial statements. These conventions provide a controlled and standardised method of measuring and documenting financial transactions, assuring the accuracy and precision with which an entity's monetary situation is reflected. 

• Reliable

The foundation of financial reporting is reliability, and accounting conventions play a critical role in maintaining this vital quality. Financial statements correctly reflect the financial status and performance of a business when standards are used consistently. To make wise decisions, stakeholders—including creditors and investors—depend on the accuracy of financial data. 

• Comparison

Comparing various entities in a meaningful way is made possible by uniform accounting rules. This comparability is essential for investors, analysts, and other stakeholders looking to assess the financial standing and performance of different companies. It makes benchmarking easier and helps spot market trends, which leads to better decision-making.

Types of Accounting Conventions

Similar to accounting concepts, accounting conventions also have different types that help implement the concept in business financials efficiently. Here is a list showcasing the types of accounting conventions:

1. Convention of conservatism

One of the most important accounting conventions that accountants apply in the business is the conservatism principle. This principle suggests that if two values are associated with a specific transaction, the lowest must be recorded on the asset or income side of the financial statement. In this case, the possibility of loss is taken care of. 

This accounting convention aims to understate profits and assets while dealing with business losses. Such practice mostly helps in enhancing the overall reliability of company stakeholders on the financial statements.

2. Convention of materiality

This accounting convention is related to all the relative information available for an item or event of a company's financial transactions. An item is generally considered material with respect to the influence it has on an investor's decisions. The aspect of materiality differs from one organisation to another.

For instance, in the case of a small company, certain information can be material but the same information may not be material for a large organisation. Hence, the application of materiality convention entirely depends on the context of analysis.

3. Convention of consistency

Consistency convention denotes that the same principles of accounting must be implemented to prepare the business financial statements, year after year. From the prepared financial statements, it is important to draw a meaningful conclusion of the same company when a comparison is made of the statements over a period.

Such financial comparisons can only be made if the same accounting practices and principles are followed uniformly by the firm over a  period of time. In the case of different accounting policies implemented every year, the comparison will not stand fruitful, and the result can also impact financial decisions.

4. Convention of full disclosure

The principle of full disclosure mandates the comprehensive revelation of all pertinent details in financial statements. This entails a thorough, impartial, and ample disclosure of accounting information. 

‘Adequate’ denotes a satisfactory amount of information to be divulged, ‘fair’ implies equitable treatment for users, and ‘full’ demands a complete and detailed presentation. Consequently, the convention underscores the necessity for financial statements to fully disclose all pertinent information. 

Examples of Accounting Conventions In Practice

Once you have understood what the different types of accounting conventions are, it is essential to have a deep knowledge of the same in the form of an example. Let us check below the examples of each accounting convention that we have discussed in the above section.

• Conservatism

Suppose in December 2022, Raj agrees to purchase a car from Mohan Motors Inc., which will be delivered to him in January 2023. From the point of view of Mohan Motors Inc., it stands as good news. But, it is possible that in future due to certain unforeseen circumstances, the deal gets broken.

Hence, according to the convention of conservatism, the revenue earned from the sale of the car is not recognised in the books until the actual delivery of the same happens.

• Materiality

Let us take into account that a large organisation has incurred a loss of Rs.150,000 due to a certain customer. The net worth of the business is around Rs.300,000,000. Hence, the loss of 0.05% can be considered immaterial for the business. 

However, if a small organisation with a net worth of Rs.250,000, a loss of Rs.150,000 will be considered as a loss of material information. Therefore, the situation and context define the application of materiality for both businesses.

• Consistency

An organisation must use the same depreciation calculating method for all their fixed assets for all financial years. This helps maintain consistency in the results of depreciation over time. 

• Full Disclosure

For a business, disclosure of information, such as encumbered assets tends to be a full disclosure. Another example of full disclosure of information by a business is letting the stakeholders know the reason for changing the application of accounting principles or methods.

Key Differences Between Accounting Concepts And Conventions

Now that you are clear about what accounting concepts and conventions are regarding a business financial perspective let us look below to understand the difference between the two:

Conclusion

Analysing the aspects of accounting concepts and conventions is important for accountants of businesses. Different business, as well as financial decisions, depend on the application of these two aspects. Even though both are different from one another, their implementation in financial statement preparation is necessary for the betterment of the business. 

Hence, by reading the points, you can get a distinctive idea of what they are and how they can be applied in your business to achieve success.