Understanding the 4 Conventions in Accounting
Introduction: The 4 Conventions in Accounting
What are Conventions?
Within the broad principles of accounting, conventions provide specific guidelines and limitations. They help clarify the application of these principles in recording and reporting financial transactions. In modern accounting, we adhere to four key conventions:
- The Convention of Consistency
- The Convention of Conservatism
- The Convention of Materiality
- The Convention of Objectivity
1. The Convention of Consistency
This convention emphasizes the importance of using the same accounting methods and procedures consistently from one period to the next. For instance, if the FIFO (First-In, First-Out) method is chosen for inventory valuation, it should be maintained unless a compelling reason necessitates a change. Any change in method and its impact should be clearly disclosed in the financial statement footnotes to ensure transparency and comparability.
This convention promotes consistency and comparability in financial reporting, facilitating a better understanding of a company’s performance over time.
2. The Convention of Conservatism
The Convention of Conservatism dictates that when faced with equally acceptable accounting alternatives, the option that results in lower asset values and higher liability values should be chosen. This approach ensures that potential losses and risks are recognized promptly, while potential gains are only recognized when realized.
For example, if the market value of inventory falls below its cost, the lower market value should be used for reporting. This convention aligns with the principle of prudence in financial reporting.
3. The Convention of Materiality
This convention states that only information that is significant enough to influence the decisions of users of financial statements should be disclosed. Insignificant or immaterial details can be omitted to avoid unnecessary complexity and expense.
The determination of materiality is subjective and depends on the context and nature of the information. While a small discrepancy might be immaterial in isolation, its recurrence could indicate a systemic issue requiring attention.
4. The Convention of Objectivity
The Convention of Objectivity emphasizes the use of verifiable and unbiased evidence in accounting. When multiple sources of information are available, the most objective and reliable source should be prioritized.
For example, when valuing an asset, an invoice providing the purchase price would be considered more objective than a subjective appraisal, even if conducted by an expert. This convention ensures that financial reporting is based on credible and impartial data.
Conclusion
Accounting relies on a set of principles and conventions to ensure accuracy, consistency, and transparency in financial reporting. These conventions provide practical guidelines for applying accounting principles in various situations, ultimately contributing to the reliability and usefulness of financial information for decision-making.
Bibliography
Introductory Accounting
Team of teachers FEA USP
Editora Atlas – 9th edition