Rules and Conventions of accounting

The rules and conventions of accounting are commonly referred to as the conceptual framework of accounting. As already discuss in the previous section accounting communicates financial information to the various stakeholders. It is necessary that there is uniformity in the preparation of financial statement of different business enterprises at a point of time and consistency over a period of time. To have uniformity and consistency in the financial statements they are prepared within a framework of “Generally Accepted Accounting Principles (GAAP)”. The Generally accepted accounting principles follows a conceptual framework which are expressed as postulates, convention, concepts, principals, axioms, etc. For our purpose we are going to use the term Accounting Principles Yorston, Smith and Brown defines accounting principles as “the body of doctrines commonly associated with the theory and procedure of accounting, serving as an explanation of current practices and as guide for selection of conventions and procedures where alternatives exist”.

The most important goal of accounting principles is to provide a coherent set of logical principles that form the general frame for the evaluation and development of sound accounting principles.

Generally Accepted Accounting Principles (GAAP) encompass the convention, rules and procedures necessary to define accepted accounting practice at a particular time. GAAP include not only broad guidelines of general application, but also detailed practices and procedures.

The accounting framework is based on the following conventions:

1. Convention of Disclosure: The doctrine of disclosure suggested that all accounting statements should be honest and to that end, full disclosure of all significant information must be made.

This doctrine lays emphasis on the actuality, materiality, objectivity and consistency of accounting data in order to disclose fully the true and fair view of the economic activities of a firm for a particular period. This doctrine is becoming more popular of present since most of the companies are joint stock companies and listed on the stock exchanges. In addition to the financial statements the reporting of accounting information is made by means of comments, footnotes, descriptive captions, supplementary schedules, etc. in financial statements.

2. Convention of Materiality : Materiality means relative importance. In other words whether a matter should be disclosed or not in the financial statements depend on its materiality. American Accounting Association (AAA) defines ‘Materiality’ as follows. “An item should be regarded as material if there is a reason to believe that knowledge of it would influence the decision of informed investors”. In this regard, the accountant is vitally concerned with the following two important matters:

1. Materiality of information; and

1. Materiality of amounts

The materiality depends on the amount and the nature of the account. It should be noted that this doctrine of materiality also refers to separate disclosure of information in the published financial statements.

3. Convention of Consistency : This doctrine implies that accounting rules, practices and conventions should be continuously observed and applied which implies that these should not be changed from year to year or one year to another. Consistency can be further sub-divided into following categories

1. Vertical Consistency : Where the same principle methods, practices are adopted within interrelated financial statements of the same date.

1. Horizontal Consistency : It helps to make proper comparison of the operations of a company from one period to another.

1. Third Dimensional Consistency : It helps to make a proper comparison of the operation between two firms with the same industry.

It should be noted that the doctrine of consistency does not preclude changes as long as of these changes are desirable and the effects of theme are made known.

4. Convention of Conservation : Conservatism refers to the principle and practices which are established by way of tradition, reluctance to change from established principles and practices and inclination to play safe.

As per this convention accountant does not assess any gain or income until the same has been realised or converted into money, but at the time of estimating expenses or losses the accountant goes beyond the doctrine of objectivity and makes a subjective estimate of possibility. It is for the reason, in accounting, proper provisions are always made against current profit for future losses and contingencies.                             

Therefore the common accounting practices are :       

(a)  Do not consider any income or gain till the same is realised in cash;                    

(b)  Create or make provision for future expected losses and contingencies on the basis of past performance.                     

The accounting process has its own syntax (Rules on which accounting entries are made in books of accounts) which is commonly known as Double Entry Book Keeping System. The basic system on which the accounting

process is based are known as Generally Accepted Accounting Principles      (GAAP) and Accounting Standards.

The basic steps used in measurement of accounting information are explained in the traditional definition of accounting by the AICPA which defines   accounting as “the art of recording classifying and summarizing in significant manner and in terms of money, transactions events which are, in part at least of a financial character and interpreting the results thereof” (AICPA, 1941).                         

Accounting principles are the basic assumptions, rules of operation, and essential characteristics that make up the framework for the construction of accounting financial statements.

In order to be useful, the accounting information must have certain characteristics, such as being dependable and practical. To be dependable, the accounting information must be unbiased, accurate, and verifiable. To be practical, accounting information must be predictable, prepared in a timely fashion, and be able to provide meaningful feedback. Additional characteristics are that the accounting information must be consistent, comparable, serve a utilitarian need (such as cost/benefit), and make a material difference.

Besides characteristics, certain operational rules are established as to the following:

• when revenue and expenses are reported; 
• how expenses are matched to revenue;
•  what to do when a choice can be made that might overstate or understate figures; and
• what information should be disclosed so that the reader will fully understand the circumstances under which the information is being presented.