Accounting Convention: Definition & Example

KEY TAKEAWAYS

• Accounting conventions got created to make accounting more comparable and consistent. 
• The primary types include conservatism, consistency, full disclosure, and materiality. 
• Businesses aren’t required to use accounting conventions, but they are commonly adopted.

What Is an Accounting Convention? 

An accounting convention is a set of rules and practices. These are guidelines for recording your business transactions. Why? Because some financial statements can have transactions that aren’t clear. 

However, there’s a difference between this and accounting standards. Accounting conventions are common among accounting professionals. But, there’s no legal obligation to follow them. This is because there can be different accounting policies and financial conditions. 

These rules got created to make accounting more comparable and consistent. One of the biggest reasons is to compare financial statements from more than one business. As well, they help to understand the financial position and performance of business activities. 

Accounting conventions aren’t legally binding or mandatory. But they help with understanding unclear or complicated business transactions. At the end of the day, this helps maintain consistent financial statements. 

What Are the Types of Accounting Conventions? 

The main accounting conventions include: 

• Conservatism 
• Consistency 
• Full disclosure 
• Materiality 

Let’s take a closer look at each and how they work.

Conservatism 

With the accounting conservatism convention, assets and liabilities get recorded at their lowest. This helps with a more conservative estimate of your financial position. Expenses and liabilities get recorded if there’s a chance of loss or liability. As well, a business will record profits and assets but only when they’re realized. 

Basically, it’s a good way to play it safe. Accountants will consider any scenarios of potential loss when recording these transactions. 

Consistency

The consistency convention follows the same methods and accounting principles. Staying consistent allows a business to accurately compare financial statements. Even if they are from different periods. 

Implementing the consistency accounting convention doesn’t mean you must keep it forever. If you want to change your accounting methods, you can. But, if you do you need to make notes of changes in financial statements. 

This convention makes financial statements more accurate. Which can help in making better business decisions. Valuing inventory is a good example of conservatism. You record all inventory at its current market value or acquisition cost, whichever is the lowest. 

Full Disclosure

The full disclosure accounting convention relates to relevant and important information. Anything about the financial status of your business needs to get highlighted, and this gets done in your financial statements. 

For example, if your business has lawsuits or contingent liabilities, the details must get included in adjoined notes.

Materiality 

In this convention, you only include relevant or important facts. It’s information that could impact or potentially influence decisions. 

For example, let’s say some material facts get left out or misreported. This might lead to a decision being influenced. That said, materiality depends on the nature of the information and this can change from year to year. 

Summary

Accounting in any business is important. But there can be times when information might not be comparable to unclear. Accounting conventions help make things more consistent and easier to compare. Common accounting processes still get used, but these allow for making effective decisions. 

They also help with understanding the financial position and performance of your business. The conventions aren’t legally required or compulsory. But they help maintain consistent financial statements and an accurate balance sheet. Your financial reporting process will also improve and you can avoid bad debts.