Accounting: Doctrines and Conventions

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Accounting Doctrines and Conventions refers to set of rules, which are to be followed for obtaining objects of accounting. Here are the list of accounting doctrines and conventions:

Historical Cost Conventions

According to historical cost concept, asset should be recorded at its actual cost, not at its fair value. Historical cost represents money outlay or its equivalent in connection with acquisition, installation or any improvement of asset. So assets like brand name, technology, goodwill etc. which are acquired free of cost are not recorded in the Balance Sheet, though such assets has their market value. However, historical cost may undergo change in the following circumstances:

  1. Exchange Fluctuations: Foreign exchange difference arising on repayment of liabilities incurred, for the purpose of acquiring assets, should be adjusted in the carrying amount of the respective assets.
  2. Price Adjustments: Any adjustment made in the price after acquisition of the assets shall be taken care of.
  3. Changes in Duties: Any changes made in duties on the assets by Government shall be adjusted in historical cost.
  4. Depreciation: Every asset reduces its capacity with the passage of time or becomes outdated due to change in technology. Such reduction (i.e. depreciation) shall be adjusted in the historical cost of the assets.

Justification

  • Subjectivity: Valuation under historical cost is not influenced by estimation of persons.
  • Verifiability: Historical cost can be verified by interested parties with the helps of documents, records and vouchers.
  • Easy Accounting: It can be recorded easily as it is certain.
  • Easily Understandable: It can be easily understood, as it is not based on estimation.
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Criticism

  1. In an inflationary economy, it does not reflect the real worth of an asset.
  2. Historical cost based accounting may lose comparability.
  3. It fails to recognise assets, which does not have acquisition cost. For instance, goodwill, which does not have acquisition cost, can not be recognised as asset under this concept.

Disclosure Conventions

The main object of financial statement is to provide information regarding financial position of the concern to its users for making various decisions. Financial Statement must disclose all material information and does not conceal any material fact. The doctrine of disclosure implies that financial statement must provide understandable, relevant, reliable and comparable information to its users to achieve the object of financial statement.
To achieve the object, many financial statements contains following information as part of it:

  1. Accounting policies and method of accounting followed in its preparation.
  2. Fact and effect of any change in policy
  3. Information of transaction with related parties.
  4. Contingent liabilities and commitments
  5. Quantitative details of goods and investments
  6. Earning per share

Nowadays, due to importance of information and to create transparency, Companies Act, 1956 and Accounting Standards issued by the Institute of Chartered Accountants of India, have made it compulsory to disclose certain information in the financial statement.

Materiality Conventions

Doctrine of Disclosure requires disclosure of accounting policies. However, it does not mean that all information need to be disclosed. Only material information should be adequately disclosed. Material information are those information, the omission or misstatement of which, can influence the economic decision of the user. Further, the information, which influences the decision of users, is a matter of personal judgement. Further, judgement of materiality is the question of personal bias. An item may be material in one case but immaterial in another case.

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Consistency Conventions

Consistency refers to the use of same accounting approach, principles and procedures for period after period to determine income and financial position of the concern. It helps in easy comparison of the performance of the concern between two different accounting periods, as revenues and expenses of each period are measured on the same basis. It makes financial statements unbiased and free from manipulation.
However, if a policy is changed during the year, then the facts and its effects shall be properly disclosed as footnote of financial statement.

Conservatism Conventions

As per this convention, anticipate no profit but recognise all probable losses. When there are alternative value to the assets, then lower value shall be considered. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only best estimate in the light of available information. On the other hand, anticipated profits or favourable future events are recorded only after their occurrence and profits are recorded only when the same shall be realised though not necessarily in cash. In valuation of closing stock, accountant should consider lower of the cost or the net realisable value, is a general example of conservatism.
However, nowadays the concept is criticised on the ground that it understates the profit of the concern. Further, due to conservatism, financial statement may be influenced by personal bias.

Comparability Conventions

As per this convention, information provided in financial statement through accounting are comparable with the financial statement of past years. Further, such information is also comparable with that of different concerns. Through comparison, one can make better decision.

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Objectivity Conventions

Object of accounting is to show true and fair financial result and financial position of the organisation. Such object can only be fulfilled if information contained in the financial statement is supported by the evidence and there is minimum application of personal judgement of an accountant. Objectivity convention states that financial statement should be free from bias, to make it reliable and trustworthy.

Dependability or Reliability Conventions

Users of financial statement take their decisions on the basis of information supplied by accounting through financial concepts. If information provided is not correct, it may mislead the users. So, information provided in financial statement must be reliable. Hence, accounting procedure, which generates such information, must also be reliable.

Add more to the list, if we missed something.

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