Accounting Convention

What Is an Accounting Convention?

Accounting conventions are guidelines used to help companies determine how to record certain business transactions that have not yet been fully addressed by accounting standards. These procedures and principles are not legally binding but are generally accepted by accounting bodies. Basically, they are designed to promote consistency and help accountants overcome practical problems that can arise when preparing financial statements.

Understanding an Accounting Convention

Sometimes, there is not a definitive guideline in the accounting standards that govern a specific situation. In such cases, accounting conventions can be referred to.

Accounting is full of assumptions, concepts, standards, and conventions. Concepts such as relevance, reliability, materiality, and comparability are often supported by accounting conventions that help to standardize the financial reporting process.

In short, accounting conventions serve to fill in the gaps not yet addressed by accounting standards. If an oversight organization, such as the Securities and Exchange Commission (SEC) or the Financial Accounting Standards Board (FASB) sets forth a guideline that addresses the same topic as the accounting convention, the accounting convention is no longer applicable.

The scope and detail of accounting standards continue to widen, meaning that there are now fewer accounting conventions that can be used. Accounting conventions are not set in stone, either. Instead, they can evolve over time to reflect new ideas and opinions on the best way to record transactions.

Accounting conventions are important because they ensure that multiple different companies record transactions in the same way. Providing a standardized methodology makes it easier for investors to compare the financial results of different firms, such as competing ones operating in the same sector.

That said, accounting conventions are by no means flawless. They are sometimes loosely explained, presenting companies and their accountants with the opportunity to potentially bend or manipulate them to their advantage.

Accounting Convention Methods

There are four main accounting conventions designed to assist accountants:

Areas Where Accounting Conventions Apply

Accounting conservatism may be applied to inventory valuation. When determining the reporting value of inventory, conservatism dictates that the lower of historical cost or replacement cost should be the monetary value.

Accounting conventions also dictate that adjustments to line items should not be made for inflation or market value. This means book value can sometimes be less than market value. For example, if a building costs $50,000 when it is purchased, it should remain on the books at $50,000, regardless of whether it is worth more now.

Estimations such as uncollectible accounts receivables and casualty losses also use the conservatism convention. If a company expects to win a litigation claim, it cannot report the gain until it meets all revenue recognition principles. However, if a litigation claim is expected to be lost, an estimated economic impact is required in the notes to the financial statements. Contingent liabilities such as royalty payments or unearned revenue are to be disclosed, too.