Explanation of Nine Conventions of accounting

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 Explanation of Nine Conventions of accounting

Accounting, without human involvement, encompasses the process of recording systematically, summarizing, analyzing, and reporting financial transactions of any business or organization. It keeps records of all monetary activities, such as sales, purchases, income, and expenses, carried out by the business in order to reflect a correct image of its financial health. 

In essence, accounting predominantly concerns itself with the preparation of financial statements, including the balance sheet, income and expenditure statement, and cash flow statement, which serve to give further insight regarding the financial performance and position of a business entity. These statements are the basis on which management, investors, creditors, and other stakeholders make their conclusions. Accounting ensures that legal and regulatory provisions are adhered to, helps in efficient allocation of resources, and facilitates financial planning and control.



1. Business Entity Concept

The business entity concept states that a business is an entity with existence apart from its owners. Such separation makes it that the financial activities of the business are recorded and reported independently of the personal financial activities of the owners. This is an important principle in that it makes it possible to have a clear, true reflection of the business in financial reporting so that the financial position and performance are not blurred by owners' personal transactions. For instance, if an owner withdraws cash for personal use, it would be treated as a drawing and not an expense of the business, thus keeping the records of the business intact.


2. Money Measurement Concept

According to the money measurement concept, only those transactions which can be expressed in monetary terms are recorded in the financial statements. This principle ensures that all the recorded data is uniform and comparable; hence, clear and consistent financial reporting. Thus, such non-quantifiable items as employee skill, customer satisfaction, and brand loyalty do not find their way into financial records. This convention ensures that all the transactions recorded are objective and verifiable. For instance, while recording a transaction for the purchase of a machine, it will be booked at cost and not its physical appearance.


3. Going Concern Concept

The going concern concept implies that a business will continue its operations for the foreseeable future and does not have the intention or need to liquidate or significantly scale down its operations. This makes the principles affect the valuation of assets and liabilities, where they are recorded based on use rather than their possible liquidation value. As an example, machinery is depreciated over its useful life instead of being stated at its probable sale value. This assumption gives long-term stability and uniformity of financial reporting for planning and investment.


4. Concept of Cost: Historical Cost

The cost concept, otherwise known as the historical cost principle, states that assets are recorded initially at their cost at the date of purchase and remains the basis for all subsequent accounting for the asset. This principle is associated with reliability and objectivity in financial reporting because the historical cost figure is verifiable. This concept does not include market fluctuations in the financial statements, which states that the assets will not be adjusted for the changes in market value. For instance, land purchased for $100,000 will continue to be recorded at that amount. Current market value might be higher, but it won't get changed.


5. Realization (Revenue Recognition) Concept

Hence, the realization concept or revenue recognition principle states that a revenue must be included only in the accounting period in which it is earned. This way, revenues will be matched with expenses incurred in earning them in correct periods of earning hence painting correct pictures for the performance of the firm. For example, when a business offers services on credit, revenues are recognized at the time the service is delivered not when money is actually received. This principle is particularly instrumental in matching revenues with expenses which a business has incurred in order to generate such revenues so that financial statements truly reflect the economic activity of the business.


6. Matching Concept

The matching concept requires that expenses should be matched with the revenues they help generate in the same accounting period. This principle ensures that financial performance is accurately represented by properly matching revenues and expenses within the same period. For example, the cost of the goods is incurred in the same period as the sales revenues generated from selling those goods. Proper matching of related costs with revenues gives an accurate picture of the profitability of the company and ensures that income statements actually show the proper financial results of the operations.


7. Accounting Period Concept

The accounting period concept is used to divide the life of a business into specific time periods—usually months, quarters, or years—for the purpose of reporting financial results. It allows timely and periodic reporting of financial performance that enables comparisons over different periods. The preparation of financial statements is made at regular intervals to let stakeholders get updates regarding the financial health of the business. For instance, a business might prepare annual financial statements for the fiscal year ending December 31. The use of this convention permits monitoring and evaluation of financial performance on a consistent basis.


8. Full Disclosure Concept

The full disclosure concept requires that all the material information affecting the financial statements must be disclosed in the financial reports. This convention assists transparency and allows users to form decisions based upon relevant information. Unless they are otherwise disclosed on the face of the financial statements, all significant events, conditions and accounting policies are disclosed in the notes to the financial statements. The concept therefore requires every company to disclose contingent liabilities, significant events taking place after the balance sheet date and also changes in accounting policies. It ensures completeness of financial statements and informativeness.


9. Consistency Concept

The consistency convention requires that accounting methods and principles be applied consistently from one accounting period to another so as to make financial statements comparable. The policy changes in accounting should therefore be disclosed and explained in a manner that allows the user meaningful comparison of performance in the financial statement in different periods. For instance, if an entity has changed its accounting policy in depreciation from straight-line to the declining balance method, the entity is under an obligation to explain and disclose the change. It ensures that there is comparability of the financial data overtime so as to provide a reliable base for analysis and decision-making.

These conventions form the foundation of generally accepted accounting principles (GAAP) and are essential for ensuring that financial statements are accurate, reliable, and useful for decision-making.

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