The Difference Between Accounting Concept and Convention

Introduction

Accounting is the backbone of financial management for businesses, governments, and

individuals. It provides a systematic approach to recording, analyzing, and interpreting
financial transactions. The accuracy and reliability of financial statements depend on a well-
established framework that ensures transparency and comparability. Two key pillars guiding
this framework are accounting concepts and accounting conventions.

Accounting concepts are fundamental principles that define how financial transactions
should be recorded. These principles form the foundation of financial reporting, ensuring
consistency and compliance with regulatory standards. On the other hand, accounting
conventions are practical guidelines derived from common industry practices. They provide
flexibility and adaptability in financial reporting, allowing accountants to apply professional
judgment where necessary.

While accounting concepts provide a theoretical foundation, accounting conventions

address practical application challenges, making financial statements more realistic and
relevant. Understanding the difference between the two is essential for accountants,
auditors, and business professionals, as it enhances their ability to interpret and prepare
financial reports accurately. This essay explores the distinctions between accounting
concepts and conventions, their significance, real-world applications, and challenges faced in
their implementation.

Accounting Concepts

Definition of Accounting Concepts

Accounting concepts are the fundamental principles that form the foundation of accounting
practices. They provide a standardized framework for recording and interpreting financial
transactions. These concepts ensure consistency, comparability, and transparency in
financial statements.

Key Accounting Concepts

1. Business Entity Concept

• This concept states that a business is considered a separate entity from its owners.
All financial transactions should be recorded from the business's perspective rather
than the owner’s.

• It ensures that the personal assets and liabilities of the owner do not interfere with
business records.

• Example: If the owner of Tata Sons withdraws money for personal use, it should be
recorded as drawings and not as a business expense.
2. Money Measurement Concept

• According to this concept, only transactions that can be measured in monetary terms
should be recorded in financial statements.

• It excludes qualitative factors like customer satisfaction, employee skill, and brand
reputation.

• Example: Reliance Industries' brand value is significant, but it will only be recorded
when it has a monetary valuation, such as during mergers or acquisitions.

3. Going Concern Concept

• This concept assumes that a business will continue to operate indefinitely unless
there is strong evidence suggesting otherwise.

• Financial statements are prepared with the assumption that the company will not
liquidate soon.

• Example: Infosys prepares its financial reports assuming it will continue to operate
and grow in the coming years rather than shut down.

4. Accrual Concept

• The accrual concept states that revenue and expenses should be recognized when
they are earned or incurred, not when cash is received or paid.

• This principle ensures that financial statements reflect the true financial position of a
business at a given time.

• Example: If Wipro provides IT services to a client in March but receives payment in

April, the revenue should be recorded in March.

5. Cost Concept

• This concept states that assets should be recorded at their original purchase cost and
not their current market value.

• It provides consistency in financial reporting but does not account for inflation.

• Example: If Tata Motors purchases land for ₹50 crore, it continues to be recorded at
₹50 crore, even if its market value rises to ₹70 crore.

6. Dual Aspect Concept

• This is the foundation of double-entry accounting, which states that every financial
transaction affects two accounts.

• The basic accounting equation derived from this principle is: Assets = Liabilities +
Owner’s Equity.
 • Example: If HDFC Bank grants a ₹10 lakh loan to a customer, the bank’s assets (loans
given) increase, and liabilities (deposits) also increase.

7. Conservatism Concept

• Accountants should recognize potential losses but not anticipate future gains.

• This ensures that financial statements do not overstate profits or assets.

• Example: If Tata Steel anticipates that a debtor may default on payment, it should
create a provision for doubtful debts.

8. Materiality Concept

• This principle states that all significant financial information should be included in the
financial reports.

• Minor details that do not impact decision-making can be omitted.

• Example: A company like ITC may not disclose minor expenses such as ₹500 spent on
office supplies, but it must disclose a ₹500 crore investment.

9. Consistency Concept

• A business should use the same accounting methods over time unless a justified
reason for change exists.

• This ensures comparability of financial statements across different periods.

• Example: If Asian Paints uses the FIFO method for inventory valuation, it should not
frequently switch to LIFO without a valid reason.

10. Realization Concept

• Revenue should only be recognized when it is earned and realizable.

• Example: A construction company in India, such as L&T, should recognize revenue

only when it hands over a completed project to the customer.

Accounting Conventions

Definition of Accounting Conventions

Accounting conventions are guidelines derived from common accounting practices. Unlike
accounting concepts, which are theoretical, conventions arise from practical application and
help in uniformity across financial statements.

Key Accounting Conventions

1. Conservatism
 • Recognizes expenses and liabilities as soon as possible but revenues only when they
are certain.

• Example: If Infosys expects a legal case settlement to cost ₹10 crore, it should record
it as an expense, but if it expects to win ₹10 crore in another case, it should not
record the revenue until received.

2. Consistency

• Once a method is chosen, it should be consistently applied unless justified.

• Example: If Tata Consultancy Services (TCS) uses the straight-line method for
depreciation, it should not frequently switch to the declining balance method unless
required.

3. Disclosure

• Financial statements must disclose all necessary information for stakeholders to

make informed decisions.

• Example: Indian companies listed on the stock exchange must disclose information
about pending litigations, major contracts, and significant financial risks in their
annual reports.

4. Materiality

• Only significant financial information should be included in reports.

• Example: A company like Reliance Jio will not disclose small office expenses
separately, but any major changes in capital investments or acquisitions will be
detailed in financial statements.

Challenges in Applying Accounting Concepts and Conventions

While accounting concepts and conventions are crucial for financial reporting, their
practical application poses several challenges:

1. Interpretation Issues – Different businesses may interpret concepts and conventions

differently, leading to inconsistencies.

2. Regulatory Changes – Frequent amendments in accounting standards can create

compliance challenges.

3. Inflation Impact – Cost concept does not account for inflation, which may lead to
undervaluation of assets.

4. Ethical Dilemmas – Accountants may face pressure to manipulate financial records to

align with business goals.

Impact on Financial Decision-Making

 Understanding accounting concepts and conventions is crucial for:

• Investors: Helps in making informed investment decisions based on accurate

financial reports.

• Managers: Aids in better financial planning and resource allocation.

• Regulatory Authorities: Ensures transparency and accountability in corporate

governance.

Diagrams for Better Understanding

1. Dual Aspect Concept - Double Entry Accounting

Transaction: A company purchases machinery for ₹5 lakh using a loan.

Assets (Machinery) + ₹5,00,000 | Liabilities (Loan) + ₹5,00,000

2. Accounting Concepts vs. Accounting Conventions

+--------------------------+--------------------------+

| Accounting Concepts | Accounting Conventions |

+--------------------------+--------------------------+

| Based on fundamental rules| Based on common practices|

| Govern financial recording| Govern application methods|

| Mandatory compliance | Flexible application |

+--------------------------+--------------------------+

Conclusion

Accounting concepts and conventions both play vital roles in financial reporting. Concepts
provide the theoretical foundation, ensuring accuracy and consistency, while conventions
allow practical flexibility. Understanding these differences helps businesses maintain reliable
financial records that meet regulatory and decision-making requirements.

The application of accounting concepts ensures that financial data is recorded systematically,
providing a clear and accurate representation of a company’s financial health. Meanwhile,
accounting conventions help businesses adapt to real-world complexities, making financial
statements more practical and relevant.

As businesses operate in an increasingly globalized environment, understanding and

applying both accounting concepts and conventions becomes crucial for maintaining
credibility and compliance. Future advancements in accounting standards and regulations
will continue to refine these principles and practices, ensuring financial transparency and
accountability in the corporate world.