Accounting Convention: Definition, Methods, and Applications

To that end, a full disclosure policy is implemented to protect the needs and interests of owners, investors, creditors, and employees. These concepts are logical, so it’s easy to figure out why they’re used and how to get a complete accounting explanation. Accounting concepts are fundamental ideas that are used in the accounting process to achieve accounting objectives. Accountants do not account for items unless they can be quantified in monetary terms.

One of the main duties of a bookkeeper is to keep track of the full accounting cycle from start to finish. The cycle repeats itself every fiscal year as long as a company remains in business. 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. Accounting concepts are the basic rules, assumptions, and conditions that define the parameters and constraints within which accounting operates.

FAQs on Accounting Period Concept

Financial statements, such as the income statement and balance sheet, identify the accounting period in their headers. The income statement includes a company’s revenue and expenses from the entire accounting period. The header will identify the last date of the accounting period, for example, “as of June 30, 20XX.” An accounting period is an established range of time during which accounting functions are performed, aggregated, and analyzed. An accounting period may consist of weeks, months, quarters, calendar years, or fiscal years.

Here, the accounting period is that of half-year, i.e., 1st January to 30th June, and the next period shall be from 1st July to 31st December. The accounting period allows the business owner to see the business from a different perspective. Their continued profitability and other business decisions keep them informed. For business owners, investors, creditors,and government authorities, this information is critical. To fully understand the accounting cycle, it’s important to have a solid understanding of the basic accounting principles.

The International Financial Reporting Standards allows a 52-week period , instead of a full year, as the accounting period. The accounting period usually coincides with the business’ fiscal year. However, there are many business entities that follow the accounting period of three months or six months. Similarly outstanding investment interest, commission earned but not received, etc. should be recorded as income even though it was not received in cash. For example, goods worth $3000 are sent to the buyer on the condition of “sale or return”.

Accounting Period Types

Much of the work that goes into setting accounting standards is based around the need for comparability. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. The concept of “materiality” is an important issue for auditors of financial accounts. We book the value of assets on the cost basis, not on the net realizable value or market value of the assets based on the assumption that a business unit is a going concern.

Investors might also benefit from this because they can see how its financial results have changed over time. Hence, an income statement shows the company’s financial performance over one year, while a balance sheet shows the financial position at the end of a year. The accounting period concept refers to the division of accounts records into similar multiple measured times. The performance of the company is measured and then disclosed to the investors in regular time periods. The accrual method of accounting requires an accounting entry to be made when an economic event occurs regardless of the timing of the cash element in the event. For example, the accrual method of accounting requires the depreciation of a fixed asset over the life of the asset.

• The entity has to record every transaction and give effect to both debit and credit elements.
• The term realization implies the creation of a legal right to receive money.
• Accountants assume, unless there is evidence to the contrary, that a company is not going broke.
• Accounting periods are used to estimate the profit, loss, and financial position of a business for a specific time window.

Items that are not accounted for include things like workforce skill, morale, market leadership, brand recognition, quality of management etc. Under the “historical cost convention”, therefore, no account is taken of changing prices in the economy. It means the collection of cash and payment in cash is ignored while calculating the profit or loss of the year. Practically, it will be correct to say that the entity will record the realized value of the asset once the asset has been sold or disposed of off, as the case may be.

4­–5 Calendar Year

Therefore, the business entity concept states that the business and the business owner are two separate/distinct persons. Accordingly, any expenses incurred by the owner for himself or his family from business will be considered as expenses and it will be represented as drawings. Generally speaking, an accounting period is a predetermined period of the accounting activities, data is accumulated, and analysis is undertaken, such as a calendar year or fiscal year, among other things. Accounting periods are used to estimate the profit, loss, and financial position of a business for a specific time window.

If it is publically listed, it must disclose its performance every quarter, if it is a private company, it is left to the company on how or whether it discloses its financial performance. The time period for which a company discloses the information mainly depends upon whether the company is privately held or publically listed. So, when an owner puts money into the business, it is seen as the owner extending a line of credit to the business. These are as common to accountants in their work as the air is around us. These are concepts and assumptions, and there is no evidence for these.

All the expenses paid in cash or payable are considered and the advance payment of expenses, if any, is deducted. The expenditures of a firm for a particular accounting period are to be matched with the revenue of the same accounting period to ascertain accurate profit or loss of the firm for the same period. Based on this concept, revenue expenditure and capital expenditure are segregated. Revenues expenditure are debited to the profit & loss account to ascertain correct profit or loss during a particular accounting period. Capital expenditure comes in the category of those expenses, the benefit of which will be utilized in the next coming accounting periods as well.

However, a financial year refers to the period starting of one full year . Let us understand the advantages and disadvantages of the accounting period principle through the discussion of points from both extremes of this concept. Accounting ProvisionsThe provision in accounting refers to an amount or obligation set aside by the business for present and future commitments. Provisions are estimates of future related probable losses from past and present events calculated by following predefined regulatory guidelines by banks and financial institutions. Generally, the accounting period follows this Gregorian calendar year which consists of twelve months. The accounting period follows this natural sequence of these 12 months.

What Is the Accounting Period Cycle Concept?

Conservatism discuss the accounting period conceptThe conservatism principle of accounting guides the accounting, according to which there is any uncertainty. In contrast, all the revenues and gains should not be recorded, and such revenues and profits should be recognized only when there is reasonable certainty of its actual receipt. In other words, transactions are to be recorded as and when they occur, not as and when the cash is received or paid, and for the period the transaction pertains. The act of chopping the continuous stream of business events into time periods is arbitrary. Since business activities do not stop or change significantly as one accounting period ends and another begins.

All such inhttps://1investing.in/ation is provided solely for convenience purposes only and all users thereof should be guided accordingly. The accounting period principle requires that such adjustments are made judicially and that an accounting record is created accordingly. Therefore, to study the results of a business, its life is divided into short periods of equal length. This concept helps the company set a formal period over which books must be closed. When comparing outcomes from one period to the next, the factual causes for the differences are ignored. The market value fluctuates, and if the company records the transaction at the market price, the account’s acceptability will suffer.

The dual concept implies that every transaction has a similar effect on assets and liabilities in such a way that the value of total assets is always equal to the value of total liabilities. It aims to understand the business rules and regulations that are required to be followed by all types of business entities, and hence simplifying the detailed and comparable financial information. Written Down Value Method The written down value method is a tool to evaluate the depreciation in a company’s fixed asset to determine the correct valuation of the asset’s value. The government and enterprises utilize a fiscal year , usually a budget year, as the time frame for accounting to create annual financial accounts and reports. On the other hand, unearned incomes and prepaid expenses are indicated as a deduction from the respective account head. But the owner can’t wait for an unlimited period to know the financial status of the business.

Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications. INVESTMENT BANKING RESOURCESLearn the foundation of Investment banking, financial modeling, valuations and more. If a business wants to change from a calendar year to a fiscal year, they need to be permitted by the IRS. In case a business wants to change from a calendar year to a fiscal year, they would need special permission from the IRS.

But, everyone in accounting believes that these concepts are self-evident. Generally Accepted Accounting ConceptsGAAP are standardized guidelines for accounting and financial reporting. The primary aim of accounting is to maintain uniformity and regularity in the preparation of accounting statements. When comparing outcomes from one era to the next, the underlying facts that caused the discrepancies are ignored. Two distinct accounts must be kept if the tax period is different from the financial year.

Sometimes, there is not a definitive guideline in the accounting standards that govern a specific situation. The accountants use this concept when there is a significant concern regarding the liquidation of the assets. The going concern concept is applied when the chances are high that the company would be liquidated in the next two or four quarters. When a transaction is noted two times on the opposite sides of the same balance sheet, it makes it incredibly easy to check whether the transactions recorded in the balance sheets are correct or wrong.

Thus, the accounting transactions are recorded in the books of accounts from the organization’s point of view and not the person owning the business. “The term accounting concepts refer to basic rules, assumptions, and principles which act as a primary standard for recording business transactions and maintaining books of accounts”. Whatever the length of an accounting period—whether monthly, quarterly, or by fiscal year, for example—during that time span a company performs, aggregates, and analyzes accounting functions.