Page 37 - DMGT104_FINANCIAL_ACCOUNTING

Unit 2: Principles of Accounting

2.2.3 The Modifying Accounting Principles (Conventions) Notes

Basic accounting assumptions and principles provide us the various rules to prepare the financial
statements. If these financial statements are relevant and reliable, they will give much useful
information to the various users of the financial statements. In order to prepare the true and fair
financial statements, there is a need to modify the accounting assumptions and principles. These
modified accounting principles are as follows:
1. Conservation (Prudence): As per the law of conservatism, at the time of preparing the
financial statements, all the possible losses must be kept in mind and all anticipated
profits/gains should be left out. In other words the accounts must follow the policy of
playing safe. Likewise stock-in-trade is valued at ‘market price or cost whichever is least’,
provision for bad and doubtful debt, provision for depreciation on fixed assets, etc., are
maintained. This principle is being criticized nowadays on the ground that it goes against
the principle of disclosure. The accountants create a secrete reserve through the provision
of bad and doubtful debts, depreciation and the valuation of stock. The financial statements
loose their true and fair view. Profit and loss account depicts the lower income and the
balance sheet understates the assets and the liabilities of the business.

Today the law of conservatism has been replaced by prudence. It means that conservatism
is adopted only in the inevitable uncertainties and doubts. The accountants should also
give the reasons for adopting a particular accounting techniques, method and policies
without undue conservatism.

2. Consistency: In order to enable the management to do the comparison of the results of the
several years of the business, whatever accounting policy is adopted in a year, must be
adopted in the coming years. There should be uniformity in accounting process, rules &
methods. As a result biasness of accountant is removed.
According to Kohlar there are three forms of consistency:
(a) Vertical Consistency is used in the different financial statements of the business on
the same date. For instance, depreciation on fixed assets is used in the income
statement and the balance sheet on the same date.
(b) Horizontal Consistency enables the comparison of the profit or performance of a
business in a year with the performance of another year for example the depreciation
methods.
(c) Third Dimensional Consistency refers to the same principles or practices of
accounting adopted by the different firms in an industry.

3. Timeliness: Accounting information given in the financial statements must be reliable and
relevant. In order to be relevant, this information must be supplied in time. If late and
obsolete information is provided, it will hamper the management and the users of the
financial statements to take appropriate, timely and rational decision.

4. Materiality: Herewith, the materiality means that only that information should be
disclosed and attached with financial statements which influence the decisions of
shareholders, investors and creditors, etc. and the other insignificant details must be
ignored. Moreover, an item of information may be material for one purpose while that
may be immaterial for other. This is a subjective matter. For example, the cost of the
component may be very much significant for small businessman while it may be
insignificant for a large businessman. In one more example, the Companies Act permits to
ignore the paise at the time of preparation of financial statements while for the income tax
purpose the income is rounded off to the nearest ten.

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