The Significance of Accounting Conventions
In regard to the fundamental accounting concepts, there are also accounting conventions. Of these the most important and widely used is the historical cost convention.
Historical cost convention: The historical cost convention refers to the value at which items are recorded in the accounts. Historical cost is the cost in cash terms paid for an item. Most sets of accounts are prepared this way because it is easiest to understand, simplest to record and preserves the double entry with cash.
Current cost convention: In inflationary environments, the use of the historical cost convention produces exceptional results where an entity might have substantial assets but these are carried at a very low value in the accounts.
To address this problem a number of conventions have been developed to include the effect of inflation in the accounts. These conventions are all quite complex and difficult to apply and are not considered further in this course.
Cost or valuation: More common is a form of modified historical cost convention where most assets are carried at historical cost but some are revalued from time to time. The most common assets for this type of treatment are current financial assets and certain types of property. Concepts of value – fair value, value in use, carrying value. While identifying these matters, it is relevant to consider some terms which accountants use to approach the question of value.
The term fair value is generally taken to be similar to “market value” – what an asset might be sold for assuming a sale to a willing third party at arm’s length, for the asset in its present condition.
Value in use is the value to the entity of the future use of the asset. This might often be more than market value and carrying value. Carrying value is the amount at which the asset is being carried in the accounts from time to time.
In regard to the fundamental accounting concepts, there are also accounting conventions. Of these the most important and widely used is the historical cost convention.
Historical cost convention: The historical cost convention refers to the value at which items are recorded in the accounts. Historical cost is the cost in cash terms paid for an item. Most sets of accounts are prepared this way because it is easiest to understand, simplest to record and preserves the double entry with cash.
Current cost convention: In inflationary environments, the use of the historical cost convention produces exceptional results where an entity might have substantial assets but these are carried at a very low value in the accounts.
To address this problem a number of conventions have been developed to include the effect of inflation in the accounts. These conventions are all quite complex and difficult to apply and are not considered further in this course.
Cost or valuation: More common is a form of modified historical cost convention where most assets are carried at historical cost but some are revalued from time to time. The most common assets for this type of treatment are current financial assets and certain types of property. Concepts of value – fair value, value in use, carrying value. While identifying these matters, it is relevant to consider some terms which accountants use to approach the question of value.
The term fair value is generally taken to be similar to “market value” – what an asset might be sold for assuming a sale to a willing third party at arm’s length, for the asset in its present condition.
Value in use is the value to the entity of the future use of the asset. This might often be more than market value and carrying value. Carrying value is the amount at which the asset is being carried in the accounts from time to time.
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