The revenue recognition convention

As accounts are produced for a specific period of time, it is necessary to decide exactly when a transaction actually occurs for accounting purposes so that it can be clearly allocated to one period or another. This classification by time periods is not as simple as it sounds and has required the development of a range of conventional approaches to aid consistent classification. The most important convention is that revenue is realised on delivery. This means that turnover for a particular period will include only those goods delivered to customers (whether or not yet paid for), and exclude those ordered, in production or waiting for delivery. (This creates particular problems for companies engaged in long term contracts or instalment contracts which require different treatments).

Prudence/conservatism - a bias towards understating profit

The exercise of prudence (also termed conservatism) was a convention intended to avoid any possibility of paying dividends from capital. It involved anticipating any expenses or losses in the profit calculation, while any revenues or profits were only recorded when actually realised. The effect was to understate assets and overstate liabilities and thus show a minimum, but highly certain, amount of profit. Provided dividends were only paid from this understated profit figure the productive capital of the company should not be diminished. Prudence avoids the possibility that shareholders might be paid dividends from their original capital invested in the company rather than as a result of its successful trading operations.