written by khatabook | November 17, 2022

Guidelines For Accounting Policies and Related Aspects

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Table of Content


The procedures, rules, and standards used by a company's management in preparing and presenting the accounts or financial statements are called accounting policies. Accounting policies are not objective; rather, they are subjective. This means that there is no available list of such policies that an entity can use for all types of transactions. Rather, entities develop their policies based on their unique circumstances. 

Thus they are different from one company to another, one industry to another industry. However, the policies must adhere to domestic and international accounting standards while also adhering to local laws and regulations. Accounting policies typically include measurement systems, accounting methods, and the method for presenting any disclosures.

Did you know? Accounting policies are different from accounting principles, as the principles are the overarching accounting rules, whereas policies are the way a company follows the rules.

Characteristics of Accounting Policies

The accounting policy is not objective, but rather subjective. There is no full list of all accounting policies used in every situation. Companies adopt appropriate alternative policy solutions based on their specific circumstances, primarily driven by extensive research and judgment by the company's management. The nature of policies must be such that they provide a true and fair picture of the business's financial circumstances. Furthermore, this must be applied thoroughly over year to ensure its consistency.

Also Read: Everything You Need to Know About Operating Cost Formula

Difference Between Accounting Principles and Accounting Policies

Accounting Principles

Accounting Policies

  • Accounting principles are rules established by various financial authorities that the firm must follow regarding accounting and reporting. 
  • Accounting Policies can be defined as a company's personal approach to implementing these principles.
  • Accounting principles are all-encompassing accounting rules while accounting policies are specific ways to follow those rules.
  • Accounting policies may vary across companies and geographies. 

 

Comparison of Conservative vs Aggressive Accounting Policies

Conservative accounting policies understate a company's current financial performance while demonstrating improved financial performance in subsequent years. It is a more sustainable approach that allows companies to improve over time, which is a good sign for investors.

Aggressive policies tend to employ accounting policies in such a way that they overstate a company's performance in previous years, resulting in a decline in a company's performance in subsequent years. Hence, If auditors or investors believe management is misrepresenting earnings or allocating costs, aggressive accounting policies may raise a red flag.

Stability of Accounting Policies 

Unless a Standard or an Interpretation permits the categorization of items for which different policies may be appropriate, an entity shall select and apply its accounting policies consistently for similar transactions, other events, and conditions. If a Standard or an Interpretation requires or allows such categorization, an appropriate accounting policy must be chosen and applied to each category.

Also Read: Guide On Accrual-Based Accounting: Important Facts and Features

How to select an Accounting Policy?

When deciding on an accounting policy, companies should remember that if a certain accounting standard applies to a transaction or occurrence, the accounting policy should be applied. 

  • During the policy development process, a corporation should look for comparable standards dealing with similar events and principles in the accounting framework addressing the treatment and meaning of assets, liabilities, income, and expenses. In addition, corporations may value the prudence idea, which stipulates that gains are not anticipated and are recognized only when realized. At the same time, provisions are made for any anticipated liabilities and losses.
  • Policies must identify revenues as soon as possible. And to postpone spending for as long as feasible. 
  • Income Smoothing is another factor for adopting accounting policies. Revenue smoothing seeks to ease the flow of income. It is recommended that you first examine your earnings. Then, try to keep earnings variations to a minimum. This will reduce the risks associated with invested shares. As a result, your prospects of earning more money will improve. This criterion also proposes smoothing net income, revenues, and expenses.
  • However, it should always be remembered that the accounting policy chosen should provide a precise and correct depiction of the company's financial affairs.

Restrictions on Accounting Policy Selection

A firm can try to adapt to a variety of policies. It does not imply that a company can choose a policy whenever it wants. It cannot abandon a policy if it no longer serves the firm's needs. Generally, a company compiles a set of policies as a permanent set. On the other hand, a secondary set is prepared to meet different needs. The techniques remain allowed even if a business splits its financial and income tax reports. The government entity just needs clear and intelligible reports about a company. The reports must be available for review. It should not conceal any previous debts that may cause problems in the future.

Also Read: What is Tapering in Finance and How Does it Impact the Economy?

Examples of Accounting Policies

Accounting policies revolve around principles, bases, conventions, rules, and practices applied by institutions for preparing and presenting financial statements. Let’s look into a few of them in detail.

Using Estimates

Preparing financial statements following Generally Accepted Accounting Principles (GAAP) necessitates management's application of accounting policies, reported amounts of assets, liabilities, income, and expenses, and disclosure of contingent liabilities on the date of the financial statements. Actual results may differ from those projections. Estimates and underlying assumptions are constantly evaluated. Any changes to accounting estimates are reflected in current and future periods.

Depreciation

Accounting firms use several techniques to calculate depreciation, such as the straight-line approach, the sum of the year's digits, the unit of output, and so on. Depreciation accounting policy would comprise expenses that can be capitalized, depreciation rate, disposal method, and so forth.

Inventory Assessment

Inventory is a key asset in every manufacturing or trading firm, and its valuation is critical. There are several ways to value inventory, including FIFO (First in, First Out), LIFO (Last in, First Out), the average cost method, and others. 

Expenses for R&D

Many businesses struggle with determining whether or not to capitalize on R&D spending and which expenses must be included. As a result, it is critical that a corporation has suitable policies in place for tracking and recognizing such costs.

Recognizing Revenue

The policies must direct the organization on when to recognize revenue and when to recognize expenses. Furthermore, it must be obvious what all conditions must be met for revenue to be recognized.

Also Read: What is Negative Working Capital and How it Affects a Business?

Accounting Policy's Importance

These policies are essential to businesses, investors, and governments.

 The following points will emphasize the significance of these policies to all stakeholders:

  • Government check 

All businesses must have policies that adhere to either GAAP or Indian Accounting standards. This enables the government to monitor the financial performance of enterprises and, as a result, defend the interests of investors.

  • Giving investors a competitive advantage 

By informing investors that they have followed specific accounting principles, investors will acquire increased confidence in the company and the statistics, and the statements can be easily compared to the financial statements of other companies.

  • Disclosure 

It is critical for businesses to disclose their policies. The disclosure will assist investors and outsiders in appropriately evaluating and interpreting the organization's financial strengths or weaknesses. Furthermore, it monitors whether or not a corporation follows its regulations consistently yearly.

  • Correct framework 

Accounting policies effectively provide organizations with a framework to publish their financial accounts uniformly.

Changes in Accounting Policies

The change in accounting policy can take place in a company in the following cases-

  • If it is required by law or applicable standard
  • If it results in a better presentation of the financial information by giving more reliable and relevant information.

Conclusion

In conclusion, accounting policies are critical in developing a framework for companies to follow when recording their day-to-day transactions. Furthermore, these policies aid in the preparation of financial statements. It is not incorrect to say that these policies serve as the foundation for an entity's accounting work. As a result, it is critical for a company to take all necessary time and precautions when developing its policies.
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FAQs

Q: What is income smoothing?

Ans:

Income smoothing is a technique used to level out fluctuation in net income which is calculated within one period to the next.

Q: What exactly is the distinction between accounting policies and estimates?

Ans:

Accounting estimates are only concerned with the measurement of items in financial statements. In contrast, accounting policies include particular concepts and procedures for the identification, classification, and presentation of items in financial statements in addition to measurement.

Q: Why is it necessary to reveal accounting policies?

Ans:

All essential accounting policies used in compiling and presenting financial statements must be disclosed to ensure the correct interpretation of financial statements.

Q: What impact do accounting policies have on financial statements?

Ans:

Accounting policy changes the financial statements and provides more trustworthy and relevant information.

Q: Is it possible for a firm to change its accounting policy?

Ans:

An institution can change its accounting policies if and only if there is a need for change in the entire organization and its standards.

Q: Is depreciation a legal accounting practice?

Ans:

The depreciation techniques employed, total depreciation for the period for each asset class, the gross quantity of each category of depreciable assets, and corresponding accumulated depreciation are all declared in the financial statements, along with other accounting policies.

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.