Accounting Policies

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Accounting policies are regulations or guidelines that businesses must follow when creating and presenting their financial statements. They establish a consistent framework for producing standard financial statements, ensuring uniformity over time and comparability across businesses. While organizations can have distinct practices, their chosen accounting policy must comply with either the International Financial Reporting Standards (IFRS) or the generally accepted accounting principles (GAAP). These policies guide how a company records transactions, values assets and liabilities, and reports its financial performance.

What are Accounting Policies?

Accounting policies act as a structure or framework for businesses to follow since they are regulations or guidelines that the business must follow when creating and presenting its financial statements.

Accounting policies are crucial because they establish a framework that all businesses must adhere to and produce similar and consistent standard financial statements over time and compared to other businesses.

Various businesses may have different accounting practices. However, whatever an organisation decides in terms of accounting policy, it must adhere to IFRS or generally accepted accounting principles (GAAP).

Understanding the Concept of Accounting Policies

This is defined as a framework within which a company is required to record its ongoing transactions, value its assets and liabilities, and report its financial performance. The management of the company chooses it. The business is free to adhere to its own unique sets of rules. But depending on the country of operation, they ought to adhere to IFRS or GAAP.

The accounting rules used by a company give a lot of information about the reported results; they suggest whether management is aggressive or conservative in how it reports the earnings. Investors may find this to be very useful as they assess the company’s financial situation. However, until it is mandated by law, a standard, or the change is such that providing a fair perspective of the firm’s financial affairs is necessary, the company should maintain consistency in its accounting standards. Furthermore, any adjustments to the company’s accounting principles must be adequately declared in the financial statements and justified.

Nature of Accounting Policies

Accounting policy’s nature is subjective rather than objective. There isn’t an all-inclusive list of accounting policies that can be used in every situation. Companies select alternate policy implementation strategies based on their unique circumstances when doing so is allowed; this is largely the result of extensive research and judgment on the part of the company’s management.

Policies must be of a type that provides a fair and accurate picture of the company’s financial situation. Additionally, this must be administered consistently year after year to preserve uniformity.

What are the five basic principles of accounting?

Over many years of dealing with accounts, the foundational ideas of accounting were created. They outline the fundamental elements of how to properly record a transaction.

Principle of Revenue Recognition

There are two methods for recognising revenue. It is accrual-based accounting if you account for them at the same accounting period that the service or good was delivered. The cash-based accounting principle states that even if there is a significant delay, you should only record it when the cash is received. Companies choose which option to implement as their accounting policy.

Cost Principle

The cost of assets is documented in financial records and statements. The worth of an asset can be determined in a variety of ways. According to the cost principle, equity, liabilities, and assets should be evaluated at their original acquisition prices. However, the appraisal of fair values is becoming more and more popular among accountants.

Principle of Business-Entity 

The owner should not be confused with the company in accounting. The company is a distinct legal person from its owner. Transactions involving the owner and the company must be recorded separately. Any cash the proprietor takes out of the company is tracked. The money will either be subtracted from the initial investment or owed to the company.

Principle of Full Disclosure 

Financial statements should provide accurate and complete information to prevent any misrepresentation. With this goal in mind, significant partners or clients will be informed about pertinent facts about your business.

Principle of Going Concern

The going concern principle keeps the books in such a way that it assumes the company will continue to operate for a long time without ceasing operations or going out of business.

What Is the Difference Between Conservative and Aggressive Accounting?

Businesses decide whether to use conservative or aggressive accounting techniques. A conservative policy increases the likelihood that the business will follow the IFRS or GAAP-established accounting standards. 

Each choice has benefits and drawbacks. A conservative policy may give outsiders the impression that a business is more trustworthy. It may also restrict a business’s ability to develop and thrive. On the other hand, an aggressive policy might increase revenues but also increase risk.

While a company adopting aggressive accounting rules will have higher financial success in the current year, one using conservative accounting policies will have lower earnings in the current year. Conservative accounting practices will typically improve long-term financial performance, whereas aggressive practices will typically worsen financial performance.

Examples of Accounting Policy 

Here are a few instances where businesses use accounting policies: 

Evaluation of Stock 

For the valuation of inventory, the corporation selects specific accounting rules like the FIFO technique, LIFO method, or average cost approach. 

Depreciation

To calculate depreciation, companies employ various accounting procedures. Here is an example of an accounting policy for calculating depreciation using the straight-line method, which is the most widely used in real-world situations. The double-declining approach, the sum of the year’s digits, the unit of production, and other accounting policies are more examples of how depreciation is calculated.

Expenditures and Revenue 

According to important accounting principles, income cannot be recognised until the client has received the goods or services. The customer must sign the receipt proof, which serves as proof of sales. The financial statement includes revenue recognition as an example of accounting policy. 

Uses of Accounting Policies

These are some common applications of accounting policies:

• It acts as a convenient resource for the company’s earlier examples of similar situations.
• Serves as a directive for the management of the organisation to create the financial statements.
• Aids in keeping the financial statement consistent.
• It enables simple comparison with data from the previous year or with other organisations.
• Assists investors in analysing financial statements and making investment-related decisions.

The Bottom Line

Accounting policies are crucial for businesses of all sizes. They set forth the guidelines for disclosing a business’s financial statement. Accurate financial statements can be prepared with the use of a good accounting framework. Investors will find it simpler to compare and evaluate a company’s financial performance as a result.

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