What are Accounting Policies? Uses, Importance, and Examples

Accounting policies are the specific principles, bases, conventions, rules, and practices applied by an entity in preparing and presenting financial statements. When an IFRS Standard or IFRS Interpretation specifically applies to a transaction, another event, or condition, an entity must apply that Standard.

Accounting Policies

Synopsis

  • Accounting policies should be determined by reference to the relevant IFRS
  • If there is no relevant IFRS, management should use judgement to select a policy which results in reliable and relevant financial information
  • A change in an accounting policy is permitted only where it is required by an IFRS or it results in more relevant and reliable information
  • Changes in accounting policy should be applied retrospectively
  • Changes in accounting estimate should be applied prospectively
  • Errors should be corrected retrospectively

What are Accounting Policies?

Accounting policies are rules and guidelines that are selected by a company for use in preparing and presenting its financial statements. Accounting policies are important, as they set a framework, which all companies follow, and provide comparable and consistent standard financial statements across years and relative to other companies.

Accounting policies contrasted with estimation techniques

The distinction between accounting policies and estimation techniques is an important one in practice because changes in accounting policies are dealt with as prior-year adjustments, whereas changes in estimation techniques are completely reflected in the profit and loss account for the year of change.

Accounting policies are defined in FRS 18 as ‘those principles, bases, conventions, rules, and practices applied by an entity that specifies how the effects of transactions and other events are to be reflected in its financial statements. The accounting policy that is adopted for a particular type of transaction involves making a selection of three factors:

  • Whether or not to recognise elements (assets, liabilities, gains or losses) as a result of the transaction – recognition criteria.
  • How to attribute a monetary amount to the elements that are recognised – measurement bases.
  • Where to present the elements in the financial statements.


Estimation techniques are the methods adopted by an entity to arrive at the estimated monetary amounts (corresponding to the measurement bases selected) for elements of the financial statements. As stated in the previous section, the distinction between accounting policies and estimation techniques is important. FRS 18 says that a change of accounting policy has occurred where there has been a change to any one of the components of the definition:

  • Recognition criteria
  • Measurement basis
  • Method of presentation

Uses and Importance of Accounting Policies

Below points justify the importance :

  • This serves as a guide to accountants and management of the company while preparing the financial statements.
  • They help in providing a ready reference for the similar set of circumstances that the company may come across.
  • They help in maintaining consistency in the presentation of the financial statement which leads to easy comparison from the previous year or with other organizations.
  • They help in maintaining internal control by following the set procedure for similar kinds of transactions.
  • They help investors in the analysis of financial statements while they are deciding if they should invest in certain businesses or not.

Examples of Accounting Policies

A few of the examples of different areas for which accounting policies are applied by the companies are as follows:

  • Valuation of Inventory: The Company chooses a specific accounting policy for the method of valuation of inventory. For example, a company may adopt the FIFO method, LIFO method, or average cost method. However, IFRS doesn’t allow the companies to use the LIFO method and the companies which are covered by these standards shall not deploy this method.
  • Depreciation: For depreciation accounting company chooses different methods of calculating depreciation like straight-line method, double declining method, sum of year’s digits, unit of production, etc. Accounting policy for depreciation would include expenses that can be capitalized, depreciation rate, disposal process, and so on.
  • Revenue and Expenses: Accounting policy for revenue recognition and measurement could include that revenue can only be recognized once goods or services are received by the customers and therefore, a proof of receipt signed by the customer would be required as evidence of revenue recognition in accounting books or financial statement.
Accounting Policies? Uses, Importance, and Examples

Consistency of accounting policies

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

Changes in accounting policies

An entity is permitted to change an accounting policy only if the change:

  • is required by a standard or interpretation; or
  • results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance, or cash flows.

FRS18 – Key disclosures

However, it is useful in the context of FRS 18 to note that the financial statements require entities to identify:

  • The accounting policies selected.
  • The key estimation techniques used (for example depreciation methods).
  • Details of any changes to accounting policies.
  • Information relevant to the assessment of an organisation as a going concern, if the going concern basis is under question.
  • Details of any departure from the requirements of any accounting standard or companies legislation in the interest of showing a true and fair view.

IFRS vs. GAAP

The International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP) are accounting principles that provide guidelines on how companies should prepare financial statements. IFRS is more principles-based and, therefore, can better capture the economics of a certain transaction.

GAAP, on the other hand, is a more rules-based approach. The differences between the two methods are evident in the different standards related to accounting policies (for example, some accounting policies that are allowed under GAAP may not be allowed under IFRS).

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