In Financial Accounting, both Rules and Policies help determine how a company prepares its financial statements. So, the differences between the two concepts might not be readily obvious.
Generally, rules and policies combine to form the guidelines that guide a company’s financial statements. The goal is to ensure that a company’s financial statements conform to legally accepted standards.
But before we consider what makes rules and policies different, it is important to understand each of them and the connection between them.
What are the Rules?
Rules in Accounting are a set of principles that “must be” adhered to by a company in the preparation and presentation of financial statements.
They are the legal guidelines regulating the recording and reports of the financial data of companies within a particular state or country. Usually, these rules are set by the financial accounting governing bodies.
In the United States, the Generally Accepted Accounting Principles (GAAP) specify the rules guiding the quality of companies’ financial reports.
The GAAP is set by the Financial Accounting Standards Board (FASB).
It is a requirement for all publicly traded companies in the US to adhere to the GAAP. It also guides the activities of non-publicly traded companies too.
Failure to adhere to these rules might attract legal action against a company by the governing bodies.
Cost, Accrual, Conservatism, Monetary Unit, Full Disclosure, and Reliability principles are some rules consistent with the GAAP.
What are the Policies?
A company’s accounting policies are the standards set by the company for preparing its financial statements.
Simply put, policies are internally established procedures for financial reports. Essentially, it is a company’s guidelines for following the general rules. They are specified by the company itself and not by external bodies.
Company policies are designed to help the company achieve its goals while conforming to the generally specified rules.
Rules Vs Policies
To draw the line between these two concepts, you must understand their connection.
Rules determine generally accepted financial report practices, while company policies are based on rules.
A company can also derive internal rules for its operations from its policies.
The internal rules ensure that company policies are properly adhered to. The policies are designed to help the company maximize its potential while conforming to the general rules.
The differences between Rules and Policies can be summarized thus:
While Rules are general accounting principles binding every company, policies are implemented by a company to help her adhere to the rules.
Rules are specified by Financial Accounting governing bodies such as the FASB and IFRS. On the other hand, companies decide their policies and how to implement them.
Rules help regulate and maintain the quality of financial reports within a territory. Policies help a company to tailor the rules to achieve its goals.
A lawsuit filed against a company for violation of rules can be detrimental to the company’s reputation. To avoid this, every company must ensure that it is guided in all its activities.
Adherence to rules by making effective policies will help a company stay out of trouble and maximize its aims and objectives.