What Are Accounting Policies? Definition, Example, and Explanation

Definition:

Accounting policies are the internal policies prepared and set by the entity to process, measure, recognize records, as well as disclose the specific items or transactions in its financial statements of an entity.

Accounting policies might be different from one company to another; however, those policies are tailored to meet the specific International Accounting Standard or other standard bodies like local standards or regulations related to the purpose of financial reporting.

To ensure this, the companies set up their own procedures and manuals to ensure the consistency of practices and ensure that their accounting records are compliant with those accounting standards or local regulations.

To make sure the company’s financial statements are prepared in accordance with specific accounting standards or regulations, accounting policies have to tailor specifically to link with the company’s operation and accounting standards.

What is the objective of accounting policy?

The primary objective of accounting policy is to ensure that a company’s financial statements accurately reflect its financial position, performance, and cash flows. 

Accounting policies provide a framework of principles, guidelines, and procedures for preparing financial statements that are consistent, comparable, and reliable.

The specific objectives of accounting policy include:

  1. Providing relevant and reliable financial information: Accounting policy aims to provide financial information that is relevant, reliable, and comparable to enable users to make informed decisions.
  2. Ensuring compliance with accounting standards: Accounting policy aims to ensure compliance with accounting standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
  3. Enhancing transparency and disclosure: Accounting policy aims to provide clear and concise information about the company’s financial position, performance, and cash flows.
  4. Supporting effective decision-making: Accounting policy aims to support effective decision-making by providing relevant and timely information.
  5. Ensuring consistency and comparability: Accounting policy aims to ensure consistency and comparability of financial information across different periods and companies.
  6. Mitigating financial risks: Accounting policy aims to mitigate financial risks by ensuring that financial information is accurate, complete, and reliable.
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What is the purpose of accounting policy?

The purpose of accounting policy is to establish a set of guidelines, principles, and procedures that a company uses to prepare and present its financial statements.

Accounting policies provide a framework for financial reporting that ensures consistency, comparability, and accuracy of financial information across different periods and companies.

The specific purposes of accounting policy include:

  1. Ensuring compliance with accounting standards: Accounting policies provide guidance on how a company should apply accounting standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), to ensure compliance.
  2. Enhancing consistency and comparability: Accounting policies ensure that financial information is reported consistently across different periods and companies to enable users to make meaningful comparisons.
  3. Providing relevant and reliable financial information: Accounting policies aim to provide relevant and reliable financial information to users, such as investors, creditors, and analysts, to enable them to make informed decisions.
  4. Supporting effective decision-making: Accounting policies aim to support effective decision-making by providing timely and accurate financial information to users.
  5. Enhancing transparency and disclosure: Accounting policies aim to enhance transparency and disclosure by providing clear and concise information about a company’s financial position, performance, and cash flows.
  6. Mitigating financial risks: Accounting policies aim to mitigate financial risks by ensuring that financial information is accurate, complete, and reliable.

Overall, the purpose of accounting policy is to ensure that a company’s financial statements are prepared in accordance with established accounting standards and provide relevant, reliable, and comparable financial information to users. 

By implementing sound accounting policies, companies can enhance transparency and disclosure, support effective decision-making, and mitigate financial risks.

Types and Examples of Accounting Policies:

Policies are related to revenue recognition and measuring. This normally includes the criteria by which the company could recognize its revenue and the amount to be recognized.

For example, the revenue is recognized only when the customer receives the goods. In this case, the evidence to support revenue recognition in the financial statements would be a delivery note signed and receipted by the customers.

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Accounting policies related to expenses include general and specific expenses like depreciation. For general expenses, for example, training is recognized only when the training is incurred or not at the time cash advance for training.

The policies for expenses normally link to liabilities, both recognition, and measurement. Account policies for depreciation would be the nature of expenses that should or should not capitalize, the depreciation rate, and the process of disposal of assets.

Another simple example of accounting policy is inventories. Those policies will include what method the company uses to measure its inventories. It could be a weighted average or FIFO. The way how to entity control and manage its inventories.

For example, by using a perpetual inventories system or periodic inventories system. If the perpetual is used, inventories have to could continuously and randomly.

All of the policies in the company are very informative. Therefore, management at all levels has to understand and needs to train their staff to understand as well.

Or example, by using a perpetual inventories system or periodic inventories system. If the perpetual is used, inventories have to could continuously and randomly.

All of the policies in the company are very informative; therefore, management at all levels has to understand and need to train their staff to understand as well.

In most cases, the company has an induction program for the first time a new employee comes to work for the company, and such a program helps the employee to be aware and understand about what are the important policies and Accounting Policies in the company, and what they need to do to avoid misconduct.

What are the major accounting policies?

Major accounting policies are the principles, guidelines, and procedures a company uses to prepare its financial statements.

These policies are critical for ensuring financial information’s accuracy, consistency, and comparability across different periods and companies. 

Some of the major accounting policies include:

  1. Revenue recognition: This policy outlines the principles for recognizing and reporting revenue in a company’s financial statements.
  2. Expense recognition: This policy outlines the principles for recognizing and reporting expenses in a company’s financial statements.
  3. Inventory valuation: This policy outlines the principles for valuing and reporting inventory in a company’s financial statements.
  4. Depreciation and amortization: This policy outlines the principles for calculating and reporting depreciation and amortization of fixed assets in a company’s financial statements.
  5. Goodwill impairment: This policy outlines the principles for testing and reporting goodwill impairment in a company’s financial statements.
  6. Lease accounting: This policy outlines the principles for accounting and reporting lease agreements in a company’s financial statements.
  7. Financial instruments: This policy outlines the principles for accounting and reporting financial instruments, such as derivatives, in a company’s financial statements.
  8. Intangible assets: This policy outlines the principles for accounting and reporting intangible assets, such as patents and trademarks, in a company’s financial statements.
  9. Foreign currency translation: This policy outlines the principles for translating and reporting financial information in a foreign currency in a company’s financial statements.
  10. Income taxes: This policy outlines the principles for accounting and reporting income taxes in a company’s financial statements.
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Why are Accounting Policies Important to the Company?

Management is responsible for preparing the company’s accounting policies to ensure that they are in line with the accounting standards, and local regulatory requirements.

These policies will help to make sure that the company’s financial transactions are correct and timely prepared and available for management to review.

Accounting policies are also used as a tool to protect the company’s assets or interest from all kinds of errors or fraud that might be happened from all levels of internal or external stakeholders.

To ensure the policies work as intended, assets or interests of the company are protected, new risks are addressed, the efficiency of the process involved in the accounting policies is improved, management should review its accounting policies at least annually and the submit the board of director for approval if there is any change.

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