Accounting policies are the specific policies and procedures used by a company to prepare its financial statements.
These include the methods, measurement systems and procedures for presentation and disclosures. Accounting policies vary from accounting principles in that the principles are the rules and the policies are a company’s way of adhering to the rules.
The selection of accounting policies is an important decision that should be made by the entity’s management. When selecting accounting policies, management should consider the following factors:
- The requirements of applicable accounting standards.
- The nature of the entity’s business.
- The needs of its users.
- The entity’s specific circumstances.
There is no single list of accounting policies, which may apply to all enterprises and in all situations. The choice of policy appropriate to the specific circumstances depends on the nature of the enterprise. Generally following are the areas where more than one accounting policy prevails, and accountants have to use their judgment:
- Method of depreciation
- Valuation of inventory
- Treatment of goodwill
- Valuation of investment
- Valuation of investment
There are many more areas where more than one share and the company may use alternative valuation methods like LIFO, and FIFO weighted average. The same is the case with inventories. The particular method chosen by the enterprise for the valuation of shares, in this case, will be called accounting policy. Different methods will lead to different values.
Selection of an Accounting Policy
The choice of accounting policy is a crucial policy decision that affects the performance as well as the financial performance of the financial position of the enterprise.
Selection of inappropriate accounting policy will lead to understatement or overstatement of performance and financial position. Therefore, accounting policy must be chosen with due care after considering its effect on the financial statement.
There is no universal set of accounting policies that can be applied to all business entities. While selecting any accounting policy, three principles of accounting should be kept in mind i.e.
- Substance over form and
Change in Accounting Policies
Once accounting policies have been selected, they should be applied consistently from period to period. However, there may be circumstances in which a change in accounting policy is necessary. For example, a change may be required if there is a new accounting standard that the entity is required to adopt. A change may also be required if there is a change in the entity’s business or operations that requires a different accounting treatment.
A change in accounting policies should be made only in the following cases-
- It is required by the statute
- It is required to comply with ASs.
- If the change in accounting policy will result in a better presentation of the financial statement.
Whenever there is a change in accounting policy, the fact should be disclosed in the enterprise’s financial statements. The following example will make it clear how the changes in accounting policies are disclosed:
- XYX Ltd. revised its accounting policy relating to the valuation of inventories to include the production overheads. The change has resulted in an increase in the value of inventory profit has been increased by $20 million.
- Tango Ltd. changed the method of depreciation from the straight-line method to the written-down value method, w.e.f. 1st January 2013. The depreciation has been recomputed from the date of acquisition of the asset at the WDV method. Consequent to this change there has been an additional charge of depreciation of 10 thousand. Due to this, the profit after tax has been lowered by $100.
The accounting treatment for changes in accounting policies depends on the type of change. Changes in accounting estimates are generally accounted for prospectively, which means that the change is applied to the current and future periods only. Changes in accounting policies are generally accounted for retrospectively, which means that the change is applied to all periods presented. Corrections of errors are always accounted for retrospectively.