Accounting policies are the specific principles and procedures implemented by a company’s management team that are used to prepare its financial statements. These include any accounting methods, measurement systems, and procedures for presenting disclosures. Accounting policies differ from accounting principles in that the principles are the accounting rules and the policies are a company’s way of adhering to those rules.
- Accounting policies are procedures that a company uses to prepare financial statements. Unlike accounting principles, which are rules, accounting policies are the standards for following those rules.
- Accounting policies may be used to manipulate earnings legally.
- A company’s choice in accounting policies will indicate whether management is aggressive or conservative in reporting its earnings.
- Accounting policies still need to adhere to generally accepted accounting principles (GAAP).
How Accounting Policies Are Used
Accounting policies are a set of standards that govern how a company prepares its financial statements. These policies are used to deal specifically with complicated accounting practices such as depreciation methods, recognition of goodwill, preparation of research and development (R&D) costs, inventory valuation, and the consolidation of financial accounts. These policies may differ from company to company, but all accounting policies are required to conform to Generally accepted accounting principles (GAAP) and/or international financial reporting standards (IFRS).
Example of an Accounting Policy
Accounting policies can be used to legally manipulate earnings. For example, companies are allowed to value inventory using the average cost,First in First out (FIFO), or Last in first out(LIFO) methods of accounting. Under the average cost method, when a company sells a product, the weighted average cost of all inventory produced or acquired in the accounting period is used to determine the cost of good sold (COGS).
Under the FIFO inventory cost method, when a company sells a product, the cost of the inventory produced or acquired first is considered to be sold. Under the LIFO method, when a product is sold, the cost of the inventory produced last is considered to be sold. In periods of rising inventory prices, a company can use these accounting policies to increase or decrease its earnings.