Accounting Policies -Definition

 Accounting Policies 

These policies refer to the specific accounting principles and the methods of applying those principles adopted by the enterprise in the preparation and presentation of financial statements. There is no single list of accounting policies that are applicable to all circumstances. The following are examples of the areas in which different accounting policies may be adopted by different enterprises:

(i) Methods of depreciation, depletion, and amortization.

(ii) Treatment of goodwill.

(iii) Valuation methods of inventories.

(iv) Valuation methods of investments.

(v) Recognition of profit on long-term contracts.

(vi) Treatment of expenditure during construction.

(vii) Valuation of fixed assets.

(viii) Treatment of retirement benefits.

(ix) Treatment of contingent liabilities.

(x) Conversion of translation of foreign currency items.

Selection of Accounting Policies

In order to select an accounting policy in particular circumstances, due consideration should be given to the characteristics of financial information such as prudence, substance over form, and materiality.

An accounting policy chosen by a decision-maker may affect the performance measurement as well as the financial position of the business firm. Selection of inappropriate accounting policy may lead to understatement or overstatement of performance and financial position.

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Let us Understand

■ Prudence, It is the inclusion of a degree of caution in the exercise of the judgments required in preparing the estimates needed under uncertainty so that income or assets are not overstated and expenses or liabilities are not understated.

■ Substance over form It is an accounting concept that means that the economic substance of transactions and events must be recorded in the financial statements rather than just their legal form in order to present a true and fair view of the affairs of the entity.

■ Materiality  It implies the relative importance of an item or an event with respect to the particular business. Information is material if it has the ability to influence the decision-making of various parties interested in accounting information, contained in financial statements.

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Change in Accounting Policy

Change in accounting policy may have a material effect on the items of financial statements.

For example, if a business entity changes depreciation method from written-down value method to straight line method, it will affect the net profit of the entity for the reporting period.

A change in accounting policies should be made in the following conditions:

(i) It is required by some statute or for compliance with an accounting standard.

(ii) Change would result in more appropriate presentation of financial statement.

Accounting Estimates

It is an approximation of an item in the financial statement which has to be debited or credited for which there is no precise means of measurement, such as depreciable assets or provisions for a loss from a law suit.

Estimates are based on the judgement and specialised knowledge derived from past experience.

Examples of accounting estimates are:

(i) Reduction in the value of Inventory and debtors to their estimated realisable value.

(ii) Provision for taxation.

(iii) Losses on construction contracts in progress.

(iv) Provision for retirement benefits like a gratuity.