Accounting Policies

Reviewed by Anjaneyulu | Updated on Aug 27, 2020

Introduction

Accounting policies are the basic standards and procedures enforced by the management team of an organization that are used to prepare their accounts. Those include all forms of accounting, measuring systems, and also the presentation of disclosures. Accounting policies vary from accounting principles in that accounting rules are the laws, and policies are the way an organization adheres to those rules.

How to Use

Accounting policies are a set of standards which govern how a company prepares its accounts. Such policies are used primarily to address complex accounting activities such as methods of depreciation, goodwill recognition, research and development ( R&D) expense management, inventory valuation, and financial account consolidation. Such policies can vary from company to company, but all accounting policies must comply with commonly accepted accounting principles (GAAP) and IFRS requirements.

Accounting principles can be seen as a system within which a company is supposed to operate. However, the framework is very flexible, and the management committee of a company may select different accounting policies that are helpful to the company's financial reporting. Since accounting principles are always lenient, a company's specific policies are very relevant.

Example

For example, companies may value inventory using the average cost, first in first out (FIFO), or last in first out (LIFO) accounting methods. Under the average cost process, the weighted average cost of all inventories produced or purchased during the accounting period is used when a business sells a product to calculate the cost of the goods sold (COGS).

When a business sells a commodity, the cost of the inventory that was first produced or acquired shall be assumed to be sold under the FIFO inventory cost system. Under the LIFO system, the latest manufactured inventory is considered to be sold when an item is delivered. A business can use these accounting policies in times of increasing inventory prices to increase or decrease its earnings.