7.2 Accounting Policies - Relevance

Accounting policies are the principles and methods a business adopts when preparing its financial statements. They are crucial for ensuring the financial statements are relevant, reliable, and comparable. This section focuses on the importance of relevance in accounting policies.

What is Relevance in Accounting?

Relevance refers to the ability of information to influence the decisions of users of financial statements. Information is relevant if it helps users to make informed judgments about the past, present, or future financial performance and position of an entity.

How Accounting Policies Affect Relevance

The accounting policies a business chooses directly impact the relevance of its financial statements. Different policies can present the same economic reality in different ways, affecting how users interpret the information.

Examples of Accounting Policies and their Relevance

Here are some examples of accounting policies and how they relate to relevance:

• Valuation of Inventory: The method used to value inventory (e.g., FIFO, weighted average) can affect the reported cost of goods sold and the value of ending inventory. This is relevant for assessing the profitability and efficiency of inventory management.
• Depreciation Methods: The choice of depreciation method (e.g., straight-line, reducing balance) impacts the reported depreciation expense and the carrying value of assets. This is relevant for understanding the cost of using assets and the financial position of the company.
• Revenue Recognition: The policies used to recognize revenue (e.g., at point of sale, over time) significantly affect the reported revenue and profitability. This is crucial for assessing the company's performance and future prospects.
• Accruals and Provisions: The methods used to recognize accruals (e.g., accounts payable) and provisions (e.g., for warranties) affect the reported expenses and liabilities. This is relevant for understanding the company's financial obligations and potential future costs.

Ensuring Relevance in Accounting Policies

Businesses should choose accounting policies that:

1. Reflect the economic substance of transactions: Policies should accurately represent what happened economically.
2. Are consistent from period to period: Changes in policies should be justified and disclosed. Consistency allows for meaningful comparisons over time.
3. Are clearly disclosed in the notes to the financial statements: Users need to understand the policies used to prepare the financial statements.

Table: Examples of Accounting Policies and their Relevance

Accounting Policy	Impact on Relevance
Inventory Valuation (FIFO)	Provides a more current view of the cost of goods sold, relevant for assessing profitability.
Depreciation (Straight-Line)	Distributes the cost of an asset evenly over its useful life, providing a consistent view of asset usage costs.
Revenue Recognition (Point of Sale)	Reports revenue when the goods or services are delivered, relevant for assessing current performance.
Accruals for Expenses	Ensures expenses are recognized when incurred, relevant for a true and fair view of profitability.

Conclusion

Choosing appropriate accounting policies is essential for ensuring that financial statements are relevant and provide useful information for decision-making. Relevance is a key principle that guides the selection and application of accounting policies.