IGCSE Accounting 0452 - 7.2 Accounting Policies

This section explains the importance of accounting policies and how they are applied in preparing financial statements. Understanding accounting policies is crucial for interpreting financial information accurately.

What are Accounting Policies?

Accounting policies are the principles and methods that an entity adopts when preparing its financial statements. They provide a framework for consistent accounting treatment of transactions and events. These policies are not dictated by accounting standards but are chosen by management, within the bounds of accounting standards.

Why are Accounting Policies Important?

Accounting policies are important for several reasons:

• Consistency: They ensure that financial information is presented in a consistent manner from one period to the next, making comparisons easier.
• Comparability: They allow for comparisons of financial statements between different entities, even if they use different accounting methods for certain items.
• Transparency: Disclosing accounting policies provides users of financial statements with information about how the entity has prepared its accounts.
• Judgement: They demonstrate the management's judgement in applying accounting standards to specific situations.

Examples of Accounting Policies

Common accounting policies include:

• Valuation of Inventory: Policies for determining the cost of inventory (e.g., FIFO, weighted average cost).
• Depreciation Methods: Methods used to allocate the cost of fixed assets over their useful lives (e.g., straight-line, reducing balance).
• Revaluation of Assets: Whether and how assets are revalued to their current market value.
• Treatment of Revenue: When revenue is recognised (e.g., at point of sale, over time).
• Accruals: Policies for recognising expenses and revenues that have been incurred but not yet paid or received.
• Allowance for Doubtful Debts: Methods for estimating and accounting for potential bad debts.

Disclosing Accounting Policies

Companies are required to disclose their accounting policies in the notes to the financial statements. This disclosure should be clear and concise, allowing users to understand the methods used to prepare the accounts.

Policy	Description
Inventory Valuation	The entity uses the FIFO (First-In, First-Out) method to value its inventory. This assumes that the first items purchased are the first ones sold.
Depreciation	Depreciation on fixed assets is calculated using the reducing balance method, providing a consistent depreciation expense each year.
Revenue Recognition	Revenue is recognised when goods are delivered to the customer and the risk of loss has been transferred.
Allowance for Doubtful Debts	An allowance for doubtful debts is calculated based on historical bad debt ratios and the ageing of accounts receivable.

Impact of Accounting Policies

The choice of accounting policies can significantly impact the reported financial results. For example, using a different depreciation method can result in different depreciation expense amounts and different profit figures. The choice of inventory valuation method can also affect the cost of goods sold and the profit margin.

It is important to understand the accounting policies used by an entity to properly interpret its financial statements. Users should be aware of the potential impact of these policies on the reported figures.