International Accounting Standard 8 (IAS 8) defines accounting policies as “the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements”.
The accounting policies are the specific policies and procedures that are used by a company to prepare its financial statements. The accounting policies include methods, measurement systems and procedures for presenting information in financial statements.
Accounting policies are very important for the proper understanding of the information provided in the financial statements. An entity should clearly state the accounting policies it has used while preparing the financial statements. Disclosure of accounting policies is important because many accounting standards allow alternative treatments for a same transaction or item. Users of financial statements will not be able to compare the financial information with other entities if the accounting policies are not cleared outlined.
For example, IAS 2 gives the entities a choice to either use weighted-average method or the first in, first out (FIFO) method for valuation of inventories. Unless an entity discloses its accounting policy regarding selection of the inventory valuation method, the users of financial statements will not be able to make relative comparisons with other entities.
IAS 8 provides the following guidance regarding selection and application of accounting policies.
- An accounting policy should be determined by applying a Standard or Interpretation which specifically applies to a transaction, an even, or condition.
- If Standards or Interpretations do not address a specific transaction, event, or condition, an entity should develop and apply a policy that is relevant to the decision making needs of users of financial statements and is reliable as well.
While making these judgments, an entity should apply the following sources in descending order:
- The requirements and guidelines in Standards and Interpretations which deal with similar and related issues
- The definitions, recognition criteria, and concepts of measurement for income, expenses, assets and liabilities as outlined in the International Accounting Standards Board (IASB) Framework.
- Most recent pronouncements of other standard setting bodies to the extent that these do not conflict with the Standards, Interpretations, and the IASB Framework.
Accounting policies are the set rules and conventions that are provided by some national or international committee of accountancy for the entities to follow while organizing their monetary statements. The entities have to follow these specific conventions and principles in the preparation and presentation of their final accounts. The reason for setting these conventions is the consistency in the financial statements of different entities and prohibiting the use of misleading policies to coerce the users of financial statements.
Interpretation according to IAS 8: Accounting policies, changes in accounting estimates and errors
For the countries that follow International accounting standards (IAS), an accounting standard IAS 8:Accounting policies, changes in accounting estimates and errors has been designed to help the entities in better understanding the need and methodology of selecting and applying the accounting policies and how to follow them consistently. This standard also defines how these entities can change their accounting policies and the right method to disclose the change.
Selection and application of accounting policies
When a Standard is available for a transaction or event, management of the entity must apply the specific guidance provided by the IASB Implementation Guidance in applying that specific accounting policy. If any preceding guidance is not available for an accounting policy, the management must use its own judgment in selecting a policy it deems fit for the scenario. Other than this, management can also use the most-recent pronouncements of the other frameworks and standard-setting bodies and apply them if the conditions match.
Consistency in accounting policies of business
For the similar transactions, an entity must apply the similar accounting policies in a consistent manner. An entity is not allowed to change its accounting policies for one transaction for consecutive periods. If an entity is going to change its accounting policy, it should have a solid reason for that, and it should properly disclose any change in its financial statements along with the reason for change.
Changes and disclosure of accounting policies:
An entity can only change its accounting policy if some specific rules and conditions are fulfilled. These are:
- Management is allowed to change its accounting policies if it is required by a Standard
- If the change in accounting policy results in the providence of more reliable and accurate information regarding transactions, events and financial statements