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Accounting policies are the exact guidelines, methods, and standards that a business uses to prepare and present its financial statements.
Depending on the sector, scale, and nature of the firm, different companies may have different accounting rules. In addition, accounting practices may alter over time as new accounting rules are released or as the business adjusts to shifting conditions.
Accounting policies have a significant impact on how a business assesses and discloses its financial performance and position. The profitability, liquidity, solvency, and valuation of a corporation can all be significantly impacted by accounting procedures. Decisions made by creditors, investors, regulators, and other parties that depend on financial statements can also be impacted by accounting rules.
Some examples of accounting policies are:
- Revenue recognition: how and when a company recognizes revenue from its sales or services
- Inventory valuation: how a company values its inventory and accounts for its cost of goods sold
- Depreciation and amortization: how a company allocates the cost of its fixed assets and intangible assets over their useful lives
- Impairment: how a company assesses whether its assets have lost value and need to be written down
- Leases: how a company classifies and records its lease contracts as either operating or financing leases
- Contingencies: how a company accounts for uncertain events or situations that may affect its financial position or results
A company's accounting policies are usually disclosed in the notes to its financial statements. The notes offer more details and justification regarding the accounting policies and how they are used in practice. Any important judgments or estimates that the business makes in implementing its accounting policies are also disclosed in the notes.
- Generally Accepted Accounting Principles (GAAP): the set of accounting standards and guidelines that apply to companies in the United States
- International Financial Reporting Standards (IFRS): the set of accounting standards and guidelines that apply to companies in many other countries
- Securities and Exchange Commission (SEC): the federal agency that oversees and regulates the financial reporting of public companies in the United States
- Financial Accounting Standards Board (FASB): the private organization that establishes and updates GAAP in the United States
- International Accounting Standards Board (IASB): the private organization that establishes and updates IFRS
Accounting practices should take into account a company's economic reality and business strategy while also adhering to all applicable rules and regulations. A corporation should maintain consistency in its accounting practices from one period to the next unless there is a good cause to do otherwise. The justification for and effects of any change in accounting policy should be stated in the notes to the financial statements.
The financial reporting and analysis processes rely heavily on accounting policies. They offer a system for assessing and expressing the state and performance of a company's finances. A company's culture, values, and objectives can be greatly inferred from its accounting practices. As a result, it's critical for those who use financial statements to comprehend, assess, and consider how an organization's accounting standards affect its financial outcomes.
