What are accounting policies?

Understanding accounting policies

Accounting policies determine how financial information is recorded and reported within an entity’s financial statements. They help ensure that similar transactions are accounted for consistently from one reporting period to the next, making financial information more reliable and comparable.

The policies adopted depend on the nature of the business, its activities and the accounting framework it follows. In the UK, this may include FRS 102, FRS 105 or IFRS Accounting Standards. Common accounting policies cover areas such as revenue recognition, depreciation, inventory valuation, foreign currency transactions and the treatment of financial instruments.

Accounting policies differ from accounting estimates. Policies establish the principles used to prepare financial statements, while estimates involve management’s judgement when applying those principles to specific circumstances.

Key features of accounting policies

• They establish the principles and methods used to prepare financial statements.
• They promote consistency in financial reporting across accounting periods.
• The policies adopted depend on the entity’s activities and the applicable accounting framework.
• Significant accounting policies are typically disclosed within the financial statements.
• They differ from accounting estimates, which involve judgement when applying the chosen policies.

How accounting policies are applied

• An entity identifies the accounting framework that applies to its financial reporting.
• Appropriate accounting policies are selected for significant transactions and balances.
• The policies are applied consistently when preparing the financial statements.
• Any changes to accounting policies are accounted for in accordance with the relevant accounting standards and disclosed where required.

Accounting policies in practice

A manufacturing company prepares its annual financial statements under FRS 102. It adopts accounting policies covering areas such as inventory valuation, depreciation of fixed assets and revenue recognition. These policies are applied consistently each year so that the financial statements provide comparable information for shareholders and other users.

Related terms

• Accounting estimates
• Financial statements
• FRS 102
• FRS 105
• IFRS Accounting Standards
• Revenue recognition
• Materiality
• Accounting standards

Common misconceptions

Accounting policies are not unique to large organisations; entities of all sizes apply them.

They do not represent management preferences alone and are determined within the applicable accounting framework.

Accounting policies are different from accounting estimates, although the two are closely related.

Questions about accounting policies

What are accounting policies?

Accounting policies are the principles, rules and practices an entity uses to prepare and present its financial statements in accordance with the relevant accounting framework.

Why are accounting policies important?

They promote consistency, reliability and comparability in financial reporting, enabling users of financial statements to better understand an entity’s financial performance and position.

Can accounting policies change?

Yes. Changes may occur where a new accounting standard applies or where a different policy provides more reliable and relevant financial information, subject to the applicable accounting requirements.

Where are accounting policies disclosed?

Significant accounting policies are normally included within the notes to an entity’s financial statements.

What is the difference between an accounting policy and an accounting estimate?

An accounting policy establishes how transactions are accounted for, while an accounting estimate reflects management’s judgement when applying that policy to amounts that cannot be measured with complete precision.