Importance of Accounting Policies

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Accounting policies are important to any business to maintain consistency and to set up a standard for decision-making. Based on policies, procedures are developed and followed, including paying bills, cash management and budgeting. Accounting policies are usually approved by top management and do not change much throughout the years. They are developed for long-term use, reflecting a firms' values and ethics. Accounting policies are not the same as accounting principles. Accounting principles are the rules, and accounting policies are how a firm adheres to these rules.

Significance

  • Policies in the area of accounting maintain standardization across the board and are used as disclosures in audited financial statements. For example, a retail firm may use the First In, First Out method as a policy on inventory and sales. That policy must be used consistently and disclosed in the footnotes of financial statements. Disclosure of accounting policies helps readers in better interpreting a company's financial situation. Accounting principles can be very general at times, so policies can be very important. A review of a specific company's accounting policies can indicate whether management is conservative or aggressive when reporting earnings.

Types

  • Accounting policies can be about any financial matter, such as consolidation of accounts, depreciation methods, goodwill, inventory pricing and research and development costs. In the non-profit sector, spending policies have become popular, especially when endowments are present. Policies may vary with individual industries and sectors.

Mandatory Policies

  • Many policies are not optional, but mandatory, especially if you are dealing with a public firm. The Securities and Exchange Commission requires full disclosure of policies regarding items that involve estimations and that are material to the financial statements. The Sarbanes-Oxley Act of 2002 spearheaded many policies, for example that executives should not take loans from the company. Based on this act, many firms now have a whistle-blower policy where employees can call in reporting possible fraud. You must have certain policies in place to avoid trouble with auditors and government.

Internal Controls

  • Having policies on internal controls is an important part of the accounting process as it helps prevent losses and misuse of assets. Segregation of duties is usually part of internal control policy. For example, a person handling live checks and money shouldn't be responsible for booking them in an accounts receivable system. The point is to create a system of checks and balances backed up by a policy.

Considerations

  • International Financial Reporting Standards (IFRS) is a new accounting system developed by the International Accounting Standards Board to make the American system and the European system similar. Many firms are migrating into this new system, most often requiring a policy change and disclosures in the financial statements.

    In large firms and governments, there is a person or even a department in charge of policies, including accounting policies. Usually a CFO or a Finance Director proposes a policy and then it is approved by a board executive or finance committee. It's a serious process as policies affect an entire company.

References

  • Photo Credit money image by Sid Viswakumar from Fotolia.com
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