Accounting policy

What it means

Accounting policy is the set of methods an accounting entity chooses where the law and accounting rules leave a choice. Examples are the threshold for fixed assets, the valuation method, the depreciation method, the inventory accounting method, and rules for accruals and deferrals or provisions.

The chosen methods are described in internal policies, and their significant parts are disclosed in the notes to the financial statements. Readers of the accounts can then see how the figures were prepared and compare them with other companies.

The basic principle is consistency. A company should apply its methods the same way from year to year and change them only if the change gives a truer picture. A change in accounting policy must be justified and described together with its effect on the results.

How it works in practice

When we take on a new client we review its existing accounting policy and fill in what is missing. Most often this concerns the low-value asset threshold, the depreciation plan, rules on exchange differences, deferral of small amounts and the stock-take procedure.

Where a choice has tax consequences, we also take the Income Tax Act into account. Some accounting choices, such as the depreciation method, may differ from tax rules, creating a difference that must be adjusted in the tax return.

Accounting policy also covers rules for accounting estimates, such as how allowances for receivables are set according to how long they are overdue. Uniform rules prevent estimates depending on mood or the desired result.

What to watch out for

A missing or merely formal accounting policy shows up in an audit, due diligence or inspection when it is impossible to explain why similar cases were treated differently. Inconsistency undermines confidence in the whole set of accounts.

Changing policy to improve a particular year’s result, such as extending depreciation periods before a loan application, without a real reason breaches the consistency principle. Both the auditor and the bank will notice such a change and view it critically.