What Are Accounting Policies?

Accounting policies are the specific principles, bases, conventions, rules and practices that a company applies when preparing and presenting its financial statements. They determine how transactions and events are recognised, measured and disclosed in the accounts.

Under FRS 102, companies must select accounting policies that result in financial statements providing relevant and reliable information. Once chosen, policies must be applied consistently from one period to the next in line with the consistency concept.

Why Accounting Policies Matter

Different accounting policies can produce significantly different reported figures from the same underlying transactions. For example, a company choosing to depreciate a vehicle over three years will report higher expenses in the early years than one depreciating the same vehicle over five years. The choice of policy affects:

• Reported profit in each accounting period
• Asset values on the balance sheet
• Tax computations (indirectly, through the accounting profit starting point)
• Comparability between companies and across periods
• Covenant compliance where banking agreements reference accounting figures

Selecting Accounting Policies

FRS 102 Hierarchy

When selecting a policy for a particular type of transaction, a company should apply the following hierarchy:

1. Specific FRS 102 requirements: If FRS 102 addresses the transaction directly, follow that guidance
2. Similar transactions: If no specific guidance exists, look at FRS 102 requirements for similar transactions
3. General principles: Apply the definitions, recognition criteria and measurement concepts from the FRS 102 conceptual framework

Key Criteria

Accounting policies should be:

• Relevant to the decision-making needs of the users
• Reliable, meaning they faithfully represent the substance of transactions
• Neutral, free from bias
• Prudent in the face of uncertainty
• Complete within the bounds of materiality and cost

Common Accounting Policies

Every UK company must establish policies for its significant areas of accounting. The following table shows the most common policies and the choices available:

Example: Depreciation Policy

A typical depreciation policy disclosure reads:

Tangible fixed assets are stated at cost less accumulated depreciation and accumulated impairment losses. Depreciation is provided on a straight-line basis over the estimated useful lives as follows:

Land is not depreciated. Residual values and useful lives are reviewed annually.

Disclosure Requirements

Notes to the Accounts

Under FRS 102 Section 8, a company must disclose in the notes:

• A summary of significant accounting policies applied
• The measurement basis (typically historical cost)
• Any other policies relevant to understanding the financial statements

This is usually the first or second note in the accounts and is titled “Accounting policies” or “Principal accounting policies.”

What Must Be Disclosed

The disclosure should cover every area where a policy choice has been made or where the treatment is not obvious from the financial statements themselves. Areas that almost always require disclosure include:

• Basis of preparation (going concern, applicable framework)
• Revenue recognition
• Tangible fixed assets and depreciation
• Intangible assets and amortisation
• Stock valuation
• Lease accounting
• Foreign currency translation
• Taxation (including deferred tax)
• Pension costs
• Financial instruments

Changing Accounting Policies

When a Change Is Permitted

A company may change an accounting policy only if:

• The change is required by FRS 102 or a new standard
• The change results in the financial statements providing more reliable and relevant information

A change in policy is not the same as a change in estimate. Changing the useful life of an asset is a change in estimate (applied prospectively). Changing from FIFO to weighted average for stock valuation is a change in policy.

How to Account for a Change

Under FRS 102 Section 10, a voluntary change in accounting policy is applied retrospectively. This means:

1. The opening balances of the earliest period presented are restated as if the new policy had always been applied
2. Comparative figures are restated
3. The cumulative effect is adjusted through the profit and loss reserve (retained earnings)

Disclosure of Changes

When a policy is changed, the notes must disclose:

• The nature of the change
• The reasons for the change
• The amount of the adjustment for the current period and each prior period presented
• The amount of the adjustment relating to periods before those presented, to the extent practicable

Accounting Policies and the Audit

Auditors pay close attention to accounting policies because:

• Inappropriate policies can materially misstate the financial statements
• Changes in policy may be used to manipulate reported results
• Consistency of application is a key audit objective
• The auditor must assess whether the policies are appropriate for the business and its circumstances

The audit report will refer to the accounting policies note and may include a key audit matter if a policy involves significant judgement.

Accounting Policies vs Accounting Estimates

Understanding the distinction is important because the accounting treatment of changes differs significantly. A policy change requires restating prior periods; an estimate change does not.