What are Accounting Policies?

Accounting policies are the rules used by an entity to ensure that transactions are recorded properly and financial statements produced correctly. These policies ensure that accounting activities are handled consistently over time. They are also needed to ensure that an organization follows the applicable accounting framework, such as GAAP or IFRS.

Aggressive Accounting Policies vs. Conservative Policies

The aggressiveness or conservativeness of a firm's accounting policies provides an indicator of how the management team uses accounting to pursue higher "book" profits. A conservative accounting policy tends to understate the reported financial performance of a business, which makes it easier to report more profits in later periods. The reverse is the case for a set of aggressive accounting policies, which result in more reported profits now and fewer profits later.

Thus, investors should peruse all published policies of an entity to see if the financial statements it produces have the potential to reflect an aggressive view of its results and financial condition.

Presentation of Accounting Policies

Accounting policies are included in the notes that accompany the financial statements of a business. In addition, the controller or bookkeeper should list all accounting policies in a standard accounting policies and procedures manual; this is a useful document for training new accountants in how the accounting department operates.

Examples of Accounting Policies

Examples of accounting policies are how a business recognizes revenue, how it recognizes depreciation, which cost flow method is used to recognize inventory, and which research and development costs are capitalized and which are expensed. Here are several more specific policies relating to the credit and collections functions of an accounting department:

Use of collection agencies policy. The collections manager is responsible for hiring and terminating collection agencies. These decisions shall be based primarily on the collection efficiency of the agencies, though under no circumstances shall fees exceeding 30% of collected funds be allowed. The basis of compensation paid shall be the successful receipt of funds from customers; under no circumstances are retainers or periodic fees to be paid. All collection agencies must be bonded. Accounts shall be referred to collection agencies as promptly as possible, once all internal collection efforts have clearly failed.
Credit balance contact policy. Customers shall be contacted regarding outstanding credit balances when the balances exceed $500. These contacts shall continue on a quarterly basis, and shall note that an inactivity fee is being applied. The fee is $10 per month, beginning six months after the credit balance first appears.
Credit holds policy. The use of credit holds is considered an extreme measure that will not be used unless all other reasonable measures have first been attempted. The credit manager must approve all credit holds. The sales manager must be notified in advance of all credit holds and when credit holds are terminated. Customers must be notified at once of all credit holds and when credit holds are terminated.