7.2 Accounting policies
Influence of International Accounting Standards and Objectives in Selecting Accounting Policies
Accounting standards and policies are essential for ensuring that financial information is consistent, comparable, and reliable across different entities and periods. International Accounting Standards (IAS) play a critical role in shaping these principles.
Influence of International Accounting Standards (IAS)
Definition: International Accounting Standards (IAS) are standards issued by the International Accounting Standards Board (IASB) to ensure that financial statements are understandable, comparable, and transparent globally.
Explanation:
Application: IAS provides a common accounting language, enabling businesses and investors to compare financial statements across different jurisdictions.
Example: IAS 16 specifies how companies should account for property, plant, and equipment, ensuring consistent treatment of these assets globally.
Practice Question: Why is it important for companies to adhere to International Accounting Standards?
Objectives in Selecting Accounting Policies
1. Comparability
Definition: Financial statements should be comparable across different entities and periods.
Explanation:
Application: Comparability allows stakeholders to identify trends and differences between businesses, enhancing decision-making.
Example: Using the same depreciation method across different periods ensures that the financial performance of a business can be compared year-on-year.
2. Relevance
Definition: Information in financial statements should be relevant to the decision-making needs of users.
Explanation:
Application: Relevant information helps stakeholders make informed decisions about the allocation of resources.
Example: Providing details about significant events, such as mergers or acquisitions, that impact the financial position of the company.
3. Reliability
Definition: Financial information should be reliable, meaning it should be accurate, free from bias, and verifiable.
Explanation:
Application: Reliable information builds trust among stakeholders and ensures that financial statements reflect the true financial position of the business.
Example: Using historical cost for asset valuation ensures that the values are based on actual transactions.
4. Understandability
Definition: Financial information should be presented clearly and concisely so that users with reasonable knowledge of business can understand it.
Explanation:
Application: Understandability ensures that financial statements are accessible to a wide range of users, including investors, creditors, and regulators.
Example: Using straightforward language and providing notes to explain complex items.
Past Paper Questions
Question 1: Which characteristic of financial information requires that financial statements be clearly presented and assumes that the users of the financial statements will have a reasonable knowledge of accounting?
A comparability
B relevance
C reliability
D understandability
Question 2:Which statement is not correct about reasons for using international accounting standards?
A assists when making comparisons between companies
B improves the reliability of accounting information
C narrows the areas of difference in financial reporting
D makes the preparation of financial statements less time-consuming
Question 3: ‘The information provided in financial statements should be capable of being independently verified.’
To which accounting policy does this statement refer?
A comparability
B relevance
C reliability
D understandability
Question 4: A business has decided to switch from using the reducing balance method to the straight-line method for depreciation. Explain how this change aligns with the objectives of comparability, relevance, reliability, and understandability.
Answer:
Comparability: The change might temporarily reduce comparability with past financial statements, but if other companies in the industry use the straight-line method, it could enhance comparability with peers.
Relevance: If the straight-line method provides a more accurate reflection of the asset's usage and future benefits, it improves the relevance of the financial information.
Reliability: The straight-line method might offer a more straightforward and less subjective approach to depreciation, thus enhancing reliability.
Understandability: The straight-line method is simpler and more intuitive, making the financial statements easier to understand for users.
Conclusion
These objectives guide the selection of accounting policies to ensure that financial information is useful and meets the needs of various stakeholders. By adhering to these principles, companies can produce financial statements that are not only compliant with international standards but also effective tools for decision-making.
