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.
Accounting policies are included in the notes that accompany the financial statements of a business. Examples of these policies are:
- How the business recognizes revenue
- How the business recognizes depreciation
- Which cost flow method is used to recognize inventory
- Which research and developments costs are capitalized and which are expensed
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. 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.