The Accounting Policies Affair

Time and time again, accounting policies are identified as an area of weakness by file reviewers and regulators alike.

In this blog we take a look at how to get them right.

What the FRC says

The FRC has been quite vocal on poor quality accounting policies over recent years. It is an area which has been specifically identified in its What Makes a Good Annual Report and Accounts guide in which it highlights:

Accounting policies that lack clarity, are not company or transaction specific, or are inconsistent with other information in the ARA Annual Reports and Accounts], are likely to attract regularity enquiry.

The FRC’s advice is to consider its 4Cs of effective communication principles:

• Company specific;
• Clear, concise and understandable;
• Clutter free and relevant; and
• Comparable

Its guidance goes on to suggest:

Preparers should replace boilerplate disclosure with information that is tailored to the company’s specific circumstances. This provides better quality, more decision useful information.

Accounting Policies Guidance

When considering accounting policies, it’s well worth looking at the guidance in IAS 1 Presentation of Financial Statements and IFRS Practice Statement 2: Making Materiality Judgements.

The Practice Statement in particular offers useful guidance on thinking about materiality of accounting policies. Even where accounts are prepared under UK GAAP, following a similar mindset shouldn’t lead preparers or auditors too far astray.

Getting Accounting Policies right

Here are our key tips:

• Don’t rely on software alone
  Whilst accounts production software is great for some things, the accounting policies most software suggests are too boilerplate and generic. Whilst they can be used as a starting point, they will always need to be reviewed and updated.
• Remove irrelevant policies
  As simple as this is, at Mercia, we see lots of accounts which include accounting policies that are totally irrelevant. If a business only provides services, then an accounting policy note about when sales of goods are recognised isn’t helpful. Likewise, if a business has no derivative financial instruments, then an accounting policy note explaining how it would account for derivatives if it had any, is also not relevant and adds little (if any) value.
• Ensure policies are tailored and relevant to the entity concerned
  Ensure that accounting policies properly reflect the activities of the entity. For example, when looking at revenue recognition, ensure the policies address all the entity’s main revenue streams. Also ensure that judgements disclosed are those that are specific to the entity, not just generic judgements which could apply to any business.
• Don’t just repeat the words of the relevant accounting standard
  Polices instead need to communicate how the principles of the relevant accounting standard have been applied by the entity concerned, for example being specific with the trigger point for revenue recognition.
• Ask someone to review the accounting policies cold
  Where possible, ask someone else in the firm, who hasn’t been involved in preparing or auditing the accounts to review them cold. They will be in a good position to feedback if there are irrelevant accounting policies, or policies that don’t make sense in the context of the business.

Final thoughts

The accounting polices section of the notes to accounts is often overlooked, but accounting policies are of fundamental importance to users of the financial statements. Care should be taken to ensure that they are made as relevant as possible.