Significant accounting policies in financial statements

November 2, 2012

US GAAP allows application of alternative accounting principles to certain types of accounting transactions or balances. Investors, creditors, and other users of financial information need to understand which accounting principles are utilized by a company. Such principles are to be described in the summary of significant accounting policies.

1. Nature of significant accounting policies

Significant accounting policies are specific accounting principles and methods a company employs and considers to be the most appropriate to use in current circumstances in order to fairly present its financial statements.

So why is it important to disclose significant accounting policies? Such disclosure helps users of financial statements (e.g., investors, creditors, vendors) to understand how particular accounting principles were used in preparing the company’s financial statements. Description of significant accounting policies also helps in comparing financial statements of different companies.

Both for-profit and non-for-profit organization should disclose the details of their significant accounting policies that are important in determining the financial position, changes in the financial position, or results of operations of the organization.

Disclosure of significant accounting policies should be done in the following situations:

  • A selection of existing acceptable alternatives.
  • Principles and methods that are specific in a particular industry in which the company operates.
  • Unusual or innovative application of GAAP.

Some areas for which significant accounting policies can be disclosed in financial statements are presented below:

  • Basis of consolidation
  • Accounts receivables and determination of allowance for bad debts
  • Advertising costs
  • Cash and cash equivalents
  • Changes in accounting policies
  • Deferred income taxes
  • Derivatives and hedging activities
  • Fair value elections, methods, assumptions, inputs used
  • Fiscal year (52-53 week year)
  • Foreign currency translation
  • Goodwill
  • Impairment of long-lived assets, goodwill, other intangibles, investments, etc.
  • Intangible assets
  • Interest capitalization
  • Internal-use software
  • Inventories and their pricing (FIFO, LIFO, Weighted-average, etc.)
  • Nature of operations
  • Operating cycle
  • Pension and other postretirement or postemployment plans
  • Property and equipment and related depreciation and amortization
  • Reclassifications
  • Research and development costs and their basis of amortization
  • Revenue recognition
  • Stock-based compensation
  • Shipping and handling costs
  • Start-up costs
  • Use of estimates
  • Warranties

Companies normally present significant accounting policies in a separate note to financial statements or in a separate summary of significant accounting policies preceding the notes to financial statements.

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