Difference Between Accounting Policies and Accounting Estimates

Accounting Policies vs Accounting Estimates
 

The preparation of a company’s financial statements is of great importance in determining the firm’s financial stability and in understanding the firm’s ability to operate in the future without facing liquidity issues. Financial statements of the firm which include profit and loss, balance sheet and cash flow statements require proper use of accounting theories and techniques. Accounting policies and accounting estimates serve this purpose by ensuring that the accounting data recorded in the company books are valid in terms of regulatory requirements and financial reporting accuracy. However, the two are very different from each other, and this article aims to give a clear explanation of how to distinguish between the two.

What are Accounting Policies?

Accounting policies are the specified guidelines, principles, rules, standards and other information that ensures the correct preparation of accounting statements by a firm. The accounting policies that firms required to follow are the International Financial Reporting Standards (IFRS), which include the International Financial Reporting Standards, International Accounting Standards and International Financial Reporting Interpretations. These policies ensure that financial statement prepared are ‘relevant and reliable’, and deviation from these policies to show a falsely inflated picture is frowned upon and is seen as a form of attempted manipulation of accounting information. The use of highly accepted accounting policies in the preparation of financial statements will significantly contribute to the firm’s ability to disclose the true financial strength of the firm, and may result in higher financing from external investors owing to the company’s better disclosure standards and accurate accounting information.

What are Accounting Estimates?

There are instances in which an accountant may face a dilemma in which he is unable to identify how to record information accurately in accounting statements. Such a situation will give rise to a need to use accounting estimates, which are judgements made on the latest information available. Examples of the need for such estimates include issues surrounding tax revenue, bad debts, obsolescence of inventories, depreciation of assets, etc. Accounting estimates are essential in cases where financial information cannot be precisely measured, and the use of such estimates must not undermine the accuracy or reliability of the statements prepared.

What is the difference between Accounting Policies and Estimates?

The main similarity between accounting policies and estimates are that, they both assist in accurately recording accounting information and result in reliable and relevant financial statements. The accounting policies are regulations that a company must meet, and have been specifically laid out with proper instructions on how exactly information must be recorded and statements prepared. The accounting estimates, on the other hand, are reliable judgements made by experienced accountants when precise policies are not available to deal with certain transactions. This is a main difference between accounting policies and estimates. The accountant must ensure that the accounting information reflects the true and fair picture of the company’s actual financial position, and the use of accounting policies and accounting estimates will help in achieving this objective.