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Accounting as a ‘language of business’ communicates the financial results of an enterprise to various stakeholders by means of financial statements. If the financial accounting process is not properly regulated, there is possibility of financial statements being misleading, tendentious and providing a distorted picture of the business, rather than the true state of affairs. In order to ensure transparency, consistency, comparability, adequacy and reliability of financial reporting, it is essential to standardise the accounting principles and policies. Accounting Standards (ASs) provide framework and standard accounting policies so that the financial statements of different enterprises become comparable.
Accounting standards are written policy documents issued by expert accounting body or by government or other regulatory body covering the aspects of recognition, treatment, measurement, presentation and disclosure of accounting transactions and events in the financial statements. The ostensible purpose of the standard setting bodies is to promote the dissemination of timely and useful financial information to investors and certain other parties having an interest in the company’s economic performance. The accounting standards deal with the issues of(i) recognition of events and transactions in the financial statements; (ii) measurement of these transactions and events; (iii) presentation of these transactions and events in the financial statements in a manner that is meaningful and understandable to the reader; and (iv) the disclosure requirements which should be there to enable the public at large and the stakeholders and the potential investors in particular, to get an insight into what these financial statements are trying to reflect and thereby facilitating them to take prudent and informed business decisions.
The whole idea of accounting standards is centered around harmonisation of accounting policies and practices followed by different business entities so that the diverse accounting practices adopted for various aspects of accounting can be standardised. Accounting Standards standardise diverse accounting policies with a view to: (i) eliminate the non-comparability of financial statements and thereby improving the reliability of financial statements; and (ii) provide a set of standard accounting policies, valuation norms and disclosure requirements. Accounting standards reduce the accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises.
4. BENEFITS AND LIMITATIONS
Accounting standards seek to describe the accounting principles, the valuation techniques and the methods of applying the accounting principles in the preparation and presentation of financial statements so that they may give a true and fair view. By setting the accounting standards, the accountant has following benefits: (i) Standards reduce to a reasonable extent or eliminate altogether confusing variations in the accounting treatments used to prepare financial statements. (ii) There are certain areas where important information are not statutorily required to be disclosed. Standards may call for disclosure beyond that required by law. (iii) The application of accounting standards would, to a limited extent, facilitate comparison of financial statements of companies situated in different parts of the world and also of different companies situated in the same country. However, it should be noted in this respect that differences in the institutions, traditions and legal systems from one country to another give rise to differences in accounting standards adopted in different countries.
However, there are some limitations of setting of accounting standards:
(i) Alternative solutions to certain accounting problems may each have arguments to recommend them. Therefore, the choice between different alternative accounting treatments may become difficult.
(ii) There may be a trend towards rigidity and away from flexibility in applying the accounting standards.
(iii) Accounting standards cannot override the statute. The standards are required to be framed within the ambit of prevailing statutes.
5. OVERVIEW OF ACCOUNTING STANDARDS IN INDIA
In India, the Institute of Chartered Accountants of India (ICAI), being a premier accounting body in the country, took upon itself the leadership role by constituting the Accounting Standards Board (ASB) on 21st April, 1977. The main function of ASB is to formulate accounting standards so that such standards may be established in India by the council of the ICAI. The council of the Institute of Chartered Accountants of India has, so far, issued thirty two Accounting Standards. However, AS 8 on ‘Accounting for Research and Development’ has been withdrawn consequent to the issuance of AS 26 on ‘Intangible Assets’. Thus effectively, there are 31 Accounting Standards at present.
The ‘Accounting Standards’ issued by the Accounting Standards Board establish standards which have to be complied by the business entities so that the financial statements are prepared in accordance with generally accepted accounting principles. Following is the list of Accounting Standards with their respective date of applicability.
A brief overview of the above mentioned accounting standards is given below:
AS 1 Disclosure of Accounting Policies (Issued 1979)
This Standard is related with presentation/disclosure requirements of the significant accounting policies (specific accounting policies and the methods of applying those principles) followed in preparing financial statements. The true and fair state of affairs and the financial results of an entity is significantly affected by the accounting policies followed in accounting. The areas in which different accounting policies can be followed are accounting for depreciation, revaluation of inventories, valuation of fixed assets etc. The disclosure of the significant accounting policies should form part of the financial statement and any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in the later periods should be disclosed. If any of the fundamental accounting assumptions viz. going concern, consistency and accrual is not followed in financial statements, the fact should be specifically disclosed.
AS 2 Valuation of Inventories (Revised 1999)
AS 2 is a measurement related standard and specifies the methods of computation of cost of inventories and the method of determination of the value of inventory to be shown in the financial statements. As per the standard, the cost of inventories should comprise costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Inventory is valued by following conservatism principle i.e., at lower of the cost or the market price. With a view to bring about uniformity in inventory valuation practices, the revised AS 2 drastically reduces the alternative choices. The revised standard permits the use of only FIFO or weighted average cost formula for determining the cost of inventories where the specific identification of cost of inventories is not possible. The standard also dispenses with the direct costing method and permits only the absorption costing method for arriving at the cost of finished goods.
AS 3 Cash Flow Statements (Revised 1997)
This standard deals with the provision of information about the historical changes in cash and cash equivalents of an enterprise by means of a cash flow statement which classifies cash flows during the period into operating, investing and financing activities. The cash flow statement is an important part of financial statement and helps in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of future cash flows of different enterprises. The requirement of presentation of cash flow statement would force the management to strive to improve the actual cash flows rather than the profits, which is ultimate goal of any business entity.
AS 4 Contingencies and Events occurring after the Balance Sheet date (Revised 1995) Pursuant to AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets becoming mandatory in respect of accounting periods commencing on or after 1st April, 2004, all paragraphs of AS 4 dealing with contingencies stand withdrawn except to the extent they deal with impairment of assets not covered by any other Indian AS. The project of revision of this standard by ASB in the light of newly issued AS 29 is under progress. Thus, the present standard (AS 4) deals with the treatment and disclosure requirements in the financial statements of events occurring after the balance sheet. Events occurring after the balance sheet date are those significant events (favourable as well as unfavourable) that occur between the balance sheet date and the date on which financial statements are approved by the approving authority (i.e. board of directors in case of a company) of any entity.
AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies (Revised 1997) This statement should be applied by an enterprise in presenting profit and loss from ordinary activities, extraordinary items and prior period items in the statement of profit and loss, in accounting for changes in accounting estimates, and disclosure of changes in accounting policies. As per AS 5, prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of financial statements of one or more prior periods. Extraordinary items are income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly. The prior period and extraordinary items are required to be disclosed in the profit and loss statement as part of the net profit for the period with separate disclosure of the nature and amount to show its impact on current year’s profit or loss.
AS 6 Depreciation Accounting (Revised 1994) This standard requires that the depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset and the depreciation method selected should be applied consistently from period to period. If there is a change in the method of providing depreciation, such a change should be treated as a change in accounting policy and its effect (deficiency or surplus arising from retrospective recomputation of depreciation as per new method) should be quantified and disclosed. In case any depreciable asset is disposed off, discarded or demolished, the net surplus/deficiency, if material, should be disclosed separately. The depreciation method used and depreciation rates are also required to be disclosed in the financial statements.
AS 7 Construction Contracts (Revised 2002) The standard prescribes the accounting treatment of revenue and costs associated with construction contracts by laying down the guidelines regarding allocation of contract revenue and contract costs to the accounting periods in which the construction work is performed, since the construction activity is generally contracted and completed in more than one accounting period. An enterprise is required to disclose the amount of recognised contract revenue with the methods used to determine that revenue and the methods applied in determining the stages of completion of contracts in progress. As per the standard, the gross amount due from and to customers for contract work are shown as asset and liability respectively.
AS 8 Accounting for Research and Development This standard stands withdrawn w.e.f. 1st April, 2003 i.e. the date from which AS 26 on Intangible Assets becomes mandatory.
AS 9 Revenue Recognition (Issued 1985) The standard deals with the basis for recognition of revenue arising in the course of ordinary activities, from the sale of goods; rendering of services; and income from interest, royalties and dividends in the profit and loss statement of an enterprise. According to the standard, revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalty and dividends. The revenue arising from construction contracts, hire purchase and lease agreements, government grants and subsidies and revenue of insurance companies from insurance contracts are outside the purview of AS 9. In addition to disclosures required by AS 1, AS 9 requires an enterprise to disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.
AS 10 Accounting for Fixed Assets (Issued 1985) The standard deals with the disclosure of the status of the fixed assets in terms of value. The standard does not take into consideration the specialised aspect of accounting for fixed assets reflected with the effects of price escalations but applies to financial statements on historical cost basis. It is important to note that from the date of AS 26 on Intangible Assets, becoming applicable, the relevant paragraphs of this standard (AS 10) dealing with patents and know-how have been withdrawn. An entity should disclose the following information relating to
(i) the gross and net book values of fixed assets at beginning and end of an accounting period showing additions, disposals, acquisitions and other movements,
(ii) expenditure incurred on account of fixed assets in the course of construction or acquisition, and
(iii) revalued amounts substituted for historical costs of fixed assets with the method applied in computing the revalued amount in the financial statements:
AS 11 Effects of Changes in Foreign Exchange Rates (Revised 2003, Applicable w.e.f. 1st April, 2004) An enterprise may carry on activities involving foreign exchange in two ways – by transacting in foreign currencies or by indulging in foreign operations. In order to include foreign currency transactions and foreign operations in the financial statements of an enterprise, transactions must be expressed in the enterprise’s reporting currency and the financial statements of foreign operations must be translated into the enterprise’s reporting currency. The standard deals with the issues involved in accounting for foreign currency transactions and foreign operations i.e., to decide which exchange rate to use and how to recognize the financial effects of changes in exchange rates in the financial statements. The standard requires the enterprises to disclose
(i) the amount of exchange differences included in the net profit or loss for the period
(ii) the amount of exchange differences adjusted in the carrying amount of fixed assets,
(iii) the amount of exchange differences in respect of forward exchange contracts to be recognised in the profit or loss in one or more subsequent accounting periods (over the life of the contract).
AS 12 Accounting for Government Grants (Issued 1991)
AS 12 deals with accounting for government grants and specifies that the government grants should not be recognised until there is reasonable assurance that the enterprise will comply with the conditions attached to them, and the grant will be received. The standard also describes the treatment of non-monetary government grants; presentation of grants related to specific fixed assets, related to revenue, related to promoters’ contribution; treatment for refund of government grants etc. The enterprises are required to disclose
(i) the accounting policy adopted for government grants including the methods of presentation in the financial statements;
(ii) the nature and extent of government grants recognised in the financial statements, including non-monetary grants of assets given either at a concessional rate or free of cost.
AS 13 Accounting for Investments (Issued 1993) The statement deals with accounting for investments in the financial statements of enterprises and related disclosure requirements. The enterprises are required to disclose the current investments (realisable in nature and intended to be held for not more than one year from the date of its acquisition) and long terms investments (other than current investments) distinctly in their financial statements. An investment property should account for as long-term investments. The cost of investments should include all acquisition costs (including brokerage, fees and duties) and on disposal of an investment, the difference between the carrying amount and net disposal proceeds should be charged or credited to profit and loss statement.
AS 14 Accounting for Amalgamations (Issued 1994)
AS 14 deals with accounting for amalgamation and the treatment of any resultant goodwill or reserves and is directed principally to companies although some of its requirements also apply to financial statements of other enterprises. An amalgamation may be either in the nature of merger or purchase. The standard specifies the conditions to be satisfied by an amalgamation to be considered as amalgamation in nature of merger. An amalgamation in nature of merger is accounted for as per pooling of interests method and in nature of purchase is dealt under purchase method. The standard also describes the disclosure requirements for both types of amalgamations in the first financial statements.
AS 15 Employee Benefits (Revised 2005) The standard requires enterprises to recognise
(i) a liability when an employee has provided services in exchange for employee benefits to be paid in future, and
(ii) an expense when enterprise consumes the economic benefit arising from services provided by an employee in exchange for employee benefits.
Employee benefits can be classified under
(i) short-term employee benefits (e.g. wages, salaries etc.), (ii) post-employment benefits (e.g. gratuity, pension etc.),
(iii) long-term employee benefits (e.g. long-term leave, long-term disability benefits etc.), and
(iv) termination benefits (e.g. VRS payments). The standard lays down recognition and measurement criteria and disclosure requirement for all the four types of employee benefits.
AS 16 Borrowing Costs (Issued 2000) The standard prescribes the accounting treatment for borrowing costs (i.e. interest and other costs) incurred by an enterprise in connection with the borrowing of funds. This standard deals with the issues related to identification of asset which qualifies for capitalisation of interest, determination of the period for which interest can be capitalized and determination of the amount that can be capitalised. The amount of borrowing costs eligible for capitalisation should be determined in accordance with provisions of AS 16 and other borrowing costs (not eligible for capitalisation) should be recognised as expenses in the period in which they are incurred.
AS 17 Segment Reporting (Issued 2000) This standard requires that the accounting information should be reported on segment basis. AS 17 establishes principles for reporting financial information about different types of products and services an enterprise produces and different geographical areas in which it operates. The information helps users of financial statements, to better understand the performance and assess the risks and returns of the enterprise and make more informed judgements about the enterprise as a whole. The standard is more relevant for assessing risks and returns of a diversified or multilocational enterprise which may not be determinable from the aggregated data.
AS 18 Related Party Disclosures (Issued 2000) This standard prescribes the requirements for certain disclosures which must be made in the financial statements of reporting enterprise for transactions between the reporting enterprise and its related parties. The requirements of the standard apply to the financial statements of each reporting enterprise as also to consolidated financial statements presented by a holding company. Since the standard is more subjective, particularly with respect to identification of related parties, obtaining corroborative evidence becomes very difficult for the auditors. Thus successful implementation of AS 18 is dependent upon how transparent the management is and how vigilant the auditors are.
AS 19 Lease (Issued 2001)
AS 19 prescribes the accounting and disclosure requirements for both finance leases and operating leases in the books of the lessor and lessee. The classification of leases adopted in this standard is based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor and the lessee. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. An operating lease is a lease other than finance lease. At the inception of the lease, assets under finance lease are capitalised in the books of lessee with corresponding liability for lease obligations as against the operating lease, wherein lease payments are recognised as an expense in profit and loss account on a systematic basis (i.e. straight line) over the lease term without capitalizing the asset. The lessor should recognize receivable at an amount equal to net investment in the lease in case of finance lease, whereas under operating lease, the lessor will present the leased asset under fixed assets in his balance sheet besides recognizing the lease income on a systematic basis (i.e. straight line) over the lease term. The person (lessor/lessee) presenting the leased asset in his balance sheet should also consider the additional requirements of AS 6 and AS 10.
AS 20 Earnings Per Share (Issued 2001) The objective of this standard is to describe principles for determination and presentation of earnings per share which will improve comparison of performance among different enterprises for the same period and among different accounting periods for the same enterprise. Earnings per share (EPS) is a financial ratio indicating the amount of profit or loss for the period attributable to each equity share and AS 20 gives computational methodology for determination and presentation of basic and diluted earnings per share.
AS 21 Consolidated Financial Statements (Issued 2001)
AS 21 deals with preparation and presentation of consolidated financial statements with an intention to provide information about the activities of group (parent company and companies under its control referred to as subsidiary companies). Consolidated financial statements are presented by a parent (holding company) to provide financial information about the economic activities of the group as a single economic entity. A parent which presents consolidated financial statements should present their statements in accordance with this standard but in its separate financial statements, investments in subsidiaries should be accounted as per AS 13.
AS 22 Accounting for Taxes on Income (Issued 2001)
AS 22 seeks to reconcile the taxes on income calculated as per the books of account with the actual taxes payable on the taxable income as per the provisions applicable to the entity for the time being in force. This standard prescribes the accounting treatment of taxes on income and follows the concept of matching expenses against revenue for the period. The concept of matching is more peculiar in cases of income taxes since in a number of cases, the taxable income may be significantly different from the income reported in the financial statements due to the difference in treatment of certain items under taxation laws and the way it is reflected in accounts.
AS 23 Accounting for Investments in Associates in Consolidated Financial Statements (Issued 2001)
AS 23 describes the principles and procedures for recognising investments in associates (in which the investor has significant influence, but not a subsidiary or joint venture of investor) in the consolidated financial statements of the investor. An investor which presents consolidated financial statements should account for investments in associates as per equity method in accordance with this standard but in its separate financial statements, AS 13 will be applicable.
AS 24 Discontinuing Operations (Issued 2002) The objective of this statement is to establish principles for reporting information about discontinuing operations, thereby enhancing the ability of users of financial statements to make projections of an enterprise’s cash flows, earnings, generating capacities, and financial position by segregating information about discontinuing operations from information about continuing operations. This standard is applicable to all discontinuing operations, representing separate major line of business or geographical area of operations of an enterprise.
AS 25 Interim Financial Reporting (Issued 2002) An enterprise may be required or may elect to present information at interim dates as compared with its annual financial statements due to timeliness and cost considerations. The standard prescribes the minimum contents of an interim financial report and requires that an enterprise which elects to prepare and present an interim financial report, should comply with this standard. It also lays down the principles for recognition and measurement in a complete or condensed financial statements for an interim period. Timely and reliable interim financial reporting improves the ability of investors, trade payables and others to understand an enterprise’s capacity to generate earnings and cash flows, its financial condition and liquidity.
AS 26 Intangible Assets (Issued 2002) The standard prescribes the accounting treatment for intangible assets that are not dealt with specifically under other accounting standards, and requires an enterprise to recognise an intangible asset if, and only if, certain criteria are met. The standard specifies how to measure the carrying amount of intangible assets and requires certain disclosures about intangible assets. This standard should be applied by all enterprises in accounting intangible assets, except
(a) intangible assets that are covered by another AS,
(b) financial assets,
(c) rights and expenditure on the exploration for or development of minerals, oil, natural gas and similar non-regenerative resources,
(d) intangible assets arising in insurance enterprise from contracts with policyholders,
(e) expenditure in respect of termination benefits.
AS 27 Financial Reporting of Interests in Joint Ventures (Issued 2002)
AS 27 set out principles and procedures for accounting of interests in joint venture and reporting of joint venture assets, liabilities, income and expenses in the financial statements of venturers and investors regardless of the structures or forms under which the joint venture activities take place. The standard deals with three broad types of joint ventures – jointly controlled operations, jointly controlled assets and jointly controlled entities. An investor in joint venture, which does not have joint control, should report its interest in a joint venture in its consolidated financial statements in accordance with AS 13, AS 21 and AS 23.
AS 28 Impairment of Assets (Issued 2002) AS 28 prescribes the procedures to be applied to ensure that the assets of an enterprise are carried at an amount not exceeding their recoverable amount (amount to be recovered through use or sale of the asset). The standard also lays down principles for reversal of impairment losses and prescribes certain disclosures in respect of impaired assets. An enterprise is required to assess at each balance sheet date whether there is an indication that an enterprise may be impaired. If such an indication exists, the enterprise is required to estimate the recoverable amount and the impairment loss, if any, should be recognised in the profit and loss account. This standard should be applied in accounting for impairment of all assets except inventories (AS 2), assets arising under construction contracts (AS 7), financial assets including investments covered under
AS 13, and deferred tax assets (AS 22). There are chances that the provision on account of impairment losses may increase sickness of companies and potentially sick companies may actually become sick.
AS 29 Provisions, Contingent Liabilities and Contingent Assets (Issued 2003) The objective of AS 29 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions and contingent liabilities and sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount.
This standard applies in accounting for provisions and contingent liabilities and contingent assets resulting from financial instruments (not carried at fair value) and insurance enterprises (other than those arising from contracts with policyholders). The standard will not apply to provisions/ liabilities resulting from executing controls and those covered under any other accounting standard.
AS 30 Financial Instruments: Recognition and Measurement (Issued 2008) Accounting Standard 30 is issued by the Council of the Institute of Chartered Accountants of India, which comes into effect in respect of accounting periods commencing on or after 1.4.2009 and will be recommendatory in nature for an initial period of two years. The preparers of financial statements are encouraged to follow the principles enunciated in the accounting treatments contained in the standard.
The objective of this Standard is to establish principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items.
AS 31 Financial Instruments: Presentation (Issued 2008) Accounting Standard 31 is issued by the Council of the Institute of Chartered Accountants of India, which comes into effect in respect of accounting periods commencing on or after 1-4-2009 and will be recommendatory in nature for an initial period of two years. The preparers of financial statements are encouraged to follow the principles enunciated in the accounting treatments contained in the standard.
The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses and gains; and the circumstances in which financial assets and financial liabilities should be offset.
AS 32 Financial Instruments: Disclosures (Issued 2008) Accounting Standard 32 is issued by the Council of the Institute of Chartered Accountants of India, which comes into effect in respect of accounting periods commencing on or after 1-4-2009 and will be recommendatory in nature for an initial period of two years. The preparers of financial statements are encouraged to follow the principles enunciated in the accounting treatments contained in the standard.
The objective of this Standard is to require entities to provide disclosures in their financial statements that enable users to evaluate the significance of financial instruments for the entity’s financial position and performance and the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks.