'Relevance, Issues & Importance of Accounting Standards Prof. V. K.

Sapovadia IIM, Indore Prologue Financial statements are prepared to summarize all business activities by an enterprise during an accounting period in monetary terms & report financial outcomes in terms of performance, status of assets, liabilities & flow of cash. These business activities vary from one enterprise to other on one hand and size & volume of business on the other hand. To compare the financial statements of various reporting enterprises poses some difficulties because of the divergence in the methods and principles adopted by these enterprises in preparing their financial statements. In order to make these methods and principles uniform, comparable, transparent, establish accountability and bring true & fair view of Financial Statement Accounting Standards are evolved. What are Accounting Standards? Accounting Standards are the statements of code of practice of the regulatory accounting bodies that are to be observed in the preparation and presentation of financial statements. In layman terms, accounting standards are the written documents issued by the expert institutes or other regulatory bodies covering various aspects of recognition, measurement, treatment, presentation and disclosure of accounting transactions. What are the objectives of Accounting Standards? The basic objective of Accounting Standards is to remove variations in the treatment of several accounting aspects and to bring about standardization in presentation. They intent to harmonize the diverse accounting policies followed in the preparation and presentation of financial statements by different reporting enterprises so as to facilitate intra-firm and inter-firm comparison. It also brings transparency, accountability, and reliability that portray true & fair view of Financial Statements. Who issues Accounting Standards in India? The Institute of Chartered Accountants of India (ICAI) recognizing the need to harmonize the diverse accounting policies and practices at present in use in India constituted Accounting Standards Board (ASB) on April 21, 1977. The main role of ASB is to formulate Accounting Standards from time to time. CBDT is also empowered to frame Accounting Standards for taxation purpose. The government is also about to bring separate body for public enterprises, local authorities & government accounting. What is the duty of Statutory Auditor for Compliance with Accounting Standards?

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Section 211(3A) of Companies Act, 1956 provides that every profit and loss account and balance sheet of the company shall comply with the accounting standards. Section 217 (2AA) lays that the Board's report shall also include a Directors' Responsibility, Statement, indicating therein, (i) that in the preparation of the annual accounts, the applicable accounting standards had been followed along with proper explanation relating to material departures; (ii) that the directors had selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year and of the profit or loss of the company for that period; (iii) that the directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities; Penalties have been prescribed for any failure on the part of BOD and its director on violation of Sec 211 & 217 under the Act. The statutory auditors are required to make qualification in their report in case any item is treated differently from the prescribed Accounting Standard. However, while qualifying, they should consider the materiality of the relevant item. In addition to this Section 227(3)(d) of Companies Act, 1956 requires an auditor to report whether, in his opinion, the profit and loss account and balance sheet are complied with the accounting standards referred to in Section 211(3C) of Companies Act, 1956. How many Accounting Standards have been prescribed? Are these applicable to all companies irrespective of its size? In all 30 Accounting Standards have been prescribed. However their applicability is dependent on its size Level I / II / III company. The following table lists out the Accounting Standards and its applicability. Level I Company: Enterprises, which fall in any one or more of the following categories, at any time during the accounting period, are classified as Level I enterprises: i) Enterprises whose equity or debt securities are listed whether in India or outside India. ii) Enterprises, which are in the process of listing their equity or debt securities as evidenced by the board of directors resolution in this regard. iii) Banks including co-operative banks.

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iv) Financial Institutions v) Enterprises carrying on insurance business. vi) All commercial, industrial and business reporting enterprises, whose turnover for the immediately preceding accounting period on the basis of audited financial statements exceeds Rs. 500 million. Turnover does not include other income. vii) All commercial, industrial and business reporting enterprises having borrowings, including public deposits, in excess of Rs. 100 million at any time during the accounting period. viii) Holding and subsidiary enterprises of any one of the above at any time during the accounting period. Level II Company: Enterprises, which are, not Level I enterprises but fall in any one or more of the following categories are classified as Level II enterprises; i) All commercial, industrial and business reporting enterprises, whose turnover for the immediately preceding accounting period on the basis of audited financial statements exceeds Rs. 4 million, but does not exceed Rs. 500 million. Turnover does not include other income. ii) All commercial, industrial and business reporting enterprises having borrowing, including public deposits, in excess of Rs. 10 million but not in excess of Rs. 100 million at any time during the accounting period. iii) Holding and subsidiary enterprises of any one of the above at any time during the accounting period. Level III Company: Enterprises, which are not covered under Level I and Level II are considered as Level III enterprises. Applicability Level II and Level III enterprises are considered as SMEs Level I enterprises are required to comply fully with all the accounting standards. No relaxation is given to Level II and Level III enterprises in respect of recognition and measurement principles. Relaxations are provided with regard to disclosure requirements. Accordingly, Level II and Level III enterprises are fully exempted from certain accounting standards, which mainly lay down disclosure requirements. In respect of

certain other accounting standards, which lay down recognition, measurement and disclosure requirements, relaxations from certain disclosure requirements are given. The following table enumerates Applicability level, prescriptions & important content of Accounting Standards.

AS No.

Particulars

Applicability Level

Prescription & content

AS-1

Disclosure Accounting Policies

of I, II, III

What are accounting policies, examples & notes to accounts, fundamental accounting assumptions, guide lines for selecting accounting policies, change in accounting policies, how to disclose them What are inventories? Applicability, measurement on basis of concept conservatism, determine cost, exclusion, net realizable value and reporting Defining cash, cash equivalent, classifying cash flow into operating, financing & investing cash, direct & indirect method of cash flow What is contingency, examples, estimation of liability, events after B/s date related to & not related to circumstances existing on B/s date, events affecting going concern, proposed dividend, how to report them Components of profit: ordinary & extraordinary activities, prior period items, change in accounting estimates & accounting policies, disclosure

AS-2

Valuation Inventories

of

I, II, III

AS-3

Cash Flow Statements

AS-4

Contingencies and Events Occurring After the Balance Sheet Date

I, II, III

AS-5

Net Profit or Loss for the period, Prior period Items and

I, II, III

Accounting Policies. Depreciable assets, depreciation, calculation & method of depreciation (SLM, WDV) Change in estimated life & historical cost, depreciation on addition or extension of existing assets, when assets are disposed etc. Disclosures Revenue recognition in long term construction contracts, what is construction contract, its types, combining & segmenting contracts, determine profit or loss by determining first contract revenue & contract cost, basic principles of recognition of revenue & expenses, provision of expected loss, effect of change in estimate in contract, percentage of completion or completion of contract method, disclosure

AS-6

Depreciation Accounting

I, II, III

AS-7

Construction Contracts

I, II, III

AS-8

Accounting for Research and Development (This standard has been withdrawn w.e.f. 01.04.2004 for all levels of enterprises and AS 26 is applicable)

Withdrawn

As withdrawn

AS-9

Revenue recognition

I, II, III

Timing of revenue recognition, what is revenue, revenue from

of sale like sale on approval, installation & inspection, warranty sales, consignment sales, special order, subscription for publication, revenue from rendering services, installation fees, advertising & insurance agency commission, financial service commission, admission fee, tuition fees, entrance & membership fees. Revenue from interest, dividend, royalty. Disclosure Define fixed assets, recognition & measurement, historical cost, cost of assets acquired in exchange of assets, revalued price, first & subsequent revaluation, upward & downward revaluation, revaluation reserve, disclosure Define reporting & foreign currency, exchange rate, monetary & non-monetary items, closing rate, Transaction in foreign currencies, translating FS of foreign operation integral & non-integral, forward exchange contracts, accounting treatments, disclosure Recognition of govt. grants, monetary & non-monetary grants, related to depreciable assets or otherwise, grants related to revenue, promoters contribution, refund, contingency, disclosure

AS-10

Accounting for Fixed Assets

I, II, III

AS-11

The Effect of Changes in Foreign Exchange Rates

I, II, III

AS-12

Accounting for Government Grants

I, II, III

AS-13

I, II, III

Investments

property, cost, carrying amount, reclassification, disposal, disclosure Amalgamation, types, merger, purchase consideration, accounting methods: pooling of interest & purchase. Statutory reserve, goodwill, disclosure Explains (retirement) benefits & its types short/long term, during/post employment benefits, scope, nature of retiring benefits & accrual system of accounting, defined contribution & defined benefit scheme, accrual valuation, accounting treatment of different schemes, PF, Superannuating, pension benefit, gratuity, funding & accounting, disclosure Borrowing cost, interest, amortization of discounts, provisions, ancillary costs, finance charges, exchange difference, qualifying assets, conditions of capitalizing borrowing costs, commencement, suspension, cessation of capitalization, disclosure Segment: business & geographical, enterprise & segment revenue, segment expenses, segment results, segment assets, segment liabilities, identification of reportable segment, primary & secondary segment, disclosure

AS-14

Accounting for Amalgamations

I, II, III

AS-15

Accounting for Retirement Benefits in the Financial Statements of Employers

I, II, III

AS-16

Borrowing Costs

I, II, III

AS-17

Segment Reporting

I II-with modification IIIwith modification

AS-18

Related Party Disclosures

I II-with modification IIIwith modification

Define related party, control/ significant influence management or operating policies, related party transactions, exceptions, what should be disclosed, disclosure Types of lease: finance & operating, define: guaranteed residual value for lessee & lessor, ungauraneed residual value, Accounting by Lessee & Lessor, recognition of revenue, sale & lease back, disclosure Basic & Diluted EPS, Calculation of NP or net loss for the period attributable to shareholders, weightage average no of outstanding shares, right issue, diluted earning share formula, right factor, restatement. Disclosure Subsidiary, format of consolidated FS, CFS is additional information, scope, consolidation procedure, minority interest, arrears of cumulative preference share. Disclosure Accounting & Income Tax profit, current & deferred tax, timing difference, permanent difference, prudence of recognizing deferred tax asset, disclosure Associate concern, accounting for investments in associate

AS-19

Leases

I II-with modification IIIwith modification

AS-20

Earning Share

Per

I II-with modification IIIwith modification

AS-21

Consolidated Financial Statements

AS-22

Accounting for Taxes on Income

I,II,III

AS-23

Accounting Investments

for in

Consolidated Financial Statements

accounting, carrying amount of investment, contingencies, disclosure Define discontinuing operation, initial & other disclosure event, manner & updating disclosure, recognition & measurement, interim financial report. FS for interim reporting, integral & discrete view, minimum content, form and content, materiality, seasonal/ occasional revenue, change in accounting policies, depreciation. Disclosures Tangible & intangible assets, unidentified & acquired intangible assets, cost, R & D, carrying amount, amortization method, impairment losses, retirement & disposal, disclosure Joint venture, contractual agreement or arrangement, financial reporting in jointly control operation/ assets, transaction between venturer & joint venture, disclosure What is impairment of asset, carrying amount, impairment loss, effect of depreciation, impairment of cash generating asset, recoverable amount, impairment loss & deferred tax, reversal, disclosure

AS-24

Discontinuing Operations

AS-25

Interim Financial Reporting

AS-26

Intangible Assets

I,II,III

AS-27

Financial Reporting of Interests in Joint Ventures

I-with clarification II-with clarification III-with clarification

AS-28

Impairment Assets

of

I II-with modification III-with modification

AS-29

Contingent Liabilities and Contingent Asset

liability, contingent asset, recognition & measurement of provision, disclosure Financial Instruments, Recognition & derecognition, initial & subsequent measurement of Financial Assets & liabilities, Fair Value, reclassification, gains & losses, Impairment, hedging & hedge accounting, Embedded derivatives, Accounting, recognition & measurement The significance of financial instruments for the entitys 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 end of the reporting period, and how the entity manages those risks. Presentation procedure. Disclosures of above (AS-31)

AS-30

Financial Instrument: Recognition measurement

&

From 1/4/2009 recommendatory, from 1/4/2011 mandatory except SMEs

AS-31

Financial Instrument: Presentation

Recommendatory from 01/04/2009

AS-32

Financial Instrument: Disclosures

Recommendatory from 01/04/2009

Challenges Accounting Standards are used as one of the regulatory mechanisms for preparation of general-purpose financial reports and subsequent audit of the same. Accounting standards are concerned with the system of measurement and disclosure rules for preparation and presentation of financials statements. They appear with a set of authoritative statements of how particular types of transactions, events and other costs should be recognized and reported in the financial statements. Accounting standards are devised to furnish useful information to different users of the financial statements, to such as shareholders, creditors, lenders, management, investors, suppliers, competitors, researchers, regulatory bodies and society at large and so on. In fact, such statements are designed and prescribed

so as to improve & benchmark the quality of financial reporting. Applying form & spirit of the applicable Accounting Standard brings good corporate governance practice. Accounting Standards are the policy documents (authoritative statements of best accounting practice) issued by recognized expert accountancy bodies relating to various aspects of measurement, treatment and disclosure of accounting transactions and events. As relate to the codification of Generally Accepted Accounting Principles (GAAP). These are stated to be norms of accounting policies and practices by way of codes or guidelines to direct as to how the items, which go to make up the financial statements should be dealt with in accounts and presented in the annual accounts. The aim of setting standards is to bring about uniformity in financial reporting and to ensure consistency and comparability in the data published by enterprises. This in result enhance value of the enterprise as stakeholders & users of Financial Statement can take appropriate decision & view about affairs of the enterprise. In modern business context, Accounting Standard & Good Corporate Governance practice has gained more importance than ever. It brings synergy, as managers are motivated to practice better corporate governance linking it with remuneration of managers. Due to invasion technology, political compulsion & increased social expectation globe is a small village for business enterprise. In the circumstances, implementing universal Accounting Standard & Corporate Governance has brought new challenges in place. Diversity in accounting standards not only means additional cost of financial reporting but also can cause difficulties to multinational groups in the manner in which they undertake transactions. It is quite possible for a transaction to give rise to a profit under the accounting standards of one country where as it may require a deferral under the standards of another. When a multinational company (MNC) has to report under the standards of both the countries it might lead to some extremely odd results. For instance, Daimler Benz, who was the first German to secure stock market listing in the United States, reported a net profit of DM 158 m for the six months to June 1998 based on German GAAP. The U.S GAAP reconciliation statement revealed that the company had incurred a loss of DM. 949m. Similarly, British Telecom Inc. reported a net profit of 1767 for the year ended 31-3-1994 under the UK GAAP but under the US GAAP reconciliation- the net profit reduced to 1476. Although there are different solutions that have been suggested to resolve the problems associated with filling financial statements across national boundaries like reciprocity and reconciliation, but they not free from limitations. International accounting standards serves the purpose of reducing diversity in accounting practices but invites qualitative differences of financial accounting and reporting systems. Again these qualitative differences may be removed if a single set of internationally accepted standards can be used for all cross-border listed financial statements. These differences may be reduced if the recognized professional accounting bodies of the world arrange a happy marriage between the national and international accounting standards.

There are few special considerations which the accountant has to take care of; i.e., the auditor should ensure that the financial statements or other financial information compiled, comply with the requirements of identified financial reporting framework and where there is no specific financial reporting framework, client may specify that accounts should be compiled on, for example, based on the requirements of Income-tax Act, 1961. If any accounting standard is not complied with, the fact should be disclosed in the notes to accounts. If the accountant becomes aware of any material misstatement, s/he must report this to the management or must withdraw from the engagement if the management doesnt act. Dilemma: History & Future Path The Government of India recognizes the importance of financial reporting in providing essential financial information about the company to its shareholders and other stakeholders, as an integral and important part of good corporate governance. Such information needs to be reliable, free from bias and should enable comparison on the basis of common benchmarks. This, in turn, necessitates an appropriate, financial reporting system in the form of accounting standards that incorporate sound accounting principles and reflect a true picture of the financial health of the company while ensuring legally enforceable accountability. The work of formulating down accounting standards for the companies operating in India was initiated when the Institute of Chartered Accountants of India (ICAI), a statutory body regulating the accounting profession in the country, first took up this task in 1977. ICAI is a statutory body established under the Chartered Accountants Act, 1949 for the regulation of the profession of chartered accountancy in India. During its more than fifty years of existence, the Institute has achieved recognition as a premier accounting body in the country for its contribution in the fields of education, professional development, maintenance of high accounting, auditing and ethical standards. Till date The Institute of Chartered Accountants of India has issued 31 Accounting Standards, out of which AS-8 is now not in force as the same is merged with AS-26. ICAI has set an internal deadline of aligning its Accounting Standards with IFRS by April 2011. However, the accounting standards prepared and issued by the ICAI were mandatory only for its members till 1999, who, while discharging their audit function, were required to examine whether the said standards of accounting were complied with. With the amendment of the Companies Act, 1956 through the Companies (Amendment) Act, 1999, accounting standards as well as the manner in which they were to be prescribed, were provided a statutory backing. Today, in pursuance of the statutory mandate provided under the Companies Act, 1956, the Central Government prescribes accounting standards in consultation with the National Advisory Committee on Accounting Standards (NACAS), also established under the Companies Act, 1956. NACAS, a body of experts including representatives of various regulatory bodies and Government agencies, has been engaged in the exercise of examining Accounting Standards prepared by ICAI for use by Indian corporate entities,

since its constitution in 2001. In this exercise, it has adapted the international norms established by the International Financial Reporting Standards issued by the International Accounting Standards Board. The Central Government notified 28 Accounting Standards (AS 1 to 7 and AS 9 to 29) in December 2006 in the form of Companies (Accounting Standard) Rules, 2006, after receiving recommendations of NACAS. These Accounting Standards are to be applied with effect from company financial year 2007-08, the accounts with respect to which are to be finalised during 2008-09. In notifying the Accounting Standards, the Government has adopted a policy of enabling disclosure of company accounts in a transparent manner at par with widely accepted international practices, through a process of convergence with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). In doing so, the requirements of the companies functioning in the country are being kept in view. The initiative for harmonization of the Indian accounting standards with IFRS, taken up by NACAS in 2001 and implemented through notification of accounting standards by the Central Government in 2006, would be continued by the Government with the intention of achieving convergence with IFRS by 2011. To begin with, these standards will apply only to public listed companies. Other companies will be brought under IFRS ambit in a phased manner. Consistent with international practices, the accounting standards are prepared in India in context of the issues concerning large publicly held and listed corporate entities so as to enable the widest possible coverage of financial issues concerning a corporate entity. Consequently, some of the requirements of accounting standards may prove to be onerous for Small and Medium Companies (SMCs), who may not have the necessary resources to apply these requirements and incur associated compliance costs. Also, users of financial statements of the SMCs and their information requirements may also have limited requirements. Keeping this in view, necessary exemptions and relaxations to SMCs have been incorporated in the accounting standards on the recommendation of NACAS to enable them to apply the broad framework of the Accounting Standards in a simple manner. Conclusion A manager working in any area of the enterprise, whether marketing, HR, system, finance, production, accounting, purchase, PR and at any level of managerial hierarchy and at any place cant be ignorant on financial aspects of the enterprise. Financial Statements on which a manager relies while taking decisions are prepared or supposed to be prepared keeping in mind provision of Accounting Standards. So knowing correct and appropriate application of Accounting Standard while preparing Financial Statement is sine-qua-non. As accounting is social science & dynamic in nature, a manager need to keep himself updated in the matters relevant to interpretation of accounting information.