What is Financial Statement Reporting?
Financial statement reporting is the process of presenting and disclosing an organization’s financial performance and position to various stakeholders, including investors, creditors, regulators, and internal management. These reports provide a comprehensive overview of a company’s financial activities and help stakeholders assess its health, profitability, and sustainability.
Table of Content
- 1 What is Financial Statement Reporting?
- 2 Financial Statement Reporting
- 2.1 Accounting Standards: AS 1 and AS 2
- 2.2 Accounting Standards: AS 4 and AS 5
- 2.3 Accounting Standards: AS 9, AS 10, AS 16 and AS 26
- 2.4 Accounting Standards: AS 13, AS 17 and AS 20
- 3 Situational Applicability of Accounting Standards
Reporting of financial statements is a major concern in accounting. Different countries follow different standards of reporting financial statements. The norms of financial statement reporting are mandatorily followed by different companies in a country. Let us go through some of the important accounting standards that deal with various aspects of accounting and reporting of financial statements.
Financial Statement Reporting
Accounting Standards: AS 1 and AS 2
Accounting Standard (AS 1): Disclosure of Accounting Policies
The ICAI issued Accounting Standard (AS) 1 which deals with ‘Disclosure of Accounting Policies’ and is a mandatory to be followed by all enterprises. It mainly deals with disclosure of significant accounting policies which are followed while preparing and presenting financial statements.
In India, generally the accounting policies are not regularly and fully disclosed in the financial statements. Many enterprises include some notes in accounts, which provide a description of some of the significant accounting policies.
There is again a considerable variation among the very few enterprise which includes a separate statement of accounting policies on financial statements. The main objective of the statement of accounting policies is promoting a better understanding of the financial statements by disclosing significant accounting policies.
Following are the main aspects of AS1:
- An enterprise should disclose all significant accounting policies that are adopted while preparing and presenting the financial statements: This is required because the accounting policies differ across organisations which makes it inevitable to provide guidelines and rules that are followed right from the recording of transactions till their presentation on the financial statements.
Such disclosures should form a part of the financial statements and the significant accounting policies should normally be disclosed in one place.
- An enterprise should disclose in case the fundamental accounting assumptions are not followed: The accounting assumptions are Going Concern, Consistency and Accrual basis of accounting. If all the fundamental accounting assumptions are followed while preparing the financial statements, then specific disclosure is not required.
However, if any one of the fundamental accounting assumptions is not followed then this fact requires a specific disclosure.
- An enterprise should give special consideration in selecting the accounting policies: Some of the major considerations for the selection and application of accounting policies are as follows:
- Prudence: As per this concept, an enterprise should not overestimate the amount of revenues that are recorded nor underestimate the amount of expenses.
- Substance over form: As per this concept, the information in the financial statements and disclosures should reflect the underlying realities of accounting transactions, rather than their legal form.
- Materiality: As per this concept, an enterprise is allowed to ignore any accounting standard if the net impact has an insignificant impact on the financial statements such that the user of the financial statements is not misled.
- Prudence: As per this concept, an enterprise should not overestimate the amount of revenues that are recorded nor underestimate the amount of expenses.
- Changes in accounting policies: As per this concept, any change in accounting policies which might materially affect the current period or which are expected to materially affect the later periods are required to be disclosed.
Accounting Standard (AS 2): Valuation of Inventories (Revised 1999)
Accounting Standards (AS) 2 deal with the ‘Valuation of Inventories’. This is a mandatory standard. Following are the main aspects of AS 2:
The objective of AS 2 is to recommend the accounting treatment for inventories. A primary issue in accounting for inventories is the amount of cost to be recognised as an asset and carried forward until the related revenues are recognised.
AS 2 deals with the determination of cost and its subsequent recognition as an expense, including any write-down to net realisable value. It also deals with the cost formulas that are used to assign costs to inventories. According to AS 2, inventories should be measured and valued at the lower of cost and net realisable value.
As per AS 2 “ The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition “
- Costs of purchase: These include the purchase price, import duties and other taxes, transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services.
- Costs of conversion: The costs of conversion of inventories include costs directly related to the units of production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods.
- Other costs: These include the cost incurred in bringing the inventories to their present location and condition. For example, other costs could be overheads other than production overheads or the costs of designing products for specific customers, such costs are included in inventories cost.
Accounting Standards: AS 4 and AS 5
Accounting Standard 4 titled “Contingencies and Events Occurring After the Balance Sheet Date” and Accounting Standard 5 titled “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies “are mandatory standards.
Accounting Standard (AS 4): Contingencies and Events Occurring After the Balance Sheet Date
Accounting Standard 4 (AS 4) deals with the treatment in financial statements of
- Events occurring after the balance sheet date
The following terms are used in AS 4:
- Contingency: This refers to a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or non-occurrence, of one or more uncertain future events.
- Events occurring after the balance sheet date: These refer to significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company, and, by the corresponding approving authority in the case of any other entity.
Two types of events identified are as follows:
- Events that provide further evidence of conditions that existed at the balance sheet date; and
- Events those are indicative of conditions that arose subsequent to the balance sheet date.
- Events that provide further evidence of conditions that existed at the balance sheet date; and
Accounting Standard (AS 5): Net Profit/loss for the Period, Prior Period Items and Changes in Accounting Policies
Accounting Standard 5 (AS 5) deals with “Net Profit/Loss for the Period, Prior Period Items and Changes in Accounting Policies”. The objective of AS 5 is to recommend the classification and disclosure of certain items in the profit and loss statement so that all organisations prepare and present the statement uniformly.
This improves the comparability of the financial statements of an enterprise over time and with the financial statements of other enterprises. The main aspects of this standard are as follows:
- AS 5 should be applied by an organisation in presenting profit or 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 in disclosure of changes in accounting policies.
- It deals with the disclosure of certain items of net profit or loss for the period. These disclosures should be made in addition to any other disclosures required by other accounting standards.
- It does not deal with the tax implications of extraordinary items, prior period items, changes in accounting estimates, and changes in accounting policies for which appropriate adjustments will have to be made depending on the circumstances.
The definitions covered in AS 5 are as follows:
- Ordinary activities: It refers to those activities which are undertaken by an organisation as part of its business and such related activities in which the organisation engages in furtherance of, incidental to, or arising from, these activities.
- Extraordinary items: It refers to income or expenses arising from events or transactions that are clearly distinct from the ordinary activities of the enterprise and thus, do not recur frequently or regularly.
- Prior period items: It refers to income or expenses arising in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.
- Accounting policies: It refers to accounting principles and methods of applying these principles by an enterprise for preparing and presenting their financial statements.
Accounting Standards: AS 9, AS 10, AS 16 and AS 26
Accounting Standard (AS 9): Revenue Recognition
Accounting Standard 9 deals with the bases for ‘Revenue Recognition’ in the statement of profit and loss of an organisation. The standard recommends the recognition of revenue arising in the course of the ordinary activities of the organisation from the following:
- Sale of goods,
- Rendering of services, and
- Use by others of enterprise resources yielding interest, royalties and dividends.
It does not deal with the following modes of revenue recognition:
- Revenue arising from construction contracts
- Revenue arising from hire-purchase, lease agreements
The definitions covered under the AS 9 are as follows:
- Revenue: It refers to the gross inflow of cash, receivables or other consideration arising from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends.
- Completed service contract method: It refers to the method of accounting for revenue recognition used by organisations in the profit and loss statement only when the rendering of services under a contract is completed or substantially completed.
- Proportionate completion method: It refers to the method of accounting which recognises revenue in the statement of profit and loss in proportion to the degree of completion of services under a contract.
Accounting Standard (AS 10): Property, Plant and Equipment
Accounting Standard (AS) 10 recommends accounting standards for ‘Property, Plant and Equipment’. The standard deals with accounting for fixed assets grouped into various categories like land, buildings, plant and machinery, vehicles, furniture, goodwill, patents, trademarks, etc.
AS 10 does not deal with accounting for the following items:
- Forests, plantations and similar regenerative natural resources
- Wasting assets including mineral rights, expenditure on the exploration for and extraction of minerals, oil, natural gas and similar non-regenerative resources
- Expenditure on real estate development
Definitions covered under AS 10 are as follows:
- Fixed asset: It refers to an asset held with the intention of being used for the purpose of producing or providing goods or services and not held for sale in the normal course of business.
- Fair market value: It refers to the price agreed to in an open and unrestricted market between knowledgeable and willing parties that deal at arm’s length who are completely informed and not under any compulsion to transact.
- Gross book value of a fixed asset: It refers to the historical cost or other amount substituted for historical cost in the account books or financial statements. When this amount is shown net of accumulated depreciation, it is termed as net book value.
Accounting Standard (AS 16): Borrowing Costs
Accounting Standard (AS) 16 is applied in accounting for borrowing costs and does not deal with the actual or imputed cost of owners’ equity, including preference share capital not classified as a liability.
Definitions covered under AS 16 are as follows:
- Borrowing costs: It refers to interest and other costs incurred by an organisation related to the borrowing of funds.
- A qualifying asset: It refers to an asset that necessarily takes a considerable amount of time to get ready for its intended use or sale
Accounting Standard (AS 26): Intangible Assets
Accounting Standard (AS) 26 recommends the accounting treatment for intangible assets not covered in another accounting standard. AS 26 require an organisation to recognise an intangible asset only if a few criteria are met.
AS 26 also specify how to measure the carrying amount of intangible assets and requires certain disclosures about intangible assets. If some accounting standard deals with a specific type of intangible asset, an organisation adopts that accounting standard instead of AS 26. For example, AS 26 does not apply to intangible assets held by an organisation for sale in the ordinary course of business.
Some of the definitions covered by AS 26 are as follows:
- Intangible asset: It is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
- Monetary assets: It refers to the money held and assets to be received in fixed or determinable amounts of money.
- Non-monetary assets: It refers to assets other than monetary assets.
- Amortisation: It refers to the systematic allocation of the depreciable amount of an intangible asset over its useful life.
- Depreciable Amount: It refers to the cost of an asset less its residual value.
- Useful life of an asset: This refers to either the time period over which an asset is expected to be used by the organisation or the amount of production or identical units expected to be obtained from the asset by the organisation.
Accounting Standards: AS 13, AS 17 and AS 20
Accounting Standard (AS 13): Accounting for Investments
Accounting Standard 13 deals with accounting for investments in the financial statements of organisations and related disclosure requirements. The standard does not deal with:
The bases for recognition of interest, dividends and rentals earned on investments which are covered by Accounting Standard 9 on Revenue Recognition;
- Operating for finance leases
- Investments of retirement benefit plans and life insurance enterprises; and
- Mutual funds and venture capital funds and/or the related asset management companies, banks and public financial institutions formed under a central or state government ACT or so declared under the Companies Act, 1956.
Some of the definitions covered under AS 13 are as follows:
- Investments: It refers to assets held by an organisation for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock-in-trade are not ‘investments’.
- Current investment: It refers to an investment that is by its nature readily realisable and is intended to be held for not more than one year from the date on which such investment is made.
- Long term investment: It refers to an investment other than a current investment.
- Investment property: It refers to an investment in land or buildings that is not intended to be occupied substantially for use by, or in the operations of, the investing organisation.
Accounting Standard (AS 17): Segment Reporting
Accounting Standards 17 establish accounting principles for reporting financial information related to different types of products and services that an organisation produces and the different geographical areas in which it operates.
Such information helps users of financial statements in the following manner:
- Understanding the performance of the enterprise
- Assessing the risks and returns of the enterprise
- Making more informed judgements about the enterprise as a whole
Some of the definitions covered under AS 17 are as follows:
It refers to a distinguishable component of an organisation that is engaged in providing an individual product or service or a group of related products or services and that is subject to risks and returns that are different from those of other business segments.
Aspects that should be considered in determining whether products or services are related include:
- The nature of the products or services
- The nature of the production processes
- The type or class of customers for the products or services
- If applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.
It refers to a distinguishable component of an organisation that is engaged in providing products or services within a particular economic environment and that is subject to risks and returns that are different from those of components operating in other economic environments.
Aspects that should be considered in identifying geographical segments include:
- Similarity of economic and political conditions
- Relationships between operations in different geographical areas
- Proximity of operations
- Special risks associated with operations in a particular area
- Exchange control regulations
- The underlying currency risks
Accounting Standard 20 prescribes accounting principles for the determination and presentation of ‘Earnings Per Share’, which would improve comparison of performance among different organisations for the same period and among different accounting periods for the same organisation.
The focus, of AS 20 is on the denominator of the earnings per share calculation. Even though earnings per share data have limitations because of different accounting policies used for determining ‘earnings’, a consistently determined denominator enhances the quality of financial reports.
Scope of AS 20
Although AS 20 is a mandatory Accounting Standard (w.e.f. July 01, 2012 ), certain Small and Medium Sized non-corporate entity falling in Level II or Level III enterprises may not disclose diluted earnings per share (both including and excluding extraordinary items).
Some of the definitions covered under AS 20 are as follows:
- An equity share: It refers to a share other than a preference share.
- A preference share: It refers to a share having preferential rights to dividends and repayment of capital.
- A financial instrument: It refers to any contract that gives rise to both a financial asset of one enterprise and a financial liability or equity shares of another enterprise.
- A potential equity share: It refers to a financial instrument or other contract that entitles, or may entitle, its holder to equity shares.
- Share warrants or options: It refers to financial instruments that give the holder the right to acquire equity shares.
Situational Applicability of Accounting Standards
To discuss situational applicability of accounting standards, we will start with a brief story of Mr. Farid who started a new business as a trader and registered his business as a trading company.
Now, we will discuss all the accounting standards one by one as follows:
- AS 1 – Disclosure of accounting plans and policies: Farid started trading business and established various accounting plans and policies as per regulatory requirements and market conditions.
- AS 2 – Inventory valuation: Now Farid started acquiring inventory for trading. He further evaluated this inventory (valuation of inventory) on the basis of various costs to be incurred, such as cost of purchase and cost of conversion.
- AS 3 – Cash flow statements: Inventory valuation and procurement is essential because it ensures smooth cash flows in the business.
- AS 4 – Contingencies and events occurring after the balance sheet: There occurred fire inside the warehouses and Farid suffered huge losses because he did not recognise contingencies and events occurring after the balance sheet. In simple words, he did not anticipate various negative events such as accidents, fire, theft, etc.
- AS 5 – Net profit or Loss for the period, Prior Period Items and Changes in Accounting Policies: He noticed that fire occurred due to faulty electric wiring done in the prior period.
- AS 7 – Construction Contracts: As the business loss was too high so he considered the opportunity to construct a new business.
- AS 9 – Revenue Recognition: Farid again started a new business because he knew that he would recognise the revenue only after constructing a new business.
- AS 10 – Property, Plant and Equipment: In order to start this new business Farid started acquiring many fixed assets such as property, plant and equipment.
- AS 11 – The Effects of Changes in Foreign Exchange Rates: To start this new business he ordered some of the equipment from a foreign supplier and followed proper regulatory guidelines to minimise the effects of changes in foreign exchange rates.
- AS 12 – Government Grants: Farid was dealing in renewable energy business and he received some grants from government to start his new venture.
- AS 13 – Accounting for Investments: Now Farid has acquired sufficient funds to start his venture and this time he recognised the importance of accounting for investments and later on he wisely disbursed his investments.
- AS 14 – Accounting for Amalgamations: He made many good investments and his business started making a considerable amount of profits. As a result, he got an offer of amalgamation from one of the reputed Multinational Corporations (MNCs).
- AS 15 – Employee Benefits: When employees got information about the said amalgamation deal, they started protesting for the settlement of their outstanding employee benefits.
- AS 16 – Borrowing Costs: For the settlement of employee benefits, Farid borrowed some money from a bank and due to this his borrowing costs also increased.
- AS 17 – Segment Reporting: Before the process of amalgamation he performed segment analysis for his business to understand the performance of his business in various segments (such as geographic and business segments). He recorded all this data in segment report.
- AS 18 – Related Party Disclosures: During the analysis of segment report, it was observed that one of the segments performed negatively and he further identified that abnormal payments were made to related parties.
- AS 19 – Leases: It was found that all abnormal payments were made in terms of high lease rentals and he closed that segment.
- AS 20 – Earnings Per Share: After closing down of that segment there was a substantial increase in earnings per share and all investors became more satisfied.
- AS 21 – Consolidated Financial Statements: Then at the end of the accounting year, he prepared consolidated financial statements for the entity and shares all the financial information about various economic activities.
- AS 22 – Accounting for Taxes on Income: After the preparation of consolidated financial statements he determined net profit and paid applicable amount of taxes to the government.
- AS 23 – Accounting for Investments in Associates: However, Farid made it clear that he did not pay any tax for its Associates business.
- AS 24 – Discontinuing Operations: He further clarified that all operations under its associates business investment are now discontinued.
- AS 25 – Interim Financial Reporting: The Income Tax Department of Government appoints a committee to evaluate the authenticity of closed associate business and this committee asks Farid to submit an interim financial report regarding the issue.
- AS 26 – Intangible Assets: The venture achieved many successful remarks in terms of earnings (or profits) and acquired many intangible assets such as goodwill, patents, copywriters, etc.
- AS 27 – Financial Reporting of Interests in Joint Ventures: Due to the goodwill of the business he got many offers from reputed many MNCs to start a new project through joint venture.
- AS 28 – Impairment of Assets: After initiating the new project under joint venture, he recognised that the book value of assets was not justified and as a result there was an impairment of assets.
- AS 29 – Provisions, Contingent Liabilities and Contingent Assets: Under the project of joint venture an accident took place and one of the labour got injured and he filed a case for compensation against the business. This created a contingent liability on the company in which it was not clear whether the liability would occur or not.