What is Accounting Standards?
Accounting standards refer to written policy documents that encompass preparation, presentation and disclosure of accounting transactions in financial statements.
In India, accounting standards are issued by the Institute of Chartered Accountants of India (ICAI), a professional body of accounting. These accounting standards provide a set of standard accounting policies, valuation norms and disclosure requirements. This helps organisations in bringing uniformity in the preparation of financial statements, thereby enhancing the reliability of statements for different users.
Table of Content
- 1 What is Accounting Standards?
- 2 Accounting Standards Definition
- 3 Objectives of Accounting Standards
- 4 Scope of Accounting Standards
- 5 Development of Accounting Standards
- 6 Significance of Setting Accounting Standards
- 7 Compliance with Accounting Standards
Accounting Standards Definition
ICAI defines accounting standards as “written policy documents issued by expert accounting body or by government or other regulatory body covering aspects of recognition, measurement, presentation and disclosure of accounting transactions in the financial statements”.
Apart from improving the credibility of financial data, accounting standards facilitate the comparability of financial statements both at intraand interlevels of an organisation. These comparisons are widely used by the users of accounting information for assessing the performance of the organisation.
Accounting standards are consistent with the provisions of the law and are, thus, extremely useful to investors and other external parties interested in assessing an organisation’s performance for the purpose of investment. The main aim of accounting standards is to eliminate variations in accounting treatment to prepare financial statements.
Objectives of Accounting Standards
Following are some other important objectives of accounting standards.
Improves the Credibility and Reliability of Financial Statements
Accounting standards improves the reliability of financial statements by providing a common framework of accounting.
Determines managerial accountability
It implies that the accounting standards determine the regulations and corporate ac- countability, which helps to assess the managerial skills in maintaining and improving profitability, liquidity and solvency.
Assists accountants and auditors
It refers to the instructions that the accounting professionals get through these accounting standards, which help them to prepare and audit the financial statements appropriately. In case of financial reporting issues, an accountant may refer to the published accounting standard to interpret on how to record the transactions.
Enables ease of understanding
Accounting standards specify the processes and formats to be followed by organisations in preparing and reporting their financial statements. users of financial statements depend on the assumptions set forth by the accounting standards while interpreting the reported figures. Once users become accustomed to these assumptions, they may use this knowledge to interpret the financial statements of different organisations with ease.
Scope of Accounting Standards
In its Preface to the Statements of Accounting Standards, the ASB has outlined the scope of accounting standards. These are as follows:
- Efforts will be made to issue Accounting Standards which are in conformity with the provisions of the applicable laws, customs, usages and business environment in India. However, if a particular Accounting Standard is found to be not in conformity with law, the provisions of the said law will prevail and the financial statements should be prepared in conformity with such law.
- The Accounting Standards by their very nature cannot and do not override the local regulations which govern the preparation and presentation of financial statements in the country. However, the ICAI will determine the extent of disclosure to be made in financial statements and the auditor’s report thereon.
Such disclosure may be by way of appropriate notes explaining the treatment of particular items. Such explanatory notes will be only in the nature of clarification and therefore need not be treated as adverse comments on the related financial statements.
- The Accounting Standards are intended to apply only to items which are material. Any limitations with regard to the applicability of a specific Accounting Standard will be made clear by the ICAI from time-to-time.
The date on which a particular standard will come into effect, as well as the class of enterprises to which it will apply, will also be specified by the ICAI. However, no standard will have retroactive application, unless otherwise stated.
- The Institute will use its best endeavours to persuade the government, appropriate authorities, industrial and business community to adopt the Accounting Standards in order to achieve uniformity in preparation and presentation of financial statements.
- In formulation of Accounting Standards, the emphasis would be on laying down accounting principles and not detailed rules for application and implementation thereof.
- The standards formulated by the ASB include paragraphs in bold italic type and plain type, which have equal authority. Paragraphs in bold italic type indicate the main principles. An individual standard should be read in the context of the objective stated in that standard and this preface.
- The ASB may consider any issue requiring interpretation on any Accounting Standard. Interpretations will be issued under the authority of the council. The authority of interpretation is the same as that of Accounting Standard to which it relates.
Development of Accounting Standards
In 1977, the ICAI formed the Accounting Standards Board (ASB) which is the apex body responsible for developing and updating accounting standards in India.
These accounting standards are developed by considering various factors such as the applicable laws, customs and the contemporary business environment of India. The standards formulated by the ASB are issued by the ICAI.
Following are the main functions of the ASB:
- To conceive of and suggest areas in which Accounting Standards need to be developed.
- To formulate Accounting Standards with a view to assisting the Council of the ICAI in evolving and establishing Accounting Standards in India.
- To examine how far the relevant International Accounting Standard/International Financial Reporting Standard can be adapted while formulating the Accounting Standard and to adapt the same.
- To review, at regular intervals, the Accounting Standards from the point of view of acceptance or changed conditions, and, if necessary, revise the same.
- To provide, from time- to-time, interpretations and guidance on Accounting Standards.
- To carry out such other functions relating to Accounting Standards.
Following are the steps in the standard formulation process by ASB:
- Identification of broad areas for developing accounting standards
- Constitution of a study group to prepare an initial draft of the proposed accounting standards
- Consideration of the initial draft and revision (if any) based on careful discussions
- Circulation of the draft to different bodies such as council members of ICAI, Department of Company Affairs (DCA), Securities and Exchange Board of India (SEBI), Comptroller and Auditor General of India (CAG), Central Board of Direct Taxes (CBDT), and Standing Conference of Public Enterprises (SCOPE)
- Ascertainment of views of specified bodies on the draft
- Finalisation of the draft of the proposed standard inviting public comments
- Consideration of comments received on the draft and finalisation of the draft of accounting standards for submission to the ICAI for approval
- Modification of the draft in case of any suggestions given (in consultation by the ASB) by the ICAI
- Issuance of the accounting standard by the ICAI
AS 1 and AS 2
AS 1 and AS 2 deal with the disclosure of accounting policies and valuation of inventories, respectively. Let us discuss them in detail.
AS 1: Disclosure of Accounting Policies
As per AS 1, an organisation is required to disclose all accounting policies that it has followed in the preparation and presentation of financial statements. Adherence to AS 1 ensures that the financial statements of an organisation can be compared with the financial statements of another organisation (inter-organisation comparisons).
Additionally, an organisation may also carry out intra-organisation comparisons from one time period to another. Also, consistent and full disclosure of accounting policies ensures that financial statements represent a true and fair picture of the cash flow and financial performance of an organisation.
The major areas with respect to which organisations must disclose their accounting policies include:
- Method of depreciation and amortisation
- Recognition of profit on long-term contracts
- Valuation of fixed assets
- Treatment of contingent liabilities
- Treatment of expenditure during construction
- Treatment of foreign currency conversion/translation
- Treatment of intangible assets
- Treatment of retirement benefits
- Valuation of inventories
- Valuation of investments
As per AS 1, organisations must disclose all significant accounting policies that they have used while preparing and presenting financial statements by the way of a note. Although all material accounting policies must be disclosed by organisations, there are certain basic assumptions that are used while preparing the financial statements for which separate disclosure is not required.
These include assumptions of going concerned, consistency and accrual. However, if an organisation does not comply with any of these assumptions, it needs to disclose the same.
AS 2: Valuation of Inventories (Revised)
In accordance with AS 2, organisations need to formulate a method for computing the cost of inventories and determining the value of closing stock that must be shown in the balance sheet till the inventories are sold and recognised as revenue. Certain cases where AS 2 is not applicable are:
- Work-in-progress inventory under a construction service contract (AS 7)
- Work-in-progress inventory in case of usual course of business for service providers such as ongoing consultancy services, ongoing medical service, etc.
- Financial instruments that are held as stock-in-trade
- Producer’s inventories such as livestock, agricultural and forest products, mineral oils, ores and gases if they are valued at net realisable value
For applicability of AS 2, it is necessary to note the following:
- Inventories include finished goods
- Inventories include raw material and work-in-progress materials
- Inventories include stores, spares, raw material, consumables, etc.
- Inventories include goods purchased and goods offered for sale
- Inventories do not include machinery and plant
- Inventories do not include spare parts, servicing equipment and standby equipment
- Inventories include machinery spares which are not used in any particular item of fixed asset and can be used generally for multiple fixed assets
AS 2 also states that inventories should be valued at the lower of cost and the net realisable value. For valuing the inventory, the cost and the net realisable value of the inventory are compared and the lower value is selected.
AS 4 AND AS 5
AS 4 AND AS 5 deal with ‘contingencies and events occurring after the balance sheet date’ and ‘net profit or loss for the period, prior period items and changes in accounting policies, respectively.
AS 4 Contingencies and Events Occurring after the Balance Sheet Date
AS 4 helps a business entity in the treatment of contingencies and events occurring in the balance sheet after the balance sheet date. A contingency refers to a future condition or event which is possible, but it cannot be determined with certainty. The contingency may result in profit or loss.
AS 4 is not applicable to the following:
- Life insurance and general insurance policy obligations
- Retirement benefit plan obligations
- Long-term lease contracts obligations
The contingencies related to conditions that exist at the balance sheet date are of two types:
- Contingent loss: Contingent losses are those which are either probable or reasonably possible or remote in nature. For contingent losses, the organisation needs to make provisions and is charged to the Profit and Loss Account.
- Contingent gain: Contingent gains are not recognised in financial statements since their recognition may result in the recognition of revenue which may never be realised. However, when the realisation of a gain is virtually certain, then such gain is not a contingency and accounting for the gain is appropriate.
Certain events usually take place in between the time when an accountant has prepared the financial statements of an organisation and the time when the financial statements are approved by the competent authorities. These events are called events occurring after the Balance Sheet date.
The events are usually of two types:
- Adjusting events: These events are related to circumstances and existed on the date of balance sheet. In this case, the losses must be accounted for in the financial statements and the assets and liabilities must be adjusted.
- Non-adjusting events: These events are related to circumstances and did not exist on the date of balance sheet. In this case, the non-adjusting events must be disclosed by providing notes with financial statements, but no adjustment needs to be made.
For AS 4, the disclosure requirements are:
- Disclose all contingencies and events which can materially change the financial position of the organisation
- Disclose in a note the nature and an estimate of financial effect of remote contingent losses
AS 5: Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
The objective of this Standard is to prescribe the classification and disclosure of certain items in the statement of profit and loss so that all businesses prepare and present such a statement uniformly.
AS 5 specifically deals with four items, which are:
- Net profit or loss for the period: The net profit or loss for the period comprises the following components, each of which should be disclosed on the face of the statement of profit and loss:
- Profit or loss from ordinary activities: These activities take place in the normal course of business; for example profit/ loss on sale of goods or services.
- Profit or loss from extraordinary activities: These activities do not arise under the normal course of business; therefore, these activities are not expected to recur frequently or regularly. For example, profit on sale of non-current assets or loss due to theft.
- Profit or loss from ordinary activities: These activities take place in the normal course of business; for example profit/ loss on sale of goods or services.
- Prior period items: These are income or expenses that arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.
- Changes in accounting estimates: A business entity needs to make certain estimates while preparing financial statements for any period; for example, estimate on the useful life of machinery.
These estimates need to be revised for various reasons such as change in circumstances, advent of new technology or information and subsequent developments. The effect of such change in estimates is to be taken into account while preparing financial statements.
- Changes in accounting policies: Accounting policies comprise specific accounting principles and the methods of applying those principles adopted by a business entity in the preparation and presentation of financial statements.
AS 10 (Revised) guides an organisation with respect to the accounting treatment for Property, Plant and Equipment (PPE). This AS helps users of financial statements find out how their investments reflect in plant, property and equipment of an organisation and what changes are made in their investments. There are four primary issues in accounting for PPE as follows:
- Recognition of PPE assets
- Determination of carrying costs of PPE
- Computation of depreciation charge
- Recognition of impairment losses
AS 10 is applicable to tangible assets. The tangible assets are those that fulfil the following conditions:
- Held for use in production or for supply of goods and services
- Held for administrative purposes
- Not held for sale
- Used for at least 12 months
For example, land, building, plant and machinery, furniture, office equipment are types of PPE. AS 10 is not applicable to the following:
- Biological assets such as forests, plantations and similar regenerative natural resources, and livestock except bearer plants
- Wasting assets such as mineral rights, expenditure on the exploration for and extraction of minerals, oil, natural gas and similar non-regenerative resources
- Expenditure on real estate development
Significance of Setting Accounting Standards
Accounting standards are important for the following three major reasons:
- Standardising alternative accounting treatments
- Setting requirements for additional disclosures
- Improving the comparability of data
There are various accounting standards that are followed at national and international levels. These are developed by different international and national bodies. The different accounting standards that are used in India are shown in the table below:
|Name of Accounting Standard||Developed/Issue By|
|AS||ASB, ICAI (notified by the Central Government)|
|Ind AS (Indian Accounting Standards)||ASB, ICAI (notified by the Central Government)|
|International Accounting Standards (IAS)||International Accounting Standards Committee (IASC)|
|International Financial Reporting Standards (IFRS)||International Accounting Standards Board (IASB)|
Compliance with Accounting Standards
On February 16, 2015, Ministry of Corporate Affairs (MCA) issued a notification to prescribe that a company have to comply with Indian Accounting Standards (Ind AS) mentioned under Rule 4 of Companies (Indian Accounting Standards) Rules, 2015 in preparation of financial statements. Compliance with accounting standard is crucial in financial and management accounting.
However, Rule 4 mentioned above is obligatory and mandatory for a company that falls under following criteria:
- Any listed or non-listed company having net worth of more than ₹500 crore.
- Any company whose parent company, subsidiary, associates or joint venture falls under the above criteria.
In case the standards are not followed, different stakeholders would interpret the accounting statements in different ways. In addition, the financial statements of different companies cannot be compared if the statements are not in compliance with the accounting standards.
The Council of ICAI lays down the following points in its Preface to the Statements of Accounting Standards:
- The Accounting Standards would be mandatory from the respective dates stated in the Accounting Standards. The mandatory status of an Accounting Standard indicates that while settling their attest functions, it would be the duty of the members of the ICAI to inspect whether the Accounting Standard conforms to the presentation of financial statements enclosed in their audit. In the event of any deviation from the Accounting Standard, it would be their duty to prepare adequate disclosures in their audit reports so that the users of financial statements may be aware of such deviation.
- Ensuring compliance with the Accounting Standards while making financial statements is the responsibility of the management of corporate. Statutes governing certain enterprises require that the financial statements are prepared in compliance with the Accounting Standards.
- Financial Statements cannot be described as complying with the Accounting Standards unless they comply with all the requirements of each applicable standard.