Chapter:05 Accounting Standards
Meaning of Accounting Standards:
Accounting standards are written statements that provide uniform rules and practices for preparing financial statements.
They are a set of norms or guidelines that businesses must follow, often established by legislation, statutes, or professional organizations like the ICAI in India.
Nature of Accounting Standards:
- They lay down accounting policies and norms, guiding how transactions should be recorded and disclosed.
- They help remove the effect of diverse accounting policies, leading to greater uniformity.
- They provide the best accounting treatment from available methods.
- They offer information to users about the policies used in preparing financial statements.
- They act like laws, setting limits within which accountants must operate.
Objectives of Accounting Standards:
- To ensure uniformity: To ensure consistency in the preparation and presentation of financial statements.
- To provide information to users: To inform users about the policies used in forming financial statements.
- To eliminate diversity: To remove the effects of diverse accounting policies and practices.
- To ensure transparency, consistency, and comparability: These are key values that accounting standards promote.
- To improve reliability and credibility: To enhance the trustworthiness of financial statements.
Utility or Benefits of Accounting Standards:
(1)Accounting Standards improve the realiability & credibility of Financial Statements: Clear and disclosed accounting policies increase the trustworthiness of financial statements. Users can understand the basis on which figures are presented, leading to greater confidence in the reported information. Builds trust among investors and other stakeholders.
Example: A manufacturing company explicitly states in its notes to accounts that it uses the FIFO method for inventory valuation. This disclosure assures stakeholders that the inventory values and cost of goods sold are consistently determined, even if inventory prices fluctuate. If the policy were vague or changed frequently without explanation, it could raise doubts about the reliability of the financial figures.
(2)Accounting Standards ensure the consistency & comparability of Financial Statements: When different companies in the same industry follow similar accounting policies, their financial statements become comparable.Financial statements prepared using standards are comparable across different periods for the same firm (intra-firm) and across different firms (inter-firm).
Example: Both “Tech Innovations Ltd.” and “Digital Solutions Inc.”, operating in the software development industry, follow the same revenue recognition policy where revenue from software licenses is recognized only when the customer gains control of the software and all significant services related to installation are complete. This allows an investor to compare the reported revenues and profitability of both companies on a like-for-like basis, providing a truer picture of their relative performance.
(3)Accounting Standards help in resolving conflict of financial interests among various groups: Sometimes, there is a conflict of financial interests among the various groups interested in financial statements.
Example: Shareholders & creditors may have opposite intrests in assessing the profitability and net worth of an enterprise.
(4) Accounting Standards significantly reduce the chances of manipulations & frauds: By establishing clear rules and procedures, accounting policies limit the scope for management to manipulate financial figures or engage in fraudulent activities.
Example: A company has a stringent expense recognition policy that requires all expenses to be supported by proper documentation and approved by specific authorities before being recorded. This policy, when effectively implemented, significantly reduces the risk of fictitious expenses being recorded to inflate costs and reduce profits for unethical purposes.
(5)Helpful to Auditors: For auditors, they are the essential rulebook that enables them to conduct a systematic and objective examination, ultimately providing assurance to stakeholders that the financial statements are reliable and conform to established principles.
Example: When auditing “XYZ Ltd.”, the auditor refers to Indian Accounting Standards (Ind-AS). If Ind-AS 101, First-time Adoption of Indian Accounting Standards, requires specific disclosures and transitional adjustments for a company newly adopting Ind-AS, the auditor will verify if XYZ Ltd. has complied with these specific requirements. If the company fails to follow a material requirement, the auditor might issue a qualified opinion or even an adverse opinion.
Limitations of Accounting Standard:
- Rigid in Nature: Accounting standards are rigid in nature.They restrain the Accountants from using a more suitable alternative solution to a particular problem.
- Based on historical costs: Some standards might primarily focus on historical costs, which may not reflect current market values.
- Restrict Initiative: Since accounting standards are mandatory in nature they restrict initiative for better presentation & disclosure
- Obstruct the judgment of Auditors: While providing guidelines, they still require professional judgment in their application, which can lead to variations.
Applicability of Accounting Standards:
International Financial Reporting Standards (IFRS):
- IFRS is a common set of rules that helps financial statements to be uniform, clear, and similar across the globe.
- These rules are published by the International Accounting Standards Board (IASB).
- They dictate how a business should manage and record its accounts.
Assumptions in IFRS:
- Going Concern Assumption: Financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. This means the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations.
- Accrual Assumptions: Financial statements are prepared on the accrual basis of accounting. This means that the effects of transactions and other events are recognized when they occur.
- Measuring Unit Assumption:It is the current purchasing power. It means that assests are not shown in the balance sheet at historical cost but they are shown at current or fair value.
- Constant Purchasing Power Assumption:This assumption requires that the value of capital be adjusted to inflation at the end of the financial year.
Objectives / Need for IFRS:
Easy Access to global capital markets: IFRS helps companies raise funds internationally by providing financial statements that foreign investors can understand and trust.
Easy to Make Comparisons:Enables easier comparison of financial statements across different countries, facilitating investment and analysis.
Uniformity in Financial Reporting: Brings clarity, comparability, and uniformity in financial reporting worldwide.
Lower Cost of Capital Raised Abroad: Companies that operate in global environment have to prepare two sets of financial statements- One set based on home country’s accounting standards & another set based on IFRS.
In case of adoption of IFRS it will have to prepare only one set of financial statements and thus the cost of raising funds from abroad will be minimized.
True and Fair Valuation of Assets: As per Indian Accounting Standards, assets are valued on historical cost whereas as per IFRS assets are reported at fair value. Adoption of IFRS would provide a uniform basis for the reporting of true & fair value of assets.
Difficult to Commit Fraud & Manipulate the Accounts: Makes it more difficult to manipulate accounts compared to traditional accounting styles.
Benefits of IFRS:
(1)Helpful to Enterprises Operating Globally: IFRS unify the accounting practices worldwide as a result of which the problem of consolidation is avoided.
(2)Helpful to Investors: The use of common set of high quality accounting standards, IFRS would be helpful to investors in comparison to financial statements prepared under different accounting standards adopted by different countries.
(3)Helpful to Industry: Most of the stock exchanges require information as per IFRS and convergence to IFRS would enable Indian Companies to access international capital market easily.
(4) Lower Cost of Raising Funds Abroad: Companies that operate in global environment have to prepare two sets of financial statements- One set based on home country’s accounting standards & another set based on IFRS.In case of adoption of IFRS it will have to prepare only one set of financial statements and thus the cost of raising funds from abroad will be minimized.
(5) Helpful to Accounting Professionals: Accounting professionals will be able to provide better services in countries adopting IFRS.
(6) True and Fair View: In IFRS based financial statements assests are valued on the concept of true and fair value. Indian Accounting Standards ignore this concept.
IND-AS
India has been transitioning towards IFRS by converging its own accounting standards with IFRS, resulting in Ind-AS. Ind-AS are IFRS-converged standards.IFRS are a set of accounting standards developed by International Accounting Standards Board(IASB).
Characteristics or Salient Feature of IND-AS:
- Ind-AS are the modified version of IFRS.
- Ind-AS are comprehensive and cover a wide area comprising revenues, expenses, losses, assets, liability and equity.
- Ind-AS are principle based.
- Ind-AS lay emphasis on transparency and accountability of financial statements.
Objectives of IND-AS:
- To ensure uniformity in the preparation and presentation of financial statements.
- To provide the information to the users about the policies adopted in the preparation of financial statements.
- To remove the effect of diverse accounting policies and practices.
- To ensure consistency, transparency and comparability of financial statements.
- To improve the reliability and credibility of financial statements.
Merits of IND-AS:
Suitable for Indian Constitution: They have been framed in such a way that they are most suitable for Indian conditions.
Clear Guidelines for Financial Reporting: Ind-AS provide a wide framework in which clear guidelines are given for financial reporting.
Uniformity in Financial Reporting: The adoption of IND-AS brings uniformity, comparability and transparency in financial statements.
Helpful to Investors: Investors require high quality, relevant, reliable, transparent and comparable information in financial statements in order to make economic decisions.
Difficult to commit Fraud and Manipulation the Accounts: There are tough and rigid rules for the preparation and presentation of financial statements under IND-AS and it is extremely difficult to manipulate the accounts.
Applicability of Accounting Standards in IND-AS:
Phased Implementation: Ind-AS has been implemented in a phased manner in India.
Currently Applicable to:
Listed Companies: All listed companies except those listed on SME Exchange.
Unlisted Companies: Large unlisted companies meeting certain net worth criteria.
Banks, NBFCs (Non-Banking Financial Companies), and Insurance Companies: Specific phases for these sectors.
Ind-AS is the current, globally aligned framework for financial reporting by major Indian companies.
Small businesses and proprietorships typically follow the old Indian GAAP or simpler accounting practices.