Serial number Title Page Number

Title Page

Declaration

Certificate

Acknowledgement

List of Tables

List of Graphs

I

ii

iii

iv

v

v

Ch.1

1.1

1.2

1.3

1.4

INDIAN ACCOUNTING STANDARD

Introduction

Meaning

Definitions

Objective of Accounting Standard

1

2-3

3-4

5-6

Ch.2

2.1

2.2

2.3

2.4

REVIEW OF LITERATURE

Introduction.

Accounting Standard issued by the institute of C.A.

of India.

Disclose of accounting policies.

Accounting for Government grants.

9

9-11

11

11

TABLE OF CONTENTS

Ch.3

3.1

3.2

3.3

3.4

3.5

RESEARCH METHODOLOGY

Earnings per Share.

Accounting For taxes on Income.

Interim Financial Reporting.

Data Collection.Reserch Methods.

12-14

14-15

15

15

19

Ch.4

4.1

4.2

4.3

4.4

ANALYSIS AND INTERPRETATION OF

DATA

Analysis.

Comliance with Accounting Standards

International Management Review.

Concluding Remark.

24-25

29-30

30-31

31

Ch.5

5.1

5.2

5.3

FINDINGS, SUGGESTION AND

CONCLUSION.

Findings of the study.

Suggestion

Conclusion of the study

32-34

34-35

36

INDIAN ACCOUNTING STANDARDS -A PERSPECTIVE

1.1 Introduction

The paradigm shift in the economic environment in India during last few years has led to increasing attention being devoted to accounting standards as a means towards ensuring potent and transparent financial reporting by corporate. Further, cross-border raising of huge amount of capital has also generated considerable interest in the generally accepted accounting principles in advanced countries such as USA. Initiatives taken by International Organisation Securities Commission (IOSCO) towards propagating International Accounting Standards (IASs)/ International Financial Reporting Standards (IFRSs), issued by the International Accounting Standards Board (IASB), as the uniform language of business to protect the interests of international investors have brought into focus the IASs/ IFRSs.

The Institute of Chartered Accountants of India, being a premier accounting body in the country, took upon itself the leadership role by establishing Accounting Standards Board, more than twenty five years ago, to fall in line with the international and national expectations. Today, accounting standards in India have come a long way. Presented hereinafter are some salient features of the accounting standard-setting endeavours in India.

RATIONALE OF ACCOUNTING STANDARDS

Accounting Standards are formulated with a view to harmonise different accounting policies and practices in use in a country. The objective of Accounting Standards is, therefore, to reduce thev accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises with a view to provide meaningful information to various users of financial statements to enable them to make informed economic decisions. The Companies Act, 1956, as well as many other statutes in India require that the financial statements of an enterprise should give a true and fair view of its financial position and working results.

This requirement is implicit even in the absence of a specific statutory provision to this effect. The Accounting Standards are issued with a view to describe the accounting principles and the methods of applying these principles in the preparation and presentation of financial statements so that they give a true and fair view. The Accounting Standards not only prescribe appropriate accounting treatment of complex business transactions but also foster greater transparency and market discipline. Accounting Standards also helps the regulatory agencies in benchmarking the accounting accuracy.

International Harmonisation of Accounting Standards

Recognising the need for international harmonisation of accounting standards, in 1973, the International Accounting Standards Committee (IASC) was established. It may be mentioned here that the IASC has been reconstituted as the International Accounting Standards Board (IASB). The objectives of IASC included promotion of the International Accounting Standards for worldwide acceptance and observance so that the accounting standards in different countries are harmonised. In recent years, need for international harmonisation of Accounting Standards followed in different countries has grown considerably as the cross-border transfers of capital

FEATURES OF USEFUL FINANCIAL INFORMATION

CONSISTENCY

CLARITY

FINANCIAL

INFORMATION

ACCURACY

RELIABILITY

RELEVANCE TIMELINESS

1.2 MeaningThe meaning of accounting standards

Accounting as a "language of business" communication the financial results of an enterprise to various interested parties by means of financial statmetns which have to exhinit a "true and fair" view of its state of affairs. 

Accounting standards which seek to sugest rules and criteria of accounitng measurements, have to keep the set of rules, social needs, legal requirments and technological developmetns in view.

Formulation of proper accounting standards, therefore is a vital step in developing accounting as a business lanuguage.

Accounting is the art of recording transactions in the best manner possible, so as to enable the reader to arrive at judgments/come to conclusions, and in this regard it is utmost necessary that there are set guidelines. These guidelines are generally called accounting policies. The intricacies of accounting policies permitted Companies to alter their accounting principles for their benefit. This made it impossible to make comparisons. In order to avoid the above and to have a harmonised accounting principle, Standards needed to be set by recognised accounting bodies. This paved the way for Accounting Standards to come into existence.

Accounting Standards in India are issued By the Institute of Chartered Accountanst of India (ICAI). At present there are 30 Accounting Standards issued by ICAI.

1.3 DefinitionsDEFINITION OF 'ACCOUNTING STANDARD'

A principle that guides and standardizes accounting practices. The Generally Accepted Accounting Principles (GAAP) are a group of accounting standards that are widely accepted as appropriate to the field of accounting. Accounting standards are necessary so that financial statements are meaningful across a wide variety of businesses; otherwise, the accounting rules of different companies would make comparative analysis almost impossible.

INVESTOPEDIA EXPLAINS 'ACCOUNTING STANDARD'

An accounting standard is a guideline for financial accounting, such as how a firm prepares and presents its business income and expense, assets and liabilities. The Generally Accepted Accounting Principles is comprised of a large group of individual accounting standards. GAAP standards apply to financial reporting in the United States and may be eventually phased out in favor of the International Accounting Standards.

OBJECTIVE OF ACCOUNTING STANDARDS

Objective of Accounting Standards is to standarize the diverse accounting policies and practices with a view to eliminate to the extent possible the non-comparability of financial statements and the reliability to the financial statements.

The institute of Chatered Accountants of India, recognizing the need to harmonize the diversre accounting policies and practices, constituted at Accounting Standard Board (ASB) on 21st April, 1977.

COMPLIANCE WITH ACCOUNTING STANDARDS ISSUED BY ICAI

Sub Section(3A) to section 211 of Companies Act, 1956 requires that every Profit/Loss Account and Balance Sheet shall comply with the Accounting Standards. 'Accounting Standards' means the standard of accounting recomended by the ICAI and prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards(NACAs) constituted under section 210(1) of

companies Act, 1956.

ACCOUNTING STANDARDS ISSUED BY THE INSTITUTE OF CHATERED ACCOUNTANTS OF INDIA ARE AS BELOW:

Present status of Accounting Standards in India in harmonisation with the International

Accounting Standards

As indicated earlier, Accounting Standards are formulated on the basis of the InternationalFinancial Reporting Standards (IFRSs)/ International Accounting Standards (IASs) issued by theIASB. Of the 41 IASs issued so far, 29 are at present in force, the remaining standards havebeen withdrawn. Apart from this, 8 IFRSs have also been issued by the IASB. Corresponding tothe IASs/IFRSs, so far, 30 Indian Accounting Standards on the following subjects have beenissued:

AS 1 Disclosure of Accounting Policies

AS 2 Valuation of Inventories

AS 3 Cash Flow Statements

AS 4 Contingencies and Events Occurring after the Balance Sheet Date

AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes inAccounting Policies

AS 6 Depreciation Accounting

AS 7 Construction Contracts

AS 8 Accounting for Research and Development (Withdrawn pursuant toAS 26 becoming mandatory)

AS 9 Revenue Recognition

AS 10 Accounting for Fixed Assets

AS 11 The Effects of Changes in Foreign Exchange Rates

AS 12 Accounting for Government Grants

AS 13 Accounting for Investments

AS 14 Accounting for Amalgamations

AS 15 Employee Benefits

AS 16 Borrowing Costs

AS 17 Segment Reporting

AS 18 Related Party Disclosures

AS 19 Leases

AS 20 Earnings Per Share

AS 21 Consolidated Financial Statements

AS 22 Accounting for Taxes on IncomeAS 23 Accounting for Investments in Associates in Consolidated FinancialStatements

AS 24 Discontinuing Operations

AS 25 Interim Financial Reporting

AS 26 Intangible Assets

AS 27 Financial Reporting of Interests in Joint Ventures

AS 28 Impairment of Assets

AS 29 Provisions, Contingent Liabilities and Contingent Assets

AS 30 Financial Instruments: Recognition and Measurement

AS 31 Financial Instruments: Presentation

DISCLOSURE OF ACCOUNTING POLICIES: 

Accounting Policies refer to specific accounting principles and the method of applying those principles adopted by the enterprises in preparation and presentation of the financial statements

VALUATION OF INVENTORIES:  The objective of this standard is to formulate the method of computation of cost of inventories / stock, determine the value of closing stock / inventory at which the inventory is to be shown in balance sheet till it is not sold and recognized as revenue.

CASH FLOW STATEMENTS:  Cash flow statement is additional information to user of financial statement. This statement exhibits the flow of incoming and outgoing cash. This statement assesses the ability of the enterprise to generate cash and to utilize the cash. This statement is one of the tools for assessing the liquidity and solvency of the enterprise.

Contigencies and Events occuring after the balance sheet date: 

In preparing financial statement of a particular enterprise, accounting is done by following accrual basis of accounting and prudent accounting policies to calculate the profit or loss for the year and to recognize assets and liabilities in balance sheet. While following the prudent accounting policies, the provision is made for all known liabilities and losses even for those liabilities / events, which are probable. Professional judgement is required to classify the likehood of the future events occuring and, therefore, the question of contingencies and their accounting arises.

Objective of this standard is to prescribe the accounting of contigencies and the events, which take place after the balance sheet date but before approval of balance sheet by Board of Directors. The Accounting Standard deals with Contingencies and Events occuring after the balance sheet date.

Net Profit or Loss for the Period, Prior Period Items and change in Accounting Policies :  The objective of this accounting standard is to prescribe the criteria for certain items in the profit and loss account so that comparability of the financial statement can be enhanced. Profit and loss account being a period statement covers the items of the income and expenditure of the particular period. This accounting standard also deals with change in accounting policy, accounting estimates and extraordinary items.

Depreciation Accounting :  It is a measure of wearing out, consumption or other loss of value of a depreciable asset arising from use, passage of time. Depreciation is nothing but distribution of total cost of asset over its useful life.

Construction Contracts :  Accounting for long term construction contracts involves question as to when revenue should be recognized and how to measure the revenue in the books of contractor. As the period of construction contract is long, work of construction starts in one year and is completed in another year or after 4-5 years or so. Therefore question arises how the profit or loss of construction contract by contractor should be determined. There may be following two ways to determine profit or loss: On year-to-year basis based on percentage of completion or On cpmpletion of the contract.

Revenue Recognition :  The standard explains as to when the revenue should be recognized in profit and loss account and also states the circumstances in which revenue recognition can be postponed. Revenue means gross inflow of cash, receivable or other consideration arising in the course of ordinary activities of an enterprise such as:- The sale of goods, Rendering of Services, and Use of enterprises resources by other yeilding interest, dividend and royalties. In other words, revenue is a charge made to customers / clients for goods supplied and services rendered.

Accounting for Fixed Assets :  It is an asset, which is:- Held with intention of being used for the purpose of producing or providing goods and services. Not held for sale in the normal course of business. Expected to be used for more than one accounting period.

The Effects of changes in Foreign Exchange Rates : 

Effect of Changes in Foreign Exchange Rate shall be applicable in Respect of Accounting Period commencing on or after 01-04-2004 and is mandatory in nature. This accounting Standard applicable to accounting for transaction in Foreign currencies in translating in the Financial Statement Of foreign operation Integral as well as non- integral and also accounting for For forward exchange.Effect of Changes in Foreign Exchange Rate, an enterprises should disclose following aspects:

Amount Exchange Difference included in Net profit or Loss; Amount accumulated in foreign exchange translation reserve; Reconciliation of opening and closing balance of Foreign Exchange translation

reserve;

Accounting for Government Grants :  Government Grants are assistance by the Govt. in the form of cash or kind to an enterprise in return for past or future compliance with certain conditions. Government assistance, which cannot be valued reasonably, is excluded from Govt. grants, Those transactions with Governement, which cannot be distinguished from the normal trading transactions of the enterprise, are not considered as Government grants.

Accounting for Investments :  It is the assets held for earning income by way of dividend, interest and rentals, for capital appreciation or for other benefits.

Accounting for Amalgamation :  This accounting standard deals with accounting to be made in books of Transferee company in case of amalgamation. This accounting standard is not applicable to cases of acquisition of shares when one company acquires / purchases the share of another company and the acquired company is not dissolved and its separate entity continues to exist. The standard is applicable when acquired company is dissolved and separate entity ceased exist and purchasing company continues with the business of acquired company

Employee Benefits :  Accounting Standard has been revised by ICAI and is applicable in respect of accounting periods commencing on or after 1st April 2006. The scope of the accounting standard has been enlarged, to include accounting for short-term employee benefits and termination benefits.

Borrowing Costs :  Enterprises are borrowing the funds to acquire, build and install the fixed assets and other assets, these assets take time to make them useable or saleable, therefore the enterprises incur the interest (cost of borrowing) to acquire and build these assets. The objective of the Accounting Standard is to prescribe the treatment of borrowing cost (interest + other cost) in accounting, whether the cost of borrowing should be included in the cost of assets or not.

Segment Reporting :  An enterprise needs in multiple products/services and operates in different geographical areas. Multiple products / services and their operations in different geographical areas are exposed to different risks and returns. Information about multiple products / services and their operation in different geographical areas are called segment information. Such information is used to assess the risk and return of multiple products/services and their operation in different geographical areas. Disclosure of such information is called segment reporting.

Related Patty Disclosure : 

Sometimes business transactions between related parties lose the feature and character of the arms length transactions. Related party relationship affects the volume and decision of business of one enterprise for the benefit of the other enterprise. Hence disclosure of related party transaction is essential for proper understanding of financial performance and financial position of enterprise.

Accounting for leases :  Lease is an arrangement by which the lesser gives the right to use an asset for given period of time to the lessee on rent. It involves two parties, a lesser and a lessee and an asset which is to be leased. The lesser who owns the asset agrees to allow the lessee to use it for a specified period of time in return of periodic rent payments.

Earnings Per Share : Earnings per share (EPS) is a financial ratio that gives the information regarding earning available to each equity share. It is very important financial ratio for assessing the state of market price of share. This accounting standard gives computational methodology for the determination and presentation of earning per share, which will improve the comparison of EPS. The statement is applicable to the enterprise whose equity shares or potential equity shares are listed in stock exchange.

Consolidated Financial Statements :  The objective of this statement is to present financial statements of a parent and its subsidiary (is) as a single economic entity. In other words the holding company and its subsidiary (is) are treated as one entity for the preparation of these consolidated financial statements. Consolidated profit/loss account and consolidated balance sheet are prepared for disclosing the total profit/loss of the group and total assets and liabilities of the group. As per this accounting standard, the consolidated balance sheet if prepared should be prepared in the manner prescribed by this statement.

Accounting for Taxes on Income :  This accounting standard prescribes the accounting treatment for taxes on income. Traditionally, amount of tax payable is determined on the profit/loss computed as per income tax laws. According to this accounting standard, tax on income is determined on the principle of accrual concept. According to this concept, tax should be accounted in the period in which corresponding revenue and expenses are accounted. In simple words tax shall be accounted on accrual basis; not on liability to pay basis.

Accounting for Investments in Associates in consolidated financial statements :  The accounting standard was formulated with the objective to set out the principles and procedures for recognizing the investment in associates in the consolidated financial statements of the investor, so that the effect of investment in associates on the financial position of the group is indicated.

Discontinuing Operations :  The objective of this standard is to establish principles for reporting information

about discontinuing operations. This standard covers "discontinuing operations" rather than "discontinued operation". The focus of the disclosure of the Information is about the operations which the enterprise plans to discontinue rather than disclosing on the operations which are already discontinued. However, the disclosure about discontinued operation is also covered by this standard.

Interim Financial Reporting (IFR) :  Interim financial reporting is the reporting for periods of less than a year generally for a period of 3 months. As per clause 41 of listing agreement the companies are required to publish the financial results on a quarterly basis.

Intangible Assets :  An Intangible Asset is an Identifiable non-monetary Asset without physical substance held for use in the production or supplying of goods or services for rentals to others or for administrative purpose

Financial Reporting of Interest in joint ventures :  Joint Venture is defined as a contractual arrangement whereby two or more parties carry on an economic activity under 'joint control'. Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefit from it. 'Joint control' is the contractually agreed sharing of control over economic activity.

Impairment of Assets :  The dictionary meaning of 'impairment of asset' is weakening in value of asset. In other words when the value of asset decreases, it may be called impairment of an asset. As per AS-28 asset is said to be impaired when carrying amount of asset is more than its recoverable amount.

Provisions, Contingent Liabilities And Contingent Assets :  Objective of this standard is to prescribe the accounting for Provisions, Contingent Liabilities, Contingent Assets, and Provision for restructuring cost.

Provision: It is a liability, which can be measured only by using a substantial degree of estimation.

Liability: A liability is present obligation of the enterprise arising from past events the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

 

Financial Instrument:  Recognition and Measurement, issued by The Council of the Institute of Chartered Accountants of India, 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. This Accounting Standard will become mandatory in respect of Accounting periods commencing on or after 1-4-2011 for all commercial, industrial and business Entities except to a Small and Medium-sized Entity. The objective of this Standard is to establish principles for recognizing and measuring Financial assets, financial liabilities and some contracts to buy or sell non-financial items. Requirements for presenting information about financial instruments are in Accounting Standard.

 

Financial Instrument: presentation :  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. The principles in this Standard complement the principles for recognizing and measuring financial assets and financial liabilities in Accounting Standard Financial Instruments:

 

Financial Instruments, Disclosures And Limited Revision To Accounting Standards:

 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.

COMPLIANCE WITH ACCOUNTING STANDARDS

Accounting Standards issued by the ICAI have legal recognition through the Companies

Act,1956, whereby every company is required to comply with the Accounting Standards and thestatutory auditors of every company are required to report whether the Accounting StandardsHave been complied with or not. Also, the Insurance Regulatory and Development Authority(IRDA) (Preparation of Financial Statements and Auditor’s Report of Insurance Companies)Regulations, 2000 requires insurance companies to follow the Accounting Standards issued byThe ICAI. The Securities and Exchange Board of India (SEBI) and the Reserve Bank of IndiaAlso require compliance with the Accounting Standards issued by the ICAI from time to time.Section 211 of the Companies Act, 1956, deals with the form and contents of balance sheet andProfit and loss account. The Companies (Amendment) Act, 1999 has inserted new sub-sections3A, 3B and 3C to Section 211, with a view to ensure that the financial statements are preparedIn accordance with the Accounting Standards. The new sub-sections as inserted are reproducedbelow:Section 211 (3A): ‘ Every profit and loss account and balance sheet of the company shallcomply with the accounting standards’Section 211 (3B): ‘ Where the profit and loss account and the balance sheet of the company donot comply with the accounting standards, such companies shall disclose in its profit and lossaccount and balance sheet, the following, namely:-a) the deviation from the accounting standards;b) the reasons for such deviation; andc) the financial effect, if any, arising due to such deviation’Section 211 (3C): ‘For the purposes of this section, the expression “accounting standards”means the standards of accounting recommended by the Institute of Chartered Accountants ofIndia, constituted under the Chartered Accountants Act, 1949 (38 of 1949), as may beprescribed by the Central Government in consultation with the National Advisory Committee onAccounting Standards established under sub- section (1) of section 210A:

Provided that the standards of accounting specified by the Institute of CharteredAccountants of India shall be deemed to be the Accounting Standards until the accounting

Standards are prescribed by the Central Government under this sub-section.’5It may also be mentioned that the National Advisory Committee on Accounting StandardsNACAS) has been constituted under section 210A as referred to under section 211 (3C) toadvise the Central Government on formulation and laying down of the accounting standards forAdoption by companies or class of companies. It is of significance to note that on therecommendation of NACAS, the Ministry of Company Affairs, has issued a Notification dated 7thDecember, 2006, whereby it has prescribed Accounting Standards 1 to 7 and 9 to 29, asrecommended by the Institute of Chartered Accountants of India, which are included in the saidNotification. As per the Notification, the Accounting Standards shall come into effect in respectof accounting periods commencing on or after the publication of these Accounting Standards,i.e., 7th December, 2006. Specific relaxations are given to particular kinds of companies, termedAs Small and Medium Sized Companies, depending upon their size and nature.The above legal provisions have cast a duty upon the management to prepare the financialStatements in accordance with the accounting standards. The corresponding provision to reporton the compliance of accounting standards has been inserted under section 227 of theCompanies Act, 1956, thereby casting a duty upon the auditor of the company to report on suchCompliance. A new clause (d) under sub-section 3 of Section 227 of the Companies Act, 1956 isread as under:‘whether, in his opinion, the profit and loss account and balance sheet comply with theaccounting standards referred to in sub-section (3C) of section 211’As far as the reporting of compliance with the Accounting Standards by the management isconcerned, clause (I) under the new sub-section 2AA of Section 217 of the Companies Act,1956, (inserted by the Companies Amendment Act, 2000) prescribes that the Board’s reportshould include a Directors’ Responsibility Statement indicating therein that in the preparation ofthe annual accounts, the applicable accounting standards had been followed along with properExplanation relating to material departures.

The conceptual frameworks of accounting

How can the credibility and usefulness of accounting and financial information be ensured? AccountingOperates within a framework. This framework is constantly changing and evolving as new problemsAre encountered, as new practices and techniques are developed, and the objectives of users ofFinancial information is modified and revised.The search for a definitive conceptual framework, a theoretical accounting model, which may dealWith any new accounting problem that may arise, has resulted in many conceptual frameworks havingBeen developed in a number of countries worldwide. The basic assumption for these conceptualFrameworks are that financial statements must be useful. The general structure of conceptual frameworks

Deals with the following six questions:1. What is the purpose of financial statement reporting?

2. Who are the main users of accounting and financial information?

3. What type of financial statements will meet the needs of these users?

4. What type of information should be included in financial statements to satisfy these needs?

5. How should items included in financial statements be defined?

6. How should items included in financial statements be recorded and measured?

Figure 1.1

The Statement of Principles (Sop)

In 1989 the International Accounting Standards Board (IASB) issued a conceptual frameworkThat largely reflected the conceptual framework of the Financial Accounting Standards Board of theUSA issued in 1985. This was based on the ideas and proposals made by the accounting professionSince the 1970s in both the USA and UK. In 1999 the Accounting Standards Board (ASB) in the

Progress check 1.1What is meant by a conceptual framework of accounting?

The Statement of Principles (SOP)

The 1975 Corporate Report was the first UK attempt at a conceptual framework. This, togetherWith the 1973 True blood Report published in the USA, provided the basis for the conceptual frameworkIssued by the IASB in 1989, referred to in the previous section. It was followed by the publicationOf the SOP by the ASB in 1999. The SOP is a basic structure for determining objectives,In which there is a thread from the theory to the practical application of accounting standards toTransactions that are reported in published accounts. The SOP is not an accounting standard andIts use is not mandatory, but it is a statement of guidelines; it is, by virtue of the subject, constantlyIn need of revision.

The SOP identifies the main users of financial information as:

■ Investors

■ Lenders

■ Employees

■ Suppliers

■ Customers

■ Government

■ The general public.

The SOP focuses on the interests of investors and assumes that each of the other users of financial

Information is interested in or concerned about the same issues as investors.The sop consists of eight chapters that deal with the following topics:

1. The objectives of financial statements, which are fundamentally to provide information that isUseful for the users of that information.

2. Identification of the entities that are required to provide financial statement reporting by virtue ofThe demand for the information included in those statements.

3. The qualitative characteristics required to make financial information useful to users:

– Materiality (inclusion of information that is not material may distort the usefulness of otherInformation)

– Relevance

– Reliability

– Comparability (enabling the identification and evaluation of differences and similarities)

– Comprehensibility.

4. The main elements included in the financial statements – the ‘building blocks’ of accounting suchAs assets and liabilities.6 5. When transactions should be recognized in financial statements.

6. How assets and liabilities should be measured.

7. How financial statements should be presented for clear and effective communication.

8. The accounting by an entity in its financial statements for interests in other entities.The UK SOP can be seen to be a very general outline of principles relating to the reporting of financialInformation. The SOP includes some of the basic concepts that provide the foundations for thePreparation of financial statements. These accounting concepts will be considered in more detail inThe next section.

Accounting concepts are the principles underpinning the preparation of accounting information

Relating to the ethical rules, boundary rules and recording and measurement rules of accounting.Ethical rules, or principles, are to do with limiting the amount of judgment (or indeedCreativity) that may be used in the reporting of financial information. Boundary rules are to doWith which types of data, and the amounts of each, that should be held by organizations, andWhich elements of financial information should be reported? Recording and measurement rulesOf accounting relate to how the different types of data should be recorded and measured by theOrganization.Fundamental accounting concepts are the broad, basic assumptions, which underlie the periodicFinancial accounts of business enterprises. The five most important concepts, which are discussed inFRS 18, Accounting Policies, is as follows.

The prudence concept

Prudence means being careful or cautious. The prudence concept is an ethical concept that is basedOn the principle that revenue and profits are not anticipated, but are included in the income statementOnly when realized in the form of either cash or other assets, the ultimate cash realization ofWhich can be assessed with reasonable certainty? Provision must be made for all known liabilitiesAnd expenses, whether the amount of these is known with certainty or is a best estimate in the lightOf information available, and for losses arising from specific commitments, rather than just guesses.Therefore, companies should record all losses as soon as they are known, but should record profitsOnly when they have actually been achieved in cash or other assets.

The consistency concept

The consistency concept is an ethical rule that is based on the principle that there is uniformity of

Accounting treatment of like items within each accounting period and from one period to the next.However, as we will see in Chapter 3, judgment may be exercised as to the application of accountingRules to the preparation of financial statements. For example, a company may choose from a varietyOf methods to calculate the depreciation of its machinery and equipment, or how to value its inventories.Until recently, once a particular approach had been adopted by a company for one accountingperiod then this approach should normally have been adopted in all future accounting periods, unlessthere were compelling reasons to change. The ASB now prefers the approaches adopted by companiesto be revised by them, and the ASB encourages their change, if those changes result in showinga truer and fairer picture. If companies do change their approaches then they have to indicate this intheir annual reports and accounts.

The going concern concept

The going concern concept is a boundary rule that assumes that the entity will continue in operationalexistence for the foreseeable future. This is important because it allows the original, historicalcosts of assets to continue to be used in the balance sheet on the basis of their being able to generatefuture income. If the entity was expected to cease functioning then such assets would be worth onlywhat they would be expected to realise if they were sold off separately (their break-up values) andtherefore usually considerably less.

The accruals concept

The accruals concept (or the matching concept) is a recording and measurement rule that isbased on the principle that revenues and costs are recognised as they are earned or incurred, arematched with one another, and are dealt with in the income statement of the period to which

they relate, irrespective of the period of receipt or payment. It would be misleading to reportprofit as the difference between cash received and cash paid during a period because some tradingand commercial activities of the period would be excluded, since many transactions are based oncredit.Most of us are users of electricity. We may use it over a period of three months for heating, lightingand running our many home appliances, before receiving an invoice from the electricity supplier forthe electricity we have used. The fact that we have not received an invoice until much later doesn’tmean we have not incurred a cost for each month. The costs have been accrued over each of thosemonths, and we will pay for them at a later date.

The separate valuation concept

The separate valuation concept is a recording and measurement rule that relates to the determinationof the aggregate amount of any item. In order to determine the aggregate amount of anasset or a liability, each individual asset or liability that makes up the aggregate must be determinedseparately. This is important because material items may reflect different economic circumstances.There must be a review of each material item to comply with the appropriate accountingstandards:

■ IAS 16 (Property, Plant and Equipment)

■ IAS 36 (Impairment of Assets)

■ IAS 37 (Provisions, Contingent Liabilities and Contingent Assets).

(See the later section, which discusses UK and international accounting and financial reporting standardscalled Financial Reporting Standards (FRSs) , International Financial Reporting Standards

(IFRSs) , and International Accounting Standards (IASs) .)Note the example of the Millennium Dome 2000 project, which was developed in Greenwich, London,throughout 1999 and 2000 and cost around £800m. At the end of the year 2000 a valuation of

the individual elements of the attraction resulted in a total of around £100m.The further eight fundamental accounting concepts are as follows.

The substance over form concept

Where a conflict exists, the substance over form concept , which is an ethical rule, requires the structuringof reports to give precedence to the representation of financial or economic reality over strict adherenceto the requirements of the legal reporting structure. This concept is dealt with in IAS 17, Leases.When a company acquires an asset using a finance lease, for example a machine, it must disclose theasset in its balance sheet even though not holding legal title to the asset, whilst also disclosing separatelyin its balance sheet the amount that the company still owes on the machine. The reason for showing theasset in the balance sheet is because it is being used to generate income for the business, in the same wayas a purchased machine. The substance of this accounting transaction (treating a leased asset as thoughit had been purchased) takes precedence over the form of the transaction (the lease itself ).

The business entity concept

The business entity concept is a boundary rule that ensures that financial accounting informationrelates only to the activities of the business entity and not to the other activities of its owners. Anowner of a business may be interested in sailing and may buy a boat and pay a subscription as a memberof the local yacht club. These activities are completely outside the activities of the business andsuch transactions must be kept completely separate from the accounts of the business.

The periodicity concept

The periodicity concept (or time interval concept) is a boundary rule. It is the requirement toproduce financial statements at set time intervals. This requirement is embodied, in the case of UKcompanies, in the Companies Act 2006 (all future references to the Companies Act will relate to the

Companies Act 2006 unless otherwise stated). Both annual and interim financial statements are requiredto be produced by public limited companies (plcs) each year.Internal reporting of financial information to management may take place within a company on amonthly, weekly, daily, or even an hourly basis. But owners of a company, who may have no involvementin the running of the business or its internal reporting, require the external reporting of theircompany’s accounts on a six-monthly and yearly basis. The owners of the company may then rely onthe regularity with which the reporting of financial information takes place, which enables them tomonitor company performance, and compare figures year on year.

The money measurement concept

The money measurement concept is a recording and measurement rule that enables information relatingto transactions to be fairly compared by providing a commonly accepted unit of converting quantifiable amounts into recognisable measures. Most quantifiable data are capable of being converted,using a common denominator of money, into monetary terms. However, accounting deals only withthose items capable of being translated into monetary terms, which imposes a limit on the scope of accountingto report such items. You may note, for example, that in a university’s balance sheet there is novalue included for its human resources, that is its lecturers, managers, and sec retarial and support staff .

The historical cost concept

The historical cost concept is a recording and measurement rule that relates to the practice of valuingassets at their original acquisition cost. For example, you may have bought a mountain bike two yearsago for which you were invoiced and paid £150, and may now be wondering what it is currently worth.

True and fair view 11One of your friends may consider it to be worth £175 because they feel that the price of new mountainbikes has increased over the past two years. Another friend may consider it to be worth only £100 because

you have used it for two years and its condition has deteriorated. Neither of your friends may beincorrect, but their views are subjective and they are different. The only measure of what your bike isworth on which your friends may agree is the price shown on your original invoice, its historical cost.Although the historical cost basis of valuation may not be as realistic as using, for instance, a currentvaluation, it does provide a consistent basis for comparison and almost eliminates the need forany subjectivity.

The realisation concept

The realisation concept is a recording and measurement rule and is the principle that increases in valueshould only be recognised on realisation of assets by arm’s-length sale to an independent purchaser.This means, for example, that sales revenue from the sale of a product or service is recognised in accountingstatements only when it is realised. This does not mean when the cash has been paid over bythe customer; it means when the sale takes place, that is when the product or service has been delivered,and ownership is transferred to the customer. Very often, salespersons incorrectly regard a ’sale’as the placing of an order by a customer because they are usually very optimistic and sometimes forgetthat orders can get cancelled. Accountants, being prudent individuals, ensure that sales are correctlyrecorded through the issuing of an invoice when services or goods have been delivered (and installed).

The dual aspect concept

The dual aspect concept is the recording and measurement rule that provides the basis for doubleentrybookkeeping. It reflects the practical reality that every transaction always includes both thegiving and receiving of value. For example, a company may pay out cash in return for a delivery intoits warehouse of a consignment of products that it subsequently aims to sell. The company’s reductionin its cash balance is reflected in the increase in its inventory of products.

The materiality concept

Information is material if its omission or misstatement could influence the economic decisions ofusers taken on the basis of the financial statements. Materiality depends on the size of the item orerror judged, its significance, in the particular circumstances of its omission or misstatement. Thus,materiality provides a threshold or cut-off point rather than being a primary qualitative characteristicthat information must have if it is to be useful. The materiality concept is the overriding recordingand measurement rule, which allows a certain amount of judgement in the application of all the otheraccounting concepts. The level of materiality, or significance, will depend on the size of the organisationand the type of revenue or cost, or asset or liability being considered. For example, the cost ofbusiness stationery is usually charged as an expense regardless of whether or not all the items havebeen used; it would be pointless to try and attribute a value to such relatively low-cost unused items.

True and fair view

The term true and fair view was introduced in the Companies Act 1947, requiring that companies’reporting of their accounts should show a true and fair view. It was not defi ned in that Act and hasnot been defined since. Some writers have suggested that conceptually it is a dynamic concept butover the years it could be argued that it has failed, and various business scandals and collapses have

12occurred without users being alerted. The concept of true and fair was adopted by the EuropeanCommunity Council in its fourth directive, implemented by the UK in the Companies Act 1981, andsubsequently in the implementation of the seventh directive in the Companies Act 1989 (sections 226and 227). Conceptually the directives require additional information where individual provisions areinsufficient.

In practice true and fair view relates to the extent to which the various principles, concepts andstandards of accounting have been applied. It may therefore be somewhat subjective and subjectto change as new accounting rules are developed, old standards replaced and new standards introduced.It may be interesting to research the issue of derivatives and decide whether the true and fairview concept was invoked by those companies that used or marketed these financial instruments, andspecifically consider the various collapses or public statements regarding losses incurred over the pastfew years. Before derivatives, the issue which escaped disclosure in financial reporting under true

International accounting standards

The International Accounting Standards Committee (IASC), set up in 1973, which is supported byeach of the major professional accounting bodies, fosters the harmonisation of accounting standardsinternationally. To this end each UK FRS (Financial Reporting Standard) includes a section explainingits relationship to any relevant international accounting standard.There are wide variations in the accounting practices that have been developed in diff erent countries.These refl ect the purposes for which financial information is required by the diff erent users ofthat information, in each of those countries. There is a diff erent focus on the type of information andthe relative importance of each of the users of financial information in each country. This is becauseeach country may diff er in terms of:

■ who finances the businesses – individual equity shareholders, institutional equity shareholders,debenture holders, banks, etc.

■ tax systems either aligned with or separate from accounting rules

■ the level of government control and regulation

■ the degree of transparency of information.

The increase in international trade and globalisation has led to a need for convergence, or harmonisation,

of accounting rules and practices. The IASC was created in order to develop internationalaccounting standards, but these have been slow in appearing because of the diffi culties in bringingtogether diff erences in accounting procedures. Until 2000 these standards were called InternationalAccounting Standards (IASs) . The successor to the IASC, the IASB (International Accounting StandardsBoard), was set up in April 2001 to make financial statements more comparable on a worldwidebasis. The IASB publishes its standards in a series of pronouncements called International FinancialReporting Standards (IFRSs) . It has also adopted the body of standards issued by the IASC, whichcontinue to be designated IASs.The former chairman of the IASB, Sir David Tweedie, who retired in June 2011, said that ‘the aimof the globalisation of accounting standards is to simplify accounting practices and to make it easierfor investors to compare the financial statements of companies worldwide’. He also said that ‘this willbreak down barriers to investment and trade and ultimately reduce the cost of capital and stimulategrowth’ ( Business Week , 7 June 2004). On 1 January 2005 there was convergence in the mandatoryapplication of the IFRSs by listed companies within each of the European Union member states. Theimpact of this should be negligible with regard to the topics covered in this book, since UK accountingstandards have already moved close to international standards. The reason for this is that the UK SOPwas drawn up using the 1989 IASB conceptual framework for guidance. A list of current IFRSs andIASs is shown in Appendix 1 at the end of this book.At the time of writing this book, major disagreements between the EU and accountants worldwideover the infl uence of the EU on the process of developing International Accounting Standardsare causing concern that the dream of the globalisation of accounting standards may not be possible

(see the article below from the 5 April 2010 edition of the Financial Times ).Progress check

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Accounting Standards-setting in India

The Institute of Chartered Accountants of India (ICAI) being a member body of the IASC,constituted the Accounting Standards Board (ASB) on 21st April, 1977, with a view toharmonise the diverse accounting policies and practices in use in India. After the avowedadoption of liberalisation and globalisation as the corner stones of Indian economic policies inearly ‘90s, and the growing concern about the need of effective corporate governance of late,the Accounting Standards have increasingly assumed importance.While formulating accounting standards, the ASB takes into consideration the applicable laws,customs, usages and business environment prevailing in the country. The ASB also gives dueconsideration to International Financial Reporting Standards (IFRSs)/ International AccountingStandards (IASs) issued by IASB and tries to integrate them, to the extent possible, in the lightof conditions and practices prevailing in India.

Composition of the Accounting Standards Board

The composition of the ASB is broad-based with a view to ensuring participation of all interestgroupsin the standard-setting process. These interest-groups include industry, representativesof various departments of government and regulatory authorities, financial institutions andacademic and professional bodies. Industry is represented on the ASB by their apex levelassociations, viz., Associated Chambers of Commerce & Industry (ASSOCHAM), Confederationof Indian Industries (CII) and Federation of Indian Chambers of Commerce and Industry(FICCI). As regards government departments and regulatory authorities, Reserve Bank ofIndia, Ministry of Company Affairs, Comptroller & Auditor General of India, Controller General ofAccounts and Central Board of Excise and Customs are represented on the ASB. Besides theseinterest-groups, representatives of academic and professional institutions such as Universities,Indian Institutes of Management, Institute of Cost and Works Accountants of India and Instituteof Company Secretaries of India are also represented on the ASB. Apart from these interestgroups,certain elected members of the Central Council of ICAI are also on the ASB.

The Accounting Standards-setting Process

The accounting standard setting, by its very nature, involves reaching an optimal balance of therequirements of financial information for various interest-groups having a stake in financialreporting. With a view to reach consensus, to the extent possible, as to the requirements of therelevant interest-groups and thereby bringing about general acceptance of the AccountingStandards among such groups, considerable research, consultations and discussions with therepresentatives of the relevant interest-groups at different stages of standard formulationbecomes necessary. The standard-setting procedure of the ASB, as briefly outlined below, isdesigned in such a way so as to ensure such consultation and discussions:

Identification of the broad areas by the ASB for formulating the Accounting Standards.

Constitution of the study groups by the ASB for preparing the preliminary drafts of theproposed Accounting Standards.

Consideration of the preliminary draft prepared by the study group by the ASB and revision,if any, of the draft on the basis of deliberations at the ASB.

Circulation of the draft, so revised, among the Council members of the ICAI and 12 specifiedoutside bodies such as Standing Conference of Public Enterprises (SCOPE), Indian Banks’Association, Confederation of Indian Industry (CII), Securities and Exchange Board of India3(SEBI), Comptroller and Auditor General of India (C& AG), and Department of CompanyAffairs, for comments.

Meeting with the representatives of specified outside bodies to ascertain their views on thedraft of the proposed Accounting Standard.

Finalisation of the Exposure Draft of the proposed Accounting Standard on the basis ofcomments received and discussion with the representatives of specified outside bodies.

Issuance of the Exposure Draft inviting public comments.

Consideration of the comments received on the Exposure Draft and finalisation of the draftAccounting Standard by the ASB for submission to the Council of the ICAI for itsconsideration and approval for issuance.

Consideration of the draft Accounting Standard by the Council of the Institute, and if foundnecessary, modification of the draft in consultation with the ASB.

The Accounting Standard, so finalised, is issued under the authority of the Council.