Introduction
Chapter 5 of DK Goel Class 11 Accountancy introduces Accounting Standards and International Financial Reporting Standards (IFRS). Accounting Standards are the framework of rules and regulations that govern how financial transactions should be recorded, reported, and disclosed in financial statements. They ensure uniformity, transparency, and comparability across different organizations, making financial information reliable and understandable for all stakeholders.
Key Definition
What are Accounting Standards?
Accounting Standards (AS) are written policy documents issued by expert accounting bodies or government agencies, covering aspects of recognition, measurement, presentation, and disclosure of accounting transactions in financial statements.
Definition: Accounting Standards are the authoritative written rules that mandate how transactions and events should be treated and presented in financial statements.
- Nature of Accounting Standards:
- They outline accounting rules, principles, concepts, and guidelines for recording transactions
- They promote better understanding of financial statements among users
- They standardize diverse accounting policies and practices
- They cannot override the statute (must comply with prevailing laws)
Institute of Chartered Accountants of India (ICAI) lays down the standards in India.
- Accounting Standards Board (ASB): Constituted by ICAI in 1977 to formulate Accounting Standards
- ASB Members Include: Representatives from government departments, academics, ICAI, ASSOCHAM, CII, FICCI, etc.
- National Financial Reporting Authority (NFRA): Recommends standards to Ministry of Corporate Affairs (MCA)
- MCA: Spells out accounting standards applicable for companies in India
Why are Accounting Standards needed?
- To eliminate variations in accounting treatments used by different enterprises
- To ensure uniformity in preparation and presentation of financial statements
- To make financial statements comparable across different companies
- To provide reliable information to investors, creditors, and government
- To reduce manipulation and fraud in financial reporting
- To enhance the credibility of financial information
Objectives of Accounting Standards
Standardization
To standardize diverse accounting policies and practices to bring uniformity in financial reporting across organizations.
Transparency
To bring transparency by enhancing the quality of financial information, enabling stakeholders to make informed decisions.
Comparability
To ensure that financial statements of different companies can be compared easily by following uniform methods.
Reliability
To provide reliable and accurate financial information that users can trust for decision-making.
Accountability
To strengthen accountability by reducing the information gap between investors and management of companies.
Legal Compliance
To provide information about policies adopted in financial statement preparation for legal and regulatory compliance.
Benefits/Advantages of Accounting Standards
BENEFITS OF AS
Key advantages of following Accounting Standards
Uniformity
Ensures uniform treatment of similar transactions
Transparency
Improves reliability and accuracy of reports
Comparability
Easy comparison between different firms
- Reduces Confusion: Eliminates confusing variations in accounting treatments used by different enterprises
- Facilitates Comparison: Makes it easier to compare financial performance across companies
- Prevents Fraud: Helps prevent manipulation of financial data
- Aids Decision Making: Provides standard framework accepted by auditors, tax authorities, and investors
- Measures Performance: Helps measure management's ability to increase profitability and maintain solvency
- Reduces Cost of Capital: Improves efficiency of capital markets, reducing cost of raising capital
- Enhances Credibility: Increases credibility of financial statements among stakeholders
- Simplifies Auditing: Makes the auditing process easier and more standardized
Limitations/Disadvantages of Accounting Standards
Rigidity
Standards can be restrictive and inflexible, not allowing companies to present information that better reflects their unique situations.
Alternative Methods
Sometimes standards allow choice between different methods, which can still lead to some level of non-comparability between firms.
Cannot Override Statute
Accounting Standards cannot override the statute. They must be framed within the ambit of prevailing laws and regulations.
One Size Doesn't Fit All
Each company faces unique situations, but must fit these into standardized guidelines even if they don't best represent the financial event.
Cost of Implementation
For small businesses, the cost of implementing and following all standards may outweigh the benefits.
Frequent Changes
Standards are regularly updated and revised, requiring continuous learning and adaptation by accountants.
List of Indian Accounting Standards (AS 1-29)
ICAI has issued 32 Accounting Standards (AS-1 to AS-32), of which AS-1 to AS-29 are mandatory. AS-6, AS-8, AS-30, AS-31, and AS-32 have been withdrawn. Currently, there are 27 active Accounting Standards.
Important Accounting Standards Explained
Objective: To ensure that significant accounting policies are disclosed in financial statements.
- Deals with disclosure of significant accounting policies followed in preparing financial statements
- Helps users understand the basis on which financial statements are prepared
- Accounting policies should be disclosed at one place
- Any change in policy should be disclosed along with its effect
- Examples: Method of depreciation, inventory valuation method, revenue recognition policy
Objective: To prescribe the accounting treatment for inventories.
- Deals with determination of value at which inventories are carried in financial statements
- Inventories should be valued at lower of cost or net realisable value
- Cost includes: Purchase price, conversion costs, and other costs to bring inventory to present location
- Methods allowed: FIFO (First In First Out), Weighted Average Cost
- Not allowed: LIFO (Last In First Out) method
Objective: To provide information about historical changes in cash and cash equivalents.
- Classifies cash flows into three activities:
- Operating Activities: Principal revenue-producing activities (sales, purchases)
- Investing Activities: Acquisition and disposal of long-term assets
- Financing Activities: Activities that change size of equity and borrowings
- Can be prepared using Direct or Indirect method
Objective: To prescribe the accounting treatment for revenue recognition.
- Covers revenue recognition from:
- Sale of Goods: When significant risks and rewards transferred to buyer
- Rendering of Services: By percentage of completion method or completed service method
- Interest: On time proportion basis
- Royalties: On accrual basis as per agreement
- Dividends: When right to receive is established
Objective: To prescribe accounting treatment for Property, Plant and Equipment (PPE).
- PPE are tangible items held for use in production, supply of goods/services, or rental
- Expected to be used for more than one accounting period
- Cost includes: Purchase price, import duties, installation costs
- Depreciation: Systematic allocation of depreciable amount over useful life
- Methods: Straight Line, Written Down Value, Units of Production
International Financial Reporting Standards (IFRS)
International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) that provide a common global language for business affairs.
IFRS
Global Accounting Standards for Financial Reporting
Issued By
International Accounting Standards Board (IASB)
Adoption
169 Jurisdictions Worldwide
Objective
One Uniform Global Accounting Standard
- Transparency: Enhance quality of financial information for market participants
- Accountability: Reduce information gap between investors and companies
- Economic Efficiency: Help investors assess investments across the world
- Global Comparability: Enable comparison of companies from different countries
- Lower Cost of Capital: Reduce cost of raising capital for companies globally
- Convergence: Establish global GAAP (Generally Accepted Accounting Principles)
- Provides transparency in operations and accessibility of financial records
- Offers a common language for evaluating financial health of multinational companies
- Improves comparability of company accounts across borders
- Increases efficiency of capital markets globally
- Saves cost by eliminating need for multiple accounting books
- Helpful for companies with subsidiaries in many countries
- Makes auditing easier and more standardized internationally
IFRS Convergence in India (Ind-AS)
India officially decided in 2007 to converge with IFRS. Instead of fully adopting IFRS, India has adopted Indian Accounting Standards (Ind-AS) which are converged standards based on IFRS with certain modifications.
Timeline
India decided to converge with IFRS in 2007. ICAI and IASB collaborated to develop quality and comparable standards.
Ind-AS
40 Indian Accounting Standards (Ind-AS) notified by MCA, named and numbered similar to IFRS standards.
Applicability
Listed companies, unlisted companies with net worth ≥ Rs. 250 crore, and companies planning to list.
- Promotes International Business: Increases influx of foreign capital into India
- Eliminates Duplicate Reporting: Indian companies abroad won't need separate financial statements
- High Quality Standards: Converged IFRS standards are globally acceptable and easily enforceable
- Increases Reliability: Lenders and investors have more confidence in Indian businesses
- Economic Growth: Helps India's economy grow and expand internationally
- More Capital for Domestic Companies: International investing brings more capital
- Legal Amendments Required: Companies Act, SEBI Act, IT Act need amendments
- Fair Value vs Historical Cost: IFRS uses fair value; Indian GAAP uses historical cost system
- SME Sector Challenges: Cost of convergence may outweigh benefits for small businesses
- Training Requirements: Accountants need extensive training on new standards
- System Changes: IT systems and processes need significant modifications
- Volatility in Statements: Fair value measurement may create volatility in financial statements
Indian AS vs IFRS Comparison
| Aspect | Indian AS (ICAI) | IFRS (IASB) |
|---|---|---|
| Issued By | Institute of Chartered Accountants of India (ICAI) | International Accounting Standards Board (IASB) |
| Applicability | Companies in India (especially non-corporate entities, SMEs) | 169 jurisdictions globally |
| Asset Measurement | Primarily Historical Cost | Fair Value System |
| Number of Standards | 27 Active Standards (AS 1-29, some withdrawn) | Multiple IFRS and IAS standards |
| Legal Backing | Companies Act, 2013 | Depends on country's adoption |
| Convergence Status | Converged through Ind-AS for large companies | Global standard |
Key Concepts Summary
Inventory Valuation (AS-2)
Three Fundamental Assumptions
- Going Concern: Business will continue operations
- Consistency: Same policies used period to period
- Accrual: Record transactions when they occur
Cash Flow Classification (AS-3)
- Operating: Main business activities
- Investing: Long-term assets
- Financing: Capital structure changes
Revenue Recognition (AS-9)
- Goods: Risks & rewards transferred
- Services: % completion method
- Interest: Time proportion basis
Bodies Involved in India
- ICAI: Issues Accounting Standards
- ASB: Formulates standards
- NFRA: Recommends to MCA
- MCA: Notifies for companies