Theory Base of Accounting, Accounting Standards and International Financial Reporting Standards (IFRS)

 For making the accounting information meaningful to its users, it is very important that such information is reliable, relevant, comparable and understandable. This becomes possible only when information provided by the financial statements is based on consistent accounting policies, principles and practices. Thus, accounting principles, concept and conventions have been formulated and these are commonly known as ‘Generally Accepted Accounting Principles’ (GAAP). The term GAAP is used to describe the rules developed for the preparation of financial statements and these accounting principles are called by various names such as concepts, conventions, axioms, postulates, principles etc. Apart from these, the Institute of Chartered Accountants of India (ICAI), which is the regulatory body for standardisation of accounting policies in the country, has also issued ‘Accounting Standards’.

Meaning and Nature of Accounting Principles

Meaning- Accounting Principles refer to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity in the preparation and the presentation of financial statements.

The term ‘principle’ has been defined as, “A general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice”. – American Institute of Certified Public Accountants (AICPA)

Nature or Features of Accounting Principles- The accounting principles have been developed by accountants and academicians on the basis of past experience and observations. The main features of accounting principles are:

            1. Accounting principles are not static.
            2. Accounting principles are man-made.

            3. Accounting principles are generally accepted- Accounting principles are generally accepted by the accounting professionals of the world because they meet the following criteria.

                        (a) Objectivity
                        (b) Relevance

                        (c) Feasibility

Accounting Principles

1.      Accounting Entity or Business Entity Principle- According to this principle, business is considered to be a separate and distinct entity from its owners. The proprietor of the business is considered as a creditor of the business to the extent of his capital. His capital is considered as liability of the firm similar to borrowing from outsiders. Transactions are to be recorded from the point of view of the business entity and not from the point of view of the proprietor.

2.      Money Measurement Principle- According to this principle, only those transactions are recorded in the books of accounts which are capable of being expressed in terms of money. Money measurement principle has its own limitations. Value of money does not remain same over a period of time due to change in the price level. Qualitative transactions are not recorded, irrespective of their importance.

3.      Accounting Period Principle- According to this principle, the economic life of an enterprise is split into periodic intervals known as accounting period so that its performance is measured at regular period. Accounting period of one year is usually adopted for this purpose. Generally business starts its accounting year on 1^st day of April and ends on 31^st of March next year.

4.      Full Disclosure Principle- According to this principle, the financial statements should completely disclose all the significant information relating to the economic affairs of the enterprise. The disclosure can be done either in the financial statements or in the footnotes.

5.      Materiality Principle- According to this principle, all relatively relevant items, the knowledge of which might influence the decision of the users of the financial statements, should be disclosed in the financial statements. As per this principle, only those items should be disclosed that have significant or relevant to the user. So, this principle is contradictory to the Full Disclosure Principle. According to American Accounting Association (AAA) “an item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of an informed investor.” Thus, an item is material to one, may not be material to another. The materiality of an item depends on its nature and on the amount involved.

6.      Principle of Conservatism or Prudence- According to this principle, all prospective losses should be recorded in the books of account, but all anticipated profits should be ignored. This principle is used in the following circumstances:

·         Valuation of closing stock at cost or market price whichever is less.
·         Creation of provision for doubtful debts.
·         Creation of provision for discount on debtors.

·         Writing off the intangible assets like goodwill, trademark etc.

Drawbacks of Conservatism Principle

·      It may lead to creation of secret reserves.

·      It may lead to overstatement of liabilities.

7.      Cost Concept or Historical Cost Principle- According to this principle, assets are recorded in the books of accounts at their purchase price which includes cost of purchase, transportation, installation and for making the asset ready to use. Asset is recorded at cost at the time of its acquisition and is reduced year after year by charging depreciation based on the useful life of that asset rather than its market value. So, an asset is shown in the Balance Sheet at its book value, i.e. cost less depreciation.

Drawbacks of Historical Cost Principle

  (a) Assets are recorded in the books of accounts if money is paid for it. If a firm has paid nothing for acquiring an asset, it will not be recorded at all. For example- Goodwill is shown in the books only when it is purchased and not otherwise.

 (b) The profit disclosed by the income statement will be completely distorted during inflationary period as depreciation charged will be inadequate in relation to market price of the asset.

8.      Matching Concept or Matching Principle- According to this principle, all revenues earned during an accounting year, whether received or not and all expenses incurred during an accounting year, whether paid or not are matched to ascertain the profit or loss for that accounting year. It is based on accrual system of accounting.

9.      Dual Aspect or Duality Principle- According to this principle, every business transaction has two aspects, a debit and a credit of equal amount. The system of recording transactions based on this principle is termed as ‘Double Entry System’. The duality principle is commonly represented in terms of accounting equation which states that:

Assets = Liabilities + Capital

10.  Revenue Recognition Principle- According to revenue recognition concept, revenue is considered as realised when transaction has taken place and obligation to receive its payment has been established. The recognition of revenue and receipt of payment are two different aspects.

Example- A sold goods to B on 20^th February, 2020 and got its payment on 20^th May, 2020. Recognition of revenue of this transaction is 20^th February, 2020 i.e. the date of sale as the legal obligation to pay the amount has been established on this date.

11.  Verifiable Objective Concept- According to this concept, all transactions should be recorded in an objective manner and they should be free from personal bias. It implies that all accounting transactions should be supported by documentary evidence or vouchers.

Accounting Standards

Introduction- Use of different methods or practices by different firms cause problem to the users of accounting information, which makes Financial Statements less meaningful and incomparable. So, there was a need to bring uniformity and consistency in the reporting of accounting information. As a result ‘International Accounting Standard Committee’ (IASC) was set up in June, 1973 comprising professional accounting bodies of  over 75 countries including the Institute of Chartered Accountants of India (ICAI) and the institute of Cost and Works Accountants of India (ICWAI).

            ICAI constituted an Accounting Standard Board (ASB) in April, 1977 to identify the areas in which uniformity in standards is required. ASB was, therefore, asked to draft the accounting standards in view of the legal provisions of the country.  ASB submitted the draft accounting standards to ICAI. Upto 1^st April 2010, 32 accounting standards have been issued by ICAI.

 

Meaning- Accounting Standards are written statements of uniform accounting rules and guidelines issued by the accounting body or by government or other regulatory body to be followed while preparing and presenting the financial statements.

 

Nature of Accounting Standards-

(a)    Accounting standards provide guidelines to the accounting professionals in order to enhance reliability of financial statements among the users.

(b)   Accounting standards is to bring uniformity in the accounting practices and to ensure consistency and comparability in the financial statements.

(c)    With the change in economic environment and law of the nation, accounting standards are subject to change from time to time but in no case they will override the provisions of law.

(d)   Accounting standards are mandatory in nature.

 

Benefits or Utility of Accounting Standards-

(a)    Accounting standards ensure uniformity in the preparation and presentation of Financial Statement.

(b)   Accounting standards reduce the chances of manipulations and frauds.

(c)    Accounting standards are mandatory in nature so auditor has to ensure the compliance of these standards.

 

Accounting Standards issued by the ICAI

AS No.	Title
AS-1	Disclosure of Accounting Policies
AS-2	Valuation of Inventories (Revised)
AS-3	Cash Flow Statement (Revised)
AS-4	Contingencies and Events Occurring after Balance Sheet Date (Revised)
AS-5	Prior Period and Extraordinary Items and Changes in Accounting Policies
AS-6	Depreciation Accounting (Revised)
AS-7	Accounting for Construction Contracts
AS-8	Accounting for Research and Development
AS-9	Revenue Recognition
AS-10	Accounting for Fixed Assets
AS-11	Accounting for the effects of changes in Foreign Exchange Rates (Revised)
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 Parties Disclosures
AS-19	Leases
AS-20	Earnings per share
AS-21	Consolidated Financial Statements
AS-22	Accounting for taxes on income
AS-23	Accounting for investments in Associates in Consolidated Financial Statements
AS-24	Discontinuing Operations
AS-25	Interim Financial Reporting
AS-26	Intangible Assets
AS-27	Financial Reporting of Interests in Joint Venture
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
AS-32	Financial Instrument: Disclosures

International Financial Reporting Standards (IFRS)

Introduction

            With the emergence of industrialisation and globalisation, various multinational companies are establishing their businesses in different countries. The accounting concepts and conventions followed by business enterprises around the world vary from country to country. Thus, it was felt to have a common set of accounting and financial reporting standards so as to understand and compare the financial information worldwide. Due to this reason, International Accounting Standards Committee (IASC) was established in 1973 through an agreement by professional accounting bodies from U.K., U.S.A., Canada, France, Germany, Japan, Australia, Maxico, Netherlands and Ireland. The Institute of Chartered Accountants of India joined IASC as an associate member in 1974 and joined the board in 1993. IASC has issued 41 accounting standards known as International Accounting Standards (IAS). IASC was replaced by International Accounting Standards Board (IASB) in 2001. Since then, accounting standards issued by IASB are known as International Financial Reporting Standards (IFRS). IASB reviewed all the 41-IAS and scrapped 12-IAS. So effective IAS are 29 now.

 Objectives of IASB

            (a) To develop and implement a single set of high quality comparable and globally enforceable Accounting Standards.
            (b) To promote the use of accounting standards.

            (c) To bring about convergence of national accounting standards and International Financial Reporting Standards to high quality solutions.