Financial Accounting – Module II

ACCOUNTING STANDARDS

Accounting standards: Concept, benefits and Process of formulation of Accounting Standards

including Ind AS (IFRS converged standards) and IFRSs; convergence Vs. adoption;
Application of accounting standards (AS and Ind AS) on various entities in India.
International Financial Reporting Standards (IFRS) – meaning, need and scope; Process of
issuing IFRS. Accounting Process. From recording of a business transaction to preparation of
trial balance including adjustments. Application of Generally Accepted Accounting
Principles in recording financial transactions and preparing financial statements.
MEANING

ACCOUNTING STANDARDS

According to ICAI, Accounting standards are “written documents, policies, procedures issued
by expert accounting body or government or other regulatory body covering the aspects of
recognition, measurement, treatment, presentation and disclosures of accounting transactions
in the financial statement.”

In simple Accounting standards are the written statements consisting of rules and guidelines,
issued by the accounting institutions, for the preparation of uniform and consistent financial
statements and also for other disclosures affecting the different users of accounting
information.

Accounting standards lay down the terms and conditions of accounting policies and practices
by way of codes, guidelines and adjustments for making the interpretation of the items
appearing in the financial statements easy and even their treatment in the books of account.

OBJECTIVES OF THE ACCOUNTING STANDARDS

The objective of Accounting Standards is to standardize diverse accounting policies with a

view to eliminate, to the maximum possible extent,

(i) the non-comparability of financial statements and thereby improving the reliability of
financial statements, and

ii) to provide a set of standard accounting policies, valuation norms and disclosure
requirements

Concept of Accounting Standards:

Generally Accepted Accounting Principles (GAAP) aims at bringing uniformity and
comparability in the financial statements. It can be seen that at many places, GAAP permits a
variety of alternative accounting treatments for the same item. For example, different
methods for valuation of stock give different results in financial statements.
Such practices sometimes can misguide intended users in taking decision relating to their
field. Keeping in view the problems faced by many users of accounting, a need for the
development of common accounting standards was aroused.
For this purpose, the Institute of Chartered Accountants of India (ICAI), which is also a
member of International Accounting Standards Committee (IASC), had constituted
Accounting Standard Board (ASB) in the year 1977. ASB identified the areas in which
uniformity in accounting was required. After detailed research and discussions, it prepared
and submitted a draft to the ICAI. After proper examination, ICAI finalized them and notified
for its use in financial statements.

Need for Accounting Standards:

a) In order to avoid the variance which may arise between the accounting principles and
accounting practices and also to find uniformity among various diverse underlying principles
of accounting.

b) Comparison between two firms is possible if both of them maintain the same principle,
otherwise proper comparison is not possible. For example, if A company follows the FIFO
method of valuation of stock whereas firm B follows the LIFO method for valuing stock, the
comparison between the two firms becomes useless. The same is possible only when both of
them follow identical method of valuing closing stock.

c) To find uniformity in accounting practice while formulating financial reports and make
consistency and proper comparison of data which are contained in financial statements for the
users of accounting information.

d) To maintain fairness, consistency and transparency in accounting practices which will

satisfy the users of accounting.

e) To resolve potential conflicts of financial interest among the various external groups that
use and rely upon published financial statements.

f) Accounting standards reduce the accounting alternatives in the preparation of financial

statements within the bounds of rationality, thereby ensuring comparability of financial
statements of different enterprises. Thus, accounting standards can be seen as providing an
important mechanism to help in the resolution of potential financial conflicts interest between
the various important groups in society.
g) To harmonise accounting policies and practices followed by different business entities so
that the diverse accounting practices adopted for various aspects of accounting can be
standardised

Benefits and Limitations

Accounting standards seek to describe the accounting principles, the valuation techniques and
the methods of applying the accounting principles in the preparation and presentation of
financial statements so that they may give a true and fair view.

By setting the accounting standards the accountant has following benefits:

(i) Standards reduce to a reasonable extent or eliminate altogether confusing

variations in the accounting treatments used to prepare financial statements.
(ii) There are certain areas where important information are not statutorily required to
be disclosed. Standards may call for disclosure beyond that required by law.

However, there are some limitations of setting of accounting standards:

 (i) Difficulties in making a choice between different treatments: Alternative solutions
to certain accounting problems may each have arguments to recommend them.
Therefore, the choice between different alternative accounting treatments may
become difficult.

(ii) Restricted Scope: Accounting standards cannot override the statute. The standards are
required to be framed within the ambit of prevailing statutes

PROCEDURE FOR ISSUING AN ACCOUNTING STANDARD

The Accounting Standards are issued under the authority of the Council of the ICAI. The
ASB has also been entrusted with the responsibility of propagating the Accounting Standards
and of persuading the concerned parties to adopt them in the preparation and presentation of
financial statements. The ASB will provide interpretations and guidance on issues arising
from Accounting Standards. The ASB will also review the Accounting Standards at
periodical intervals and, if necessary, revise the same. The following procedure is adopted
for formulating Accounting Standards:

1. The ASB determines the broad areas in which Accounting Standards need to be
formulated and the priority in regard to the selection thereof.

2. In the preparation of Accounting Standards, the ASB will be assisted by Study Groups
constituted to consider specific subjects. In the formation of Study Groups, provision will be
made for wide participation by the members of the Institute and others.

3. The draft of the proposed standard will normally include the following:

a) Objective of the Standard,

b) Scope of the Standard, c) Definitions of the terms used in the Standard, d) Recognition
and measurement principles, wherever applicable, e) Presentation and disclosure
requirements.

4. The ASB will consider the preliminary draft prepared by the Study Group and if any
revision of the draft is required on the basis of deliberations, the ASB will make the same or
refer the same to the Study Group.
5. The ASB will circulate the draft of the Accounting Standard to the Council members of
the ICAI and the specified bodies for their comments.

6. The ASB will hold a meeting with the representatives of specified bodies to ascertain
their views on the draft of the proposed Accounting Standard. On the basis of comments
received and discussion with the representatives of specified bodies, the ASB will finalize
the Exposure Draft of the proposed Accounting Standard.

7. The Exposure Draft of the proposed Standard will be issued for comments by the
members of the Institute and the public. The Exposure Draft will specifically be sent to
specified bodies (as listed above), stock exchanges, and other interest groups, as appropriate.

8. After taking into consideration the comments received, the draft of the proposed Standard
will be finalized by the ASB and submitted to the Council of the ICAI.

Convergence of IFRS and Indian AS

Indian Accounting Standards are formulated by the Accounting Standard Board (ASB) of the
ICAI as notified by the Ministry of Corporate Affair. These standards are framed keeping in
mind the economic environment and practices of India. They are made to suit the Indian
companies and the disclosure requirements of the Indian government.

The IFRS, on the other hand, are made keeping global standards and environment in mind.
Convergence would mean bridging the gap between the two, i.e the IFRS and the India AS.
Convergence will involve alignment of the two sets of standards. The compromise is done by
adopting the policies of the IFRS either fully or at least partially.

Following are the few benefits of Convergence.

Benefits of Convergence

1] Beneficial to the Economy

If the accounting standards are converged it will promote international business and increase the
influx of capital into the country. This will help India’s economy grow and expand. International
investing will also mean more capital for domestic companies as well.
2] Beneficial to Investors

Convergence is a boon for investors who wish to invest in foreign markets or economies. It
makes it much easier for them to study and compare the financial statements of foreign
companies. Since the financial statements are made using the same set of standards it is also
easier for the investors to understand and analyze them.

3] Beneficial to the Industry

With globally accepted standards the industry can also surge ahead. So convergence is important
for the industry as well. It will allow the industry to lower the cost of foreign capital. If
companies are not burned by adopting two different sets of standards it will allow them easier
entry into the market.

4] More Transparency 

Convergence will benefit the users of the financial statements as well. It will make it easier for
them to understand the financial statements. And this will generate better transparency and raise
the confidence of the investors to invest funds.

5] Cost Saving

Firstly it will exempt companies from maintaining separate accounting books according to

separate standards. This will save a lot of work hours and money for the finance department.
And also planning and executing auditing will also become easier.

It will be especially helpful for those companies that have subsidiaries in many countries. And
the cost of capital will also reduce since capital would be more accessible and easily available.

STANDARDS SETTING PROCESS

The Institute of Chartered Accountants of India (ICAI), being a premier accounting body in
the country, took upon itself the leadership role by constituting the Accounting Standards
Board (ASB) in 1977. The ICAI has taken significant initiatives in the issuing of
 Accounting Standards to ensure that the standard-setting process is fully consultative and
transparent. The ASB considered the International Accounting Standards
(IASs)/International Financial Reporting Standards (IFRSs) while framing Indian
Accounting Standards (ASs) and tried to integrate them, in the light of the applicable laws,
customs, usages and business environment in the country. The composition of ASB includes
representatives of industries (namely, ASSOCHAM, CII, FICCI), regulators, academicians,
government departments, etc. Although ASB is a body constituted by the Council of the
ICAI, it (ASB) is independent in the formulation of accounting standards and Council of the
ICAI is not empowered to make any modifications in the draft accounting standards
formulated by ASB without consulting with the ASB. It may be noted that ASB is a
committee under Institute of Chartered Accountants of India (ICAI) which consists of
representatives from government department, academicians, other professional bodies viz.
ICSI, ICAI, representatives from ASSOCHAM, CII, FICCI, etc. NFRA recommend these
standards to the Ministry of Corporate Affairs (MCA). MCA has to spell out the
accounting standards applicable for companies in India.

The standard-setting procedure of Accounting Standards Board (ASB) can be briefly

outlined as follows:

 Identification of broad areas by ASB for formulation of AS.

 Constitution of study groups by ASB to consider specific projects and to prepare

preliminary drafts of the proposed accounting standards. The draft normally includes
objective and scope of the standard, definitions of the terms used in the standard, recognition
and measurement principles wherever applicable and presentation and disclosure
requirements.

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

 Circulation of draft of accounting standard (after revision by ASB) to the Council members
of the ICAI and specified outside bodies such as Ministry of Corporate Affairs (MCA),
Securities and Exchange Board of India (SEBI), Comptroller and Auditor General of India
(C&AG), Central Board of Direct Taxes (CBDT), Standing Conference of Public
Enterprises (SCOPE), etc. for comments.

 Meeting with the representatives of the specified outside bodies to ascertain their views on
the draft of the proposed accounting standard.
 Finalisation of the exposure draft of the proposed accounting standard and its issuance
inviting public comments.

 Consideration of comments received on the exposure draft and finalisation of

the draft accounting standard by the ASB for submission to the Council of the ICAI for its
consideration and approval for issuance.

 Consideration of the final draft of the proposed standard and by the Council of the ICAI,
and if found necessary, modification of the draft in consultation with the ASB is done.

 The accounting standard on the relevant subject (for non-corporate entities) is then issued by
the ICAI. For corporate entities the accounting standards are issued by the Central
Government of India.

Identification of area

Constitution of study group

Preparation of draft and its circulation

Ascertainment of views of different bodies on

draft

Finalisation of exposure draft (E.D.)

Comments received on exposure draft (E.D.)

Modification of the draft

Issue of AS
IFRS
International Financial Reporting Standards (IFRS) are a set of accounting standards
developed by the International Accounting Standards Board (IASB) that is becoming the
global standard for the preparation of public company financial statements.

IFRS are designed to serve as a common global language of business affairs so that accounts
of various companies are understandable and comparable across international boundaries.
National accounting standards prevailing in different countries are being replaced by these
International Financial Reporting Standards.

Need of IFRS

Check on manipulation in financial statements: IFRS helps to keep a check on the

manipulation associated with the figures related to financial statements. This encourages
consistency in the recognition and measurement of financial statements.

Global harmony, uniformity, and comparability: IFRS helps the economies of the world
to establish global harmony, uniformity, and comparability in the process of preparation of
their financial statements.

The flow of foreign investment: The Financial Reporting Standards and Accounting

Standards together create a sense of security in the minds of foreign investors which
facilitates a free flow of direct as well as the indirect flow of foreign investments across the
countries.

Aim of IFRS

The basic aim of IFRS is to enable the comparison of financial statements not just in
our country but around the globe. This is quite difficult as every country today has its
own standards, for example, in the US, US GAAPs are followed, and similarly, in
India, Indian GAAPs are followed. So, it becomes very difficult to comprehend all
such standards which are being followed around the world in one set of rules.

Steps in the IASB standard-setting process

1. Agenda consultation
Every five years, the IASB conducts a comprehensive review and consultation to define
international standard-setting priorities and develop its project work plan.

The IASB can also add topics to its work plan if necessary between agenda consultations.
This can include topics following post-implementation reviews of Standards; the IFRS
Interpretations Committee may also request the IASB review an issue.

[Link] programme

We begin most projects with research—explore the issues, identify possible solutions and
decide whether standard-setting is required. Often, we set out our ideas in a discussion paper
and seek public comment.

If we find sufficient evidence that an accounting problem exists, the problem is sufficiently
important to warrant changing an Accounting Standard or issuing a new one and a practical
solution can be found, we begin standard-setting.

Post-implementation Reviews

After a new Accounting Standard has been in use for a few years, the IASB carries out
research through a post-implementation review to assess whether the Standard is achieving its
objective and, if not, whether any amendments should be considered. As a result of the post-
implementation review, the IASB may start a new research project.

3. Standard-setting programme

If the IASB decides to amend an Accounting Standard or issue a new one, we generally
review the research, including comments on the discussion paper, and propose amendments
or Accounting Standards to resolve issues identified through research and consultation.

Proposals for a new Accounting Standard or an amendment to an Accounting Standard are

published in an exposure draft for public consultation. To gather additional evidence,
members of the IASB and IFRS Foundation technical staff consult with a range of
stakeholders from all over the world.

The IASB analyses feedback and refines proposals before the new Accounting Standard, or
an amendment to an Accounting Standard, is issued.
[Link] programme

Our work doesn’t stop once an Accounting Standard is issued. We also support consistent
application of the Accounting Standards and we make sure we maintain them.

This process includes consulting on the implementation of a new or amended Accounting

Standard to identify any implementation or application problems that may need to be
addressed. If issues arise, the IFRS Interpretations Committee may decide to create an IFRIC
Interpretation of the Accounting Standard or recommend a narrow-scope amendment. Such
amendments follow the IASB's normal due process.

Scope of IFRSs

IASB Standards are known as International Financial Reporting Standards.

All International Accounting Standards (IASs) and Interpretations issued by the former
IASC and SIC continue to be applicable unless and until they are amended or withdrawn.

IFRSs apply to the general purpose financial statements and other financial reporting by
profit-oriented entities – those engaged in commercial, industrial, financial, and similar
activities, regardless of their legal form.

Entities other than profit-oriented business entities may also find IFRSs appropriate.

General purpose financial statements are intended to meet the common needs of
shareholders, creditors, employees, and the public at large for information about an entity's
financial position, performance, and cash flows.

Other financial reporting includes information provided outside financial statements that
assists in the interpretation of a complete set of financial statements or improves users'
ability to make efficient economic decisions.

IFRS apply to individual company and consolidated financial statements.

A complete set of financial statements includes a statement of financial position, a statement

of comprehensive income, a statement of cash flows, a statement of changes in equity, a
summary of accounting policies, and explanatory notes. When a separate income statement
is presented in accordance with IAS 1(2007), it is part of that complete set. In developing
Standards, IASB intends not to permit choices in accounting treatment. Further, IASB
intends to reconsider the choices in existing IASs with a view to reducing the number of
those choices.

IFRS will present fundamental principles in bold face type and other guidance in non-bold
type (the 'black-letter'/'grey-letter' distinction). Paragraphs of both types have equal
authority. The provision of IAS 1 Presentation of Financial Statements that conformity with
IAS requires compliance with every applicable IAS and Interpretation requires compliance
with all IFRSs as well.

Accounting Process

Recording of transactions
As soon as the transaction occurs it is the responsibility of an accountant to record such a
transaction in subsidiary books. Accounting transaction should be recorded in the books
according to the accounting policies, principles followed by such entity.

Journal

Next step in this accounting cycle is to record the financial transactions in the journal. We
record financial transactions in Journal chronologically.

There can be one or more than one accounts debited and one or more accounts can be
credited. An accountant shall check that both the debit and the credit balance match.

Ledger

All the journal entries prepared in the earlier step are posted into respected ledgers
chronologically. A ledger shows the summary of all the financial transactions related to such
account. For example: – In cash ledger, we find a summary of all the cash transactions.

Trial balance

After completion of the posting of entries to ledgers, we need to prepare a trial balance. We
prepare trial balance after considering all the ledger account closing balances.

We prepare it at the end of the accounting period for the preparation of financial statements.
Accounting period may be monthly, quarterly or yearly based on the entity’s requirements.

Adjustment Entries

We need to record the adjustment entries properly. We need to make these entries before the
preparation of financial statements of an entity. At the end of the accounting period,
adjusting entries must be posted to the ledgers.

Adjusted Trial Balance

After preparation of trial balance and making adjustment entries (if any), an adjusted trial
balance may also be prepared. An accountant shall also check that the debit and credits on
the trial balance match.

Closing Entries
We shall make proper entries for the closure of nominal accounts. We shall close accounts
by transferring the balances to Trading Account & Profit and Loss Account.

Financial Statements

After following the above steps, we can prepare financial statements easily. Financial
statements will show the true financial position and operating results of the entity’s business.

We can easily prepare financial statements like Balance sheet, Profit and loss account using
the correct balances.

Generally Accepted Accounting Principles

Generally accepted accounting principles (GAAP) refer to a common set of accepted

accounting principles, standards, and procedures that business reporting entity must follow
when it prepares and present its financial statements.

GAAP is a combination of authoritative standards (set by policy boards) and the commonly
accepted ways of recording and reporting accounting information. At international level such
authoritative standards are known as International Financial Reporting Standards (IFRS) and
in India we have authoritative standards named as AS and IND-AS.

Principles of GAAP
There are ten principles that can help you understand the mission of the GAAP standards and
rules.
1. Principle of Regularity
The principle states that the accountant has complied to the GAAP rules and regulations.
2. Principle of Consistency
The accountants should enter all items in exactly the same way that it has been fixed. By
applying similar standards in the reporting process, accountants can avoid errors or
discrepancies.
If the standards are changed or updates, the accountants are expected to fully disclose and
explain the reasons behind the changes.
3. Principle of Sincerity
As per this principle, the accountant should provide the correct depiction of the financial
situation of a business.
4. Principle of Permanence of Method
The focus of this principle is that there should be a consistency in the procedures used in
financial reporting.
5. Principle of Non-Compensation
The full details of the financial information should be disclosed including negatives and
positives. This should be done without the expectation of debt compensation by an asset or
revenue by an expense.
6. Principle of Prudence
The financial data representation should be done “as it is” and not based on any speculation.
7. Principle of Continuity
The principle assumes that the business will continue its operations in the future.
8. Principle of Periodicity
The accounting entries are distributed across the suitable time periods.
9. Principle of Full Disclosure
While creating the financial reports, the accountants must strive for full disclosure.
10. Principle of Utmost Good Faith
This principle states presupposes that the parties remain honest in transactions.
While the GAAP principles are used by large companies while reporting their financial
information, if you believe your small business may eventually be subject to GAAP, you may
want to adopt the standard early on.