Accounting Principles, Accounting Standard and IFRS [Financial Accounting Notes BCOM NEP 2023]

Accounting Principles, Accounting Standard and IFRS

Accounting Standards are the policy documents or written statements issued, from time to time, by an apex expert accounting body in relation to various aspects of measurement, treatment and disclosure of accounting transactions for ensuring uniformity in accounting practices and reporting. These standards are prepared by Accounting Standard Board (ASB). Accounting Standards are formulated with a view to harmonies different accounting policies and practices in use in a country.

Objectives or Purposes of Accounting Standards:

The  whole  idea  of  accounting  standards  is  centered  around  harmonization   of   accounting  policies  and practices  followed  by  different  business  entities   so  that  the  diverse  accounting  practices  adopted  for   various  aspects   of  accounting  can be  standardized. Accounting   standards   standardizes diverse accounting policies   with a view to:

a.      To provide information to the users as to the basis on which the accounts have been prepared and the financial statements have been presented.

b.      To serve the statutory purpose of eliminating the impact of diverse accounting policies and practices and to ensure uniformity in accounting policies & practices, i.e., to harmonize the diverse accounting policies & practices which are in use the preparation & presentation of financial statements.

c.       To make the financial statements more meaningful and comparable and to make people place more reliance on financial statements prepared in conformity with the accounting standards.

d.      To guide the judgment of professional accountants in dealing with those items, which are to be followed consistently from year to year.

e.       To provide   a  set  of  standard  accounting  policies, valuation  norms  and  disclosure  requirements.

Accounting Standard Board

The Institute of Chartered Accountants of India (ICAI), after recognising the need to harmonies the diverse accounting policies and practices, constituted an Accounting Standards Board (ASB) on April 21, 1977. The main function of ASB is to formulate accounting standards so that such standards may be mandated by the Council of ICAI. While formulating the standards in India, ASB will take into consideration the applicable laws, customs, usages and business environment.

Objectives and function of Accounting Standard Board:

1. Primary objectives of accounting standard board are:

a)    To suggest areas in which accounting standard is needed.

b)    To formulate accounting standards which are to be followed while preparing financial statements.

c)     To improve the reliability of financial statements.

d)    To review the existing accounting standards at regular intervals and revise the same if the current business environment so demands.

e)    To ease inter-firm and intra-firm comparison.

f)     To harmonise different accounting policies which are used in preparation of financial reports.

2. The main function of accounting standard board is to formulate accounting standards so that such standards may be mandated by the Council of ICAI. While formulating the standards in India, ASB will take into consideration the applicable laws, customs, usages and business environment.

1.    Accounting standard board also gives due importance to IASs/IFRSs issued by the International accounting standard board and tries to integrate them with Indian accounting standards.

2.    Another function of accounting standard board is to promote the accounting standard and induce the concerned parties to adopt them in preparation and presentation of financial statements.

3.    ASB also promotes international accounting standards in the country with a view to facilitate global harmonization of accounting standards.

Procedure adopted in formulation of Accounting Standards:

Following procedure will be adopted for formulating Accounting Standards:

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

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

c.       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.

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

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

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

g.      Issuance of the Exposure Draft inviting public comments.

h.      Consideration of the 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.

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

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

Benefits and Limitations of Accounting Standard:

Accounting  standard  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:

a.       Standards  reduce  to a reasonable  extent or  eliminate  altogether  confusing   variations   in   the  accounting  treatments  used  to prepare  financial  statements.

b.      There are certain areas where important information is not statutorily required to be disclosed. Standards may call for disclosure beyond that required by law.

c.       The  application   of  accounting standards  would ,to  a  limited  extent, facilitate  comparison  of  financial  statements  of  companies  situated in  different parts  of  the  world  and also of  different   companies  situated  in  the  same  country. However, it  should  be  noted  in  this  respect  that  differences in the institutions, traditions  and  legal  systems  from  one  country  to  another give rise  to  differences   in  accounting   standards  adopted  in  different  countries.

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

                (i)Alternative solution to certain   accounting problems may   each have   arguments to recommend them. Therefore, the choice between   different alternative   accounting   treatments may   become difficult.

                (ii)there may  be  a   trend  towards  rigidity  and  away  from  flexibility in   applying  the  accounting  standards.

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

LIST OF ACCOUNTING STANDARDS                  

Accounting Policies

Accounting policies refer to:

a) Specific accounting principles, and

b) Methods adopted by enterprises, in applying these principles in the preparation and presentation of financial statements.

There is no single list of accounting policies which are applicable to all circumstances. The differing circumstances in which enterprises operate in a situation of diverse and complex economic activity make alternative accounting principles and methods of applying those principles acceptable. The choice of the appropriate accounting principles and the methods of applying those principles in the specific circumstances of each enterprise call for considerable judgment by the management of the enterprise.

Areas in Which Differing Accounting Policies are Encountered

The following are examples of the areas in which different accounting policies may be adopted by different enterprises.

a.      Methods of depreciation, depletion and amortization

b.      Treatment of expenditure during construction

c.       Conversion or translation of foreign currency items

d.      Valuation of inventories

e.       Treatment of goodwill

f.        Valuation of investments

g.      Treatment of retirement benefits

h.      Recognition of profit on long-term contracts

i.         Valuation of fixed assets

j.        Treatment of contingent liabilities.

Disclosure of Accounting Policies:

This statement deals with the disclosure of significant accounting policies followed in preparing and presenting financial statements. The view presented in the financial statements of an enterprise of its state of affairs and of the profit or loss can be significantly affected by the accounting policies followed in the preparation and presentation of the financial statements. The accounting policies followed vary from enterprise to enterprise. Disclosure of significant accounting policies followed is necessary if the view presented is to be properly appreciated.

Need for Disclosure of Accounting Policies

a) To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Such disclosure should form part of the financial statements.

b) It would be helpful to the reader of financial statements if they are all disclosed as such in one place instead of being scattered over several statements, schedules and notes.

c)  Any change in an accounting policy which has a material effect should be disclosed. The amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated.

If a change Is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.

Considerations in the Selection of Accounting Policies

The primary consideration in the selection of accounting policies by an enterprise is that the financial statements prepared and presented on the basis of such accounting policies should represent a true and fair view of the state of affairs of the enterprise as at the balance sheet date and of the profit or loss for the period ended on that date. For this purpose, the major considerations governing the selection and application of accounting policies are:

a. Prudence: In view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.

b. Substance over Form: The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form.

c. Materiality: Financial statements should disclose all “material” items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements.

Changes in Accounting Policies

A   change   in accounting policies should be made   in the following condition:

(a)It is required by some Statute or for compliance   with an Accounting standard.

(b)change  would  result  in  more  appropriate  presentation    of  financial  statement.

Change   in   accounting  policy  may  have  a   material  effect  on  the  items  of  financial  statements. For   example, if  depreciation    method  is   changed  from straight   -line   method   to  written  -down  value  method, or  if  cost  formula  used  for  inventory   valuation  is   changed   from  weighted    average  to  FIFO, or   if  interest  is  capitalised  which  was   earlier   not in  practice,  or  if  proportionate   amount   of  interest  is changed  to   inventory  which  was  earlier  not  the  practice , all these may  increase   or  decrease  the  net  profit. Unless   the  effect   of  such   change in  accounting   policy   is  quantified ,the  financial  statements  may  not  help  the  users  of  accounts. Therefore, it is   necessary  to  quantify  the  effect of  change  on  financial  statements  items  like  assets, liabilities ,profit  / loss  .

Fundamental Accounting Assumptions (Fundamental Accounting Concept)

AS-1 highlights three important practical rules. Certain fundamental accounting assumptions underlie the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed. The following have been generally accepted as fundamental accounting assumptions:

a.      Going Concern Concept: This concept is applied on the basis that the reporting entity is normally viewed to be continuing in operation in the foreseeable future, and without there being any intention or necessity for it to either liquidate or curtail materially its scale of business operations.

b.      Accrual Concept: This is relevant in the area of revenue and costs. These are accrued, i.e., recognised, as they are earned or incurred (and not as cash is received or paid). Also, they are recorded in the period to which they relate.

c.       Consistency Concept: There should be consistency of accounting treatment of comparable (similar) items, not only within each accounting period, but also from one period to another.

These concepts, which are fundamental to accounting, are the broad-based assumptions, underlying preparation of financial statements periodically. Financial statements are assumed to be prepared by adhering, among others, to these.

Accounting Principles and Generally Accepted Accounting Principles (GAAP)

The term principle refers to fundamental belief or a general truth which one established does not change. AICPA defined the term principle as a guide of to action, a settled ground or basis of conduct or practice. Accounting principles may be defined as those rules of conduct or procedure which are adopted by the accountants universally while recording the accounting transaction. If accounting has to serve its purpose of communicating the results of a business to the outside world, it should be based on certain uniform and scientifically laid down principles which are known as accounting principles. Accounting principles can be classified into two categories: accounting concepts and accounting conventions.

Generally Accepted Accounting Principles are the rules and concepts which have been accepted by accounting community for sound accounting practice. Their usefulness depends on ‘general acceptability’ rather than ‘individual acceptability’ of accounting concepts.  They (GAAP) have been formalised on the basis of usage, reason and experience.  

Simply, Generally Accepted Accounting Principles (GAAP) comprises a set of rules, concept and Conventions used in preparing financial accounting reports.

Difference between Accounting Standard and Accounting Principles

Accounting Standard is the set of rules that should be applied for measurement, valuation, presentation and disclosure of a subject matter. For example, measurement of deferred tax, valuation of assets, intangibles and financial instruments etc. and presentation and disclosure of such measurements and valuations.

Accounting Principles however, are the fundamental principles providing a framework within which accounting should be done. These principles also govern the formulation of Accounting Standards. For example, Accrual accounting, Substance over legal form, Prudence etc.

Basis	Accounting Standard	Accounting Principles
1.Nature	Accounting standards are fixed in nature.	Accounting principles are flexible in nature.
2. Compulsory	Following of accounting standards is compulsory for every person.	Following of accounting principles is not   compulsory.
3. Responsibility	Accounting standards creates more responsibility in accountant and auditors.	Accounting principles are less responsible.
4. Uniformity	Accounting standard are uniform rules.	Accounting principles are various.

Essential features of Accounting Principles

(i)      Man made: Accounting principles are manmade. They are not tested in a laboratory.

(ii)    Objectivity: It means accounting principles must be based on facts and free from personal bias or judgment of the individuals who prepares the statements.

(iii)   Usefulness/relevance: Accounting principles must be relevant and useful to the person who is using financial statements.

(iv)  Feasibility: The accounting principles should be practicable or feasible.

(v)    Axiom: It denotes a statement of truth which cannot be questioned by anyone.

Need and Significance of GAAP

1) Consistency: Corporations, non-profits and government organizations must prepare their financial statements in accordance with generally accepted accounting principles (GAAP) set by the Indian Accounting Standards Board (IASB). Accounting principles are important because they establish a consistency that allows for more accurate and efficient viewing of company statements and reports.

2) Standards: The generally accepted accounting principles represent a complex, important set of accounting definitions, methods and assumptions that create a standard method of reporting the financial details of a business. With the GAAP, a hierarchy exists that dictates which standard should be used and when.

3) Industry Comparisons: Potential investors who want to direct funds to a certain type of industry without a particular company in mind will find accounting principles an important tool as individual businesses are reviewed. Standards allow the investor to compare and contrast companies across a singular industry or multiple industries quickly through balance sheet, income statement and annual report reviews.

4) Company Performance: Because of the long-term consistency in key accounting definitions and methods, standard company performance measures listed on financial statements and annual reports provide a realistic view of the company's growth or lack of growth over a period of years.

Structure of GAAP

Accounting Concepts, Accounting Conventions and Accounting assumptions these three jointly forms the structure of Generally Accepted Accounting Principles (GAAP).

Accounting concepts: The term ‘concept’ is used to denote accounting postulates, i.e., basic assumptions or conditions upon which the accounting structure is based. The following are the common accounting concepts adopted by many business concerns.

i) Business Entity Concept: Business entity concept implies that the business unit is separate and distinct from the persons who provide the required capital to it. This concept can be expressed through an accounting equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself owns the assets and in turn owes to various claimants.

ii) Money Measurement Concept: According to this concept, only those events and transactions are recorded in accounts which can be expressed in terms of money. Facts, events and transactions which cannot be expressed in monetary terms are not recorded in accounting. Hence, the accounting does not give a complete picture of all the transactions of a business unit.

iii) Going Concern Concept: Under this concept, the transactions are recorded assuming that the business will exist for a longer period of time. Keeping this in view, the suppliers and other companies enter into business transactions with the business unit. This assumption supports the concept of valuing the assets at historical cost or replacement cost.      

iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction has a two-fold aspect, Viz., 1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry system is that every debit has a corresponding and equal amount of credit. This is the underlying assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or Capital = Assets – Liabilities, will further clarify this concept, i.e., at any point of time the total assets of the business unit are equal to its total liabilities.

V) Periodicity Concept: Under this concept, the life of the business is segmented into different periods and accordingly the result of each period is ascertained. Though the business is assumed to be continuing in future, the measurement of income and studying the financial position of the business for a shorter and definite period will help in taking corrective steps at the appropriate time. Each segmented period is called “accounting period” and the same is normally a year.

vi) Historical Cost Concept: According to this concept, the transactions are recorded in the books of account with the respective amounts involved. For example, if an asset is purchases, it is entered in the accounting record at the price paid to acquire the same and that cost is considered to be the base for all future accounting.

vii) Matching Concept: The essence of the matching concept lies in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business.

viii) Realisation Concept: This concept assumes or recognizes revenue when a sale is made. Sale is considered to be complete when the ownership and property are transferred from the seller to the buyer and the consideration is paid in full.

ix) Accrual Concept: According to this concept the revenue is recognized on its realization and not on its actual receipt. Similarly the costs are recognized when they are incurred and not when payment is made. This assumption makes it necessary to give certain adjustments in the preparation of income statement regarding revenues and costs.

Accounting Conventions: Accounting conventions are common practices, which are followed in recording and presenting accounting information of a business. They are followed like customs in a society. The following conventions are to be followed to have a clear and meaningful information and data in accounting:

i) Consistency: The convention of consistency implies that the same accounting procedures should be used for similar items over periods. It is essential for clear and correct understanding and interpretation of the financial statements. It is also important for inter-period comparison.

ii) Full Disclosure: According to this principle, all accounting statements should be honestly prepared and all information of material interest to proprietors, creditors, investors, etc. should be disclosed in the accounting statements. Moreover, books of accounts should be prepared in such a way that they become reliable, informative and transparent.

iii) Conservatism or Prudence: This convention follows the policy of caution or playing safe. It takes into account” all possible losses but not the possible profits or gains”. The implication of this principle is to give a pessimistic view of the financial position of the business.

iv) Materiality: Materiality deals with the relative importance of accounting information. In order to make financial statements more meaningful and to economize costs, accountants should incorporate in the financial statements only that information which is material and useful to users. They should ignore insignificant details.

International Financial Reporting Standards (IFRS)

IFRS is a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements. IFRS are generally principles-based standards and seek to avoid a rule-book mentality. Application of IFRS requires exercise of judgment by the preparer and the auditor in applying principles of accounting on the basis of the economic substance of transactions. IFRS are issued by the International Accounting Standards Board (IASB). IASB issued only thirteen (17) IFRS which are as follows:

IFRS 1 - First-time adoption of International Financial Reporting Standards

IFRS 2 - Share-based payment

IFRS 3 - Business combinations

IFRS 4 - Insurance contracts

IFRS 5 - Non-current assets held for sale and discontinued operations

IFRS 6 - Exploration for and evaluation of mineral resources

IFRS 7 - Financial instruments: disclosures

IFRS 8 - Operating segments

IFRS 9 - Financial instruments

IFRS 10 - Consolidated financial statements

IFRS 11- Joint arrangements

IFRS 12- Disclosure of interests in other entities

IFRS 13- Fair Value measurement

IFRS 14- Regulatory Deferral Accounts

IFRS 15- Revenue from Contracts with Customers

IFRS 16- Leases

IFRS 17- Insurance Contracts

Need and Importance of IFRS

The goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements. IFRS provides general guidance for the preparation of financial statements, rather than setting rules for industry-specific reporting. Having an international standard is especially important for large companies that have subsidiaries in different countries. Adopting a single set of world-wide standards will simplify accounting procedures by allowing a company to use one reporting language throughout. A single standard will also provide investors and auditors with a comprehensive view of finances. 

Merits of IFRS

1. IFRS brings improvement in comparability of financial information and financial performance with global peers and industry standards. This will result in more transparent financial reporting of a company’s activities which will benefit investors, customers and other key stakeholders in India and overseas.

2. The adoption of IFRS is expected to result in better quality of financial reporting due to consistent application of accounting principles and improvement in reliability of financial statements. 

3. IFRS provide better access to the capital raised from global capital markets since IFRS are now accepted as a financial reporting framework for companies seeking to raise funds from most capital markets across the globe.

4. IFRS minimize the obstacles faced by Multi-national Corporations by reducing the risk associated with dual filings of accounts.

5. The impact of globalization causes spectacular changes in the development of Multi-national Corporations in India. This has created the need for uniform accounting practices which are more accurate, transparent and which satisfy the needs of the users.

6. Uniform accounting standards (IFRS) enable investors to understand better the investment opportunities as against multiple sets of national accounting standard.

7. With the help of IFRS, investors can increase the ability to secure cross border listing.

Limitations of IFRS

1. The perceived benefits from IFRS’ adoption are based on the experience of IFRS compliant countries in a period of mild economic conditions. Any decline in market confidence in India and overseas coupled with tougher economic conditions may present significant challenges to Indian companies.

2. IFRS requires application of fair value principles in certain situations and this would result in significant differences in financial information currently presented, especially in relation to financial instruments and business combinations.

3. This situation is worsened by the lack of availability of professionals with adequate valuation skills, to assist Indian corporate in arriving at reliable fair value estimates.

4. Although IFRS are principles-based standards, they offer certain accounting policy choices to preparers of financial statements.

5. IFRS are formulated by the International Accounting Standards Board (IASB) which is an international standard body. However, the responsibility for enforcement and providing guidance on implementation vests with local government and accounting and regulatory bodies, such as the ICAI in India. Consequently, there may be differences in interpretation or practical application of IFRS provisions, which could further reduce consistency in financial reporting and comparability with global peers.

Difference between GAAP and IFRS

1)      GAAP stands for Generally Accepted Accounting Principles. IFRS is an abbreviation for International Financial Reporting Standard.

2)      GAAP is a set of accounting guidelines and procedures, used by the companies to prepare their financial statements. IFRS is the universal business language followed by the companies while reporting financial statements.

3)      Financial Accounting Standard Board issues GAAP (FASB) whereas International Accounting Standard Board (IASB) issued IFRS.

4)      Use of Last in First out (LIFO) is not permissible as per IFRS which is not in the case of GAAP.

5)      Extraordinary items are shown below the statement of income in case of GAAP. Conversely, in IFRS, such items are not segregated in the statement of income.

6)      Development Cost is treated as an expense in GAAP, while in IFRS, the cost is capitalised provided the specified conditions are met.

7)      Inventory reversal is strictly prohibited under GAAP, but IFRS allows inventory reversals subject to specific conditions are fulfilled.

8)      IFRS is based on principles, whereas GAAP is based on rules.

Salient features of First-Time Adoption of Indian Accounting Standard (Ind-AS) 101

Applicability of Ind AS – 101: First time adoption of Indian Accounting Standards:

The objective of this Indian Accounting Standard (Ind AS) is to ensure that an entity’s first Ind-AS financial statements, and its interim financial reports for part of the period covered by those financial statements, contain high quality information that:

(a) Is transparent for users and comparable over all periods presented;

(b) Provides a suitable starting point for accounting in accordance with Ind ASs; and

(c) Can be generated at a cost that does not exceed the benefits.

An entity shall apply this Ind-AS in:

(a) Its first Ind-AS financial statements and

(b) Each interim financial report, if any that it presents in accordance with Ind AS 34 Interim Financial Reporting for part of the period covered by its first Ind-AS financial statements.

This Indian Accounting Standard does not apply to changes in accounting policies made by an entity that already applies Ind-ASs. Such changes are the subject of:

(a) Requirements on changes in accounting policies in Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors; and

(b) Specific transitional requirements in other Ind-ASs.

Mandatory Application of Ind AS:

a) Ind AS is applicable to all listed or unlisted company if its net worth is greater than or equal to Rs. 250 crore.

b) Ind AS is applicable to all Banks, NBFCs and Insurance companies is more than or equal to INR Rs. 250 crore.

If Ind AS becomes applicable to any company, then Ind AS shall automatically be made applicable to all the subsidiaries, holding companies, associated companies, and joint ventures of that company, irrespective of individual qualification of such companies.