Need for Accounting Standards
Accounting standards establish rules relating to recognition, measurement and disclosures, thereby ensuring that all enterprises that follow them are comparable and that their financial statement are true and fair and transparent. High-quality accounting standards are a necessary and important element of a sound capital market system. In public capital markets such as those in the united states, high-quality accounting standards reduce uncertainty and increase overall efficiency and investor confidence by requiring that financial reports provide decision-useful information that is relevant, reliable, comparable , and transparent. Once confined by national borders, transactions in today’s capital markets often are driven by a demand for and supply of capital that transcends national boundaries. With the increase in cross-border capital raising and investment transactions comes an increasing demand for a set of high-quality international accounting standards that could be used as a basis for financial reporting worldwide.
Factors that influence Accounting Standards
The evolution of an accounting framework in various countries are based on various factors and have led to interesting and significant differences in accounting practices. As culture traditions, state of economic development, economic model, inflation, legal system, etc vary from country to country so does the accounting framework and models. Free trade countries encouraged and developed more robust accounting models; whereas Communist countries had far less reasons to do so, since quotas and not economic performance, were of greater concern to their governments. Nations that are exposed to rapid price changes are more receptive to departures from historical cost financial reporting, such as Latin American countries. Nations that witness complexities in economic activities faster than other countries are quicker in responding by developing accounting standards that meet those challenges. For example, US developed standard on accounting for derivatives earlier than many other nations. Nations like Japan and Germany have an overriding concern with creditor protection, since most financing is by large commercial banks and not by individual shareholders. These societies are structured on the collective good of their people, and the value systems has also affected their accounting models. For example, income smoothing has extra conservatism are permitted in Germany, as they would tend to benefit the society at large over the long term. An agrarian economy will have less pressure to develop a robust and elaborate set of accounting standards.
What is Indian GAAP?
Indian GAAP comprises a set or pronouncements issued by various regulatory authorities, but is predominantly controlled by the ICAI. In fact the multiplicity of formulating and monitoring agencies have been an impediment in the smooth implementation of Indian GAAP. Besides accounting standards, ICAI issues Guidance Notes on areas not specifically covered by Accounting Standards. However, with the introduction of new accounting standards the Guidance Notes on these subjects are being increasingly withdrawn. For example, with the introduction of AS-22 on ‘Accounting for Taxes on Income’, the Guidance Note on ‘Accounting for Taxes on Income’ was withdrawn. Besides accounting standards and various guidance notes, the Expert Advisory Committee formulated by ICAI provides opinions on a wide range of accounting and auditing issues. The ICAI has also started issuing Accounting Standards Interpretations (ASIs) and General Clarifications (GCs) which also form part of Indian GAAP. At the current date all GC’s have been replaced by ASI’s or limited revisions to the accounting standards. The ICAI also makes several announcements and issues clarifications on accounting related matters.
The Indian Companies Act
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Requires books of account to be maintained on an accrual basis
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Requires compliance with mandatory accounting standards issued by ICAI
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Lays down format of financial statements (Schedule VI)
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Prescribes depreciation rates
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Prescribes treatment of general and capital reserves etc.
Financial statement formats are also laid out for insurance companies, banks and electricity companies by their respective Acts.
SEBI mandates certain disclosures in the annual reports of listed companies such as cash flow statements, corporate governance reporting, consolidation of companies, etc. The format for quarterly disclosures by listed companies too are prescribed by SEBI. The Circular on Disclosure and Compliance Standards of Mutual Fund specifies additional disclosures in respect of portfolio by mutual funds. SEBI has also issued guidelines for valuation of securities and identification and provisioning of NPAs by mutual funds. SEBI (ESOS & ESPS) Guidelines specifies accounting in respect of ESOPs and ESOSs to be followed by listed companies. Also guidelines are provided in respect of Sweat Equity.
RBI has issued various circulars dealing with income recognition, asset classification and provisioning by banks. RBI specifies valuation of investments by banks according to the category of investments. NBFCs Prudential Norms (Reserve Bank) Directions, 1998 specifies additional accounting (income recognition, provisioning of NPA’s, accounting for investments, asset classification, etc) and disclosure requirements for NBFCs IRDA also prescribes prudential and accounting norms in respect of insurance companies.
As regards ‘Government Accounting’ in India, the CAG has constituted a ‘Government Accounting Standards Advisory Board’ (GASAB), which has issued its first accounting standard ‘Guarantees given by Government- Disclosure Requirements’. There are several other accounting standards in the pipeline.
Process of Formulating Accounting Standards in India
The Institute of Chartered Accountants of India (ICAI), recognizing 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 Council of ICAI. While formulating the standards in India, ASB will take into consideration the applicable laws, customs, usages and business environment. ICAI is one of the members of the International Federation of Accountants (IFAC) and has agreed to support the objectives of IFAC. ASB will give due consideration to IFRSs and try to integrate them to the extent possible, in light of the considerations and practices prevailing in India.
The constitution of the ASB is fairly broad-based and comprises of nominees of various government agencies and institutions. Besides formulating the accounting standards, the ASBs objective is also to provide time to time interpretations and guidance on Accounting Standards.
The procedure for issuing an Accounting Standards is set out in the ‘preface to the Statement on Accounting Standards’. The same procedure is generally followed in the case of limited revision to an accounting standard as well. However, the preface does not contain the procedure for making an announcement, providing clarifications or issuing of ASI’s by the ICAI.
Improvement Required in Indian GAAP
There are several areas, which require special attention, the critical one’s are enumerated below.
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Accounting for goodwill needs to be made consistent across all standards, right now, there is a lot of inconsistency.
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Standards need to be issued in newer areas, such as, for financial instruments, investment property, agriculture etc.
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Industry specific accounting standard or guidance notes need to be issued.
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The drafting of standard needs to be made more robust. In several cases, exposure drafts were issued without any transitional provision on first time application of the accounting standards.
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Financial statement disclosure and practices should be delinked from regulatory requirements, for example, Schedule VI under the Companies Act is an outdated mode of presenting financial statements. Schedule VI does not even have a current vs. noncurrent distinction for presentation of assets and liabilities.
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The powers of High Court to stay applicability of accounting standards should be curbed.
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New standards should not be issued, unless the old standards are revised in accordance with the new IFRS standards.
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Understanding and implementation of accounting standards needs to be strengthened. In many instances, enterprises reach consensus numbers by just changing accounting policies, though they are otherwise compliant with mandatory accounting standards.
Poor implementation of Accounting Standards
Enterprises have to comply with a plethora of accounting standards (Presently 29); consequently, one would assume that the scope to manage one’s bottom line has drastically reduced.
What about changing your accounting policies!
Internationally extreme caution is exercised whilst changing accounting policies; in India, it is often misused, though AS 5 requires changes in accounting polices only when the situation so demands. Corporate India is replete with examples of such aberrant practices and worse still; it is applauded rather than abhorred. Whilst the objective of changing accounting policies in some cases may be innocuous,
For example, Aligning with group policies, at times, the change may have been to reduce book profits with an eye on MAT, but in most cases the objective may be to shore up sagging profits or reduce losses.
Common examples of changes in accounting policies are changes in depreciation methods, inventory cost formulae, revenue recognition practices, amortization policy, etc. Let’s consider a few examples published in the annual report of some big listed companies.
Accounting Standards apply to General Purpose Financial Statements
The Accounting Standards issued will apply to ‘general purpose financial statements’. This would include balance sheet, P&L account, cash flows (where applicable) and other statements and explanatory notes which form part thereof, issued for the use of various stakeholders, governments and their agencies and the public. It may be noted that based on this definition of general purpose financial statements contained in the preface, accounts prepared solely for tax purpose and/or for use by lenders would be considered to be ‘general purpose financial statements’.
The Standards are generally expected to apply prospectively, unless otherwise stated. The responsibility for proper preparation of the financial statements is that of the management. The auditor’s responsibility is to give an opinion on those financial statements.
Application of Accounting Standards to Charitable Entities
As per the ‘Preface to the Statements of Accounting Standards’, accounting standards apply to enterprises engaged in commercial, industrial or business activities irrespective of whether it is profit oriented or established purely for charitable or religious purposes. Therefore they do not apply to enterprises that do not carry out any commercial, industrial or business activity. For example, collecting donations and distributing them to flood affected people. If a charitable entity is also engaged in industrial, business or commercial activity (howsoever insignificant) then accounting standards would apply to its entire activity, charitable and non-charitable.
Application of Accounting Standards to Co-operative Societies
The ‘Preface to the Statements of Accounting Standards’, sets out the applicability of accounting standards to co-operative societies. The accounting standards issued by the Institute shall apply in respect of financial statements of co-operative societies, which carry on commercial, industrial or business activities, and are subject to the attest function of the members of the Institute. The Accounting Standards made mandatory by the Institute, as specified in the respective standards or made mandatory by separate announcements, are also mandatory in respect of co-operative societies.
For the removal of doubts it is stated that even if a very small proportion of the activities of a co-operative society is considered to be commercial, industrial or business in nature, then it cannot claim exemption from the application of Accounting Standards. The Accounting Standards would apply to all its activities; ie, commercial and not commercial.
It is reiterated that mandatory status of an accounting standard implies that it will be the duty of the members of the Institute to examine whether the Accounting Standard is complied with in the presentation of financial statements covered by their audit. In the event of any material deviation from the Accounting Standard, it will be their duty to qualify their audit reports so that the users of financial statements may be aware of such deviations.
Accounting Standards and Mutual Funds
As per the ‘Preface to the Statement of Accounting Standards’ issued by ICAI, accounting standards apply to general purpose financial statements of enterprises (of any form) that conduct industrial, commercial or business activities. This would include trust and hence the accounting standards apply to mutual funds. ICAI would make efforts to issue accounting standards which are in conformity with the provisions of the applicable laws, customs, usages and business environment in India. However, if due to subsequent amendments in the law, a particular accounting standards is found to be not in conformity with such law, the provisions of the said law will prevail and the financial statements would be prepared in conformity with such law. In relation to mutual funds accounting treatment and disclosure requirements as required under SEBI mutual fund regulations should be followed. Where for a particular matter SEBI regulations have not prescribed the accounting treatment, ICAI standards should be followed. Where an accounting standard is inconsistent with SEBI’s mutual fund regulation and the financial statements are appropriately prepared in accordance with SEBI regulations, an auditor’s qualification on mandatory standards issued by ICAI is inappropriate, though a clarificatory note should be included in the audit report. AS 13 specifically excludes AMC’s and mutual funds, therefore in that regard SEBI mutual fund regulations on accounting, disclosure and valuation of investments should be followed.
Applicability of Accounting Standards to Partnership and Proprietorship
The preface to the Statements of Accounting Standards’ requires accounting standards to be complied by any enterprise that conducts industrial, business or commercial activity. The form of the enterprise is not important. What is important is whether an industrial, business or commercial activity is carried out by that enterprise. Such enterprise in the preparation of the general purpose financial statement will have to comply with the mandatory accounting standards. The compliance is required even if a small portion of the enterprises activity pertains to industrial, commercial or business activity. Therefore accounting standards would apply to partnership and proprietorship.
Application of Accounting Standards under the Indian Companies Act, 1956
ICAI not being a regulatory body cannot on its own force enterprises to follow mandatory accounting standards unless they are backed by relevant statutory approval. A mandatory accounting standard if not followed requires auditors who are members of ICAI to qualify their audit reports, failing which they will be guilty of professional misconduct. However preparers of financial statements were not obliged to conform to these mandatory accounting standards. SEBI and the Indian Companies Act made the implementation of accounting standards by preparers of financial statements compulsory for listed companies and the entire corporate sector respectively. Both SEBI and the Companies Act require auditors to qualify audit reports that do not conform to mandatory accounting standards. Section 217(2AA) of the Companies Act also casts a responsibility on the Board of Directors to comply with mandatory accounting standards. As per this section, the Boards report shall include a director’s responsibility statement indicating therein (a) the applicable accounting standards have been followed with proper explanation relating to material departure if any (b) the director’s had selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company (c) that the directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets and for preventing and detecting frauds and other irregularities, and (d) that the directors had prepared the accounts on a going concern basis.
Definition of Ind as
With India deciding to converge with IFRS and not adopt IFRS, Ind as is certainly the way forward for Indian Companies.
In simple terms, convergence with IFRS means that India would not be applying the IFRS as issued by the international body but would try to get its own accounting standards Indian accounting standards are popularly referred to as ‘Ind – AS’
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