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CHAPTER II
ACCOUNTING STANDARDS AND FINANCIAL REPORTING
INFORMATION
2.1. Introduction
2.2.Meaning of Accounting
2.3.Objectives of Accounting
2.3.1. Accounting Concepts
2.3.2. Accounting Principles
2.3.3. Accounting Conventions
2.4. Limitations of Accounting
2.5. Branches of Accounting
2.5.1. Financial Accounting (FA)
2.5.2. Cost Accounting (CA)
2.5.3. Management Accounting (MA)
2.6. Financial Statement
2.6.1. Objectives of Financial Statement
2.7. Financial Reporting
2.7.1. Objective of Financial Reporting
2.8. Development of Financial Reporting Objectives
2.9. Benefits of Financial Reporting
2.9.1. Managerial Decisions Making
2.9.2. Economic Decisions Making
2.9.3. Customers Decisions Making
2.9.4. Employee Decisions
2.9.5. Cost of Capital
2.9.6. Keeping Minimizing Fluctuations in Share Price
2.10. Qualitative Characteristic of Financial Reporting Information
2.10.1. Relevance
2.10.2. Faithful representation (Reliability)
2.10.3. Comparability
2.10.4. Verifiability
2.10.5. Timeliness
2.10.6. Understandability
2.11. Constraints on Financial Reporting
2.11.1. Constraints on Financial Reporting – Materiality
2.11.2. Constraints on Financial Reporting – Benefits and Cost
2.12. Accounting Standards
2.12.1. International accounting standards (IAS)
2.12.2. International Financial Reporting Interpretation Committee (IFRIC)
2.12.3. International Accounting Standards Board (IASB)
2.12.4. Financial Accounting Standards Board (FASB)
2.12.5. Accounting Standards in India
2.12.6. International Financial Reporting Standards (IFRS)
2.12.7. International Financial Reporting Standards (IFRS) Vs. (IGAAP)
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CHAPTER II
ACCOUNTING STANDARDS AND FINANCIAL REPORTING
INFORMATION
2.1. Introduction
Historically, accounting and financial reporting evolved themselves independently
and often very differently in different countries. Practice, regulation and especially the
mode of regulation differed often vary greatly in these countries. Accounting, especially
appropriate and relevant accounting, is a critical tool and an information source in any
country's efforts towards economic growth and development (Kapaya, 2000). The end
product of accounting is financial reporting. Initially, financial reporting was mainly
confined to internal reporting. It provided company owners with a vehicle to manage the
company. Later on, in the early 1800s, private capital alone was insufficient to finance
business activities. Capital was gathered from source outside the company and the
owners delegated to managing function to directors and provided them with the
necessary authority to run the business activity. This resulted in the extension of
accounting from internal financial reporting system to external financial reporting
system. Nowadays, the external financial reporting provides a means of reporting the
results and accounts to the owners.
On the other hand, the structure of annual reports and financial reporting has
changed dramatically in recent years. Today, annual reports are no longer restricted to
the financial statements, but encompass a broad array of additional matters that must
also be disclosed. No longer focused on historic results, it now includes prospective
elements, such as guidance on future revenue and earnings targets. Moreover, disclosure
of a growing number of non-financial performance metrics is being required, together
with an ever-increasing number of financial metrics.
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2.2. Meaning of Accounting
There is no single or unanimously accepted definition of accounting, but some of
the definitions presented below:
American Institute of Certified Public Accountants (AICPA, 1953) definition:
―accounting is the art of recording, classifying and summarizing in a significant manner
and in terms of money, transactions and events which are, in part at least, of financial
character and interpreting the results thereof‖. This institute also definition ―accounting
is a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making
reasoned choices about the alternative course of action‖. The American Accounting
Association (AAA, 1966) initiated a paradigm shift in the role of accounting by
defining it as ―accounting refers to the process of identifying, measuring and
communicating economic information to permit informed judgments‘ and decisions by
users of the information‖.
2.3. Objectives of Accounting
The main objectives of accounting are systematic recording of transactions,
ascertainment of results of recorded transactions and the financial position of the
business, providing information to the users for rational decision-making and to know
the solvency position. The functions of accounting are measurement, forecasting, and
decision-making, comparison & evaluation, control, government regulation and
Taxation. On the other hand the general objectives of accounting according to the
Accounting Principles Board (APB) are:
To provide quantitative financial information about a business enterprise that's
useful to the users, particularly the owners and creditors, in making economic
decisions.
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To provide reliable financial information about economic resources and
obligations of a business enterprise.
To provide reliable information about changes is not resources of an
enterprise that result from its profit directed activities.
To provide other needed information that assists in estimating the earning
potential of the enterprise.
To provide other needed information about changes in economic resources
and obligation.
To disclose, to the extent possible, other information related to the financial
statements that is relevant to the user‘s needs.
2.3.1. Accounting Concepts
Accounting concepts define the assumptions on the basis of which financial
statements of a business entity are prepared. Certain concepts are perceived, assumed
and accepted in accounting to provide a unifying structure and internal logic to
accounting process. The word concept means idea or notion, which has universal
application. Financial transactions are interpreted in the light of the concepts, which
govern accounting methods. Concepts are those basic assumptions and conditions,
which form the basis upon which the accountancy has been laid. Unlike physical
science, accounting concepts are only result of broad consensus. These accounting
concepts lay the foundation on the basis of which the accounting principles are
formulated.
2.3.2. Accounting Principles
Accounting principles are a body of doctrines commonly associated with the
theory and procedures of accounting serving as an explanation of current practices and
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as a guide for selection of conventions or procedures where an alternative exists.
Accounting principles must satisfy the following conditions:
They should be based on real assumptions;
They must be simple, understandable and explanatory;
They must be followed consistently;
They should be able to reflect future predictions;
They should be informational for the users.
2.3.3. Accounting Conventions
Accounting conventions emerge of accounting practices, commonly known as
accounting, principles, adopted by various organizations above a period of time. These
conventions are derived by usage and practice. The accountancy bodies of the world
may change any of the convention to improve the quality of accounting information.
Accounting conventions need not have universal application.
2.4. Limitations of Accounting
The financial statements are prepared on the basis of the above-mentioned
assumptions, conventions and the accounting principles which the accountant chooses
to adopt. These bring in lot of subjectivity to the financial statements and hence these
basis assumptions conventions and principles become the limitation of accounting.
The financial statements as the name states accounts only for the items that can be
measured by money. There are lots of items that money cannot measure but still are the
most valuable assets for the enterprise, like Human Resources, which the financial
statements does not depict.
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The language of accounting has certain practical limitations and, therefore, the
financial statements should be interpreted carefully keeping in mind all various factors
influencing the true picture.
2.5.Branches of Accounting
On the basis of information generated by accounting system, there are three main
branches of accounting:
2.5.1. Financial Accounting (FA)
Financial Accounting (FA) deals with preparation of final accounts/financial
statements.
Income Statement to get previous year‘s result of business operation profit/loss.
Income statement is also termed as profit & loss account (P & L A/c).
Balance Sheet (B/S) to get previous year‘s financial position picture of assets
and liabilities.
2.5.2. Cost Accounting (CA)
Cost accounting deals with present information determining unit cost at different
levels (known as cost centers) of ongoing production. Cost accounting process includes
accounting and financial management:
Cost determination i.e. costing.
Cost analysis i.e. studying behavior of profit with respect to cost and
volume.
Cost control comparison of actual cost with predetermined cost/standard
cost.
For above-mentioned information, CA system generates:
Cost sheet for cost determination.
Report on CVP (Cost-Volume-Profit) analysis/BE (Break-Even) analysis for
analyzing behavior of profits with respect to cost and volume.
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Report on variance analysis for determining variances and to take corrective
action whenever needed and hence cost control.
Both FA and CA take input data for further processing from book-keeping
system.
In an organization book-keeping system functions as a part of FA system. In other
words, it is not in isolation.
2.5.3. Management Accounting (MA)
Management Accounting (MA) deals with all those information, which helps in
decision-making process planning and controlling financial activities. In an
organization, MA is common to both FA and CA because all those information, which
are generated by FA and CA system are useful in decision-making process and comes
under the preview of MA system. CVP analysis and variance analysis of CA system
also form part of MA system. Fund Flow Statement (FFS) of FA system also form part
of MA system. Because it presents the flow of fund through business organization
during financial year and is of great help in assessing fund position. Apart from above
information which is common to both FA system and CA system, there are some
information exclusively generated by management accountants.
Projected statements like:
Projected income statement to estimate coming year‘s target profit.
Projected balance sheet to estimate coming year‘s target financial position.
C-Projected FFS/CFS to estimate coming year‘s target fund/cash position.
Developing budget and budgetary control system for the purpose of budgeting.
Marginal costing techniques for short-term decision-making purposes (Singh,
2007).
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2.6. Financial Statement
Financial statements form part of the process of financial reporting. A complete
set of financial statements normally includes a balance sheet, a statement of profit and
loss (also known as ‗income statement‘), a cash flow statement and those notes and
other statements and explanatory material that are an integral part of the financial
statements. They may also include supplementary schedules and information based on
or derived from, and expected to be read with, such statements. Such schedules and
supplementary information may deal, for example, with financial information about
business and geographical segments, and disclosures about the effects of changing
prices. Financial statements do not, however, include such items as reports by directors,
statements by the chairman, discussion and analysis by management and similar items
that may be included in a financial or annual report.
2.6.1. Objectives of Financial Statement
The objective of financial statements is to provide information about the financial
position, performance and cash flows of an enterprise that is useful to a wide range of
users in making economic decisions.
Financial statements prepared for this purpose meet the common needs of most
users. However, financial statements do not provide all the information that users may
need to make economic decisions since (a) they largely portray the financial effects of
past events, and (b) do not necessarily provide non-financial information.
A list of the objectives of financial statements proposed by the True Blood
Committee (TBC):
The basic objective of financial statements is to provide information on which to
base economic decisions.
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An objective of financial statements is to serve primarily those users who have
limited authority, ability, or resources to obtain information and who rely on
financial statements as their principal source of information about enterprise‘s
activity.
An objective of financial statements is to provide information useful to investors
and creditors for predicting, comparing, and evaluating potential cash flows to
them in terms of amount timing and related uncertainly.
An objective of financial statements is to provide users with information for
predicting, comparing and evaluating enterprise earning power.
An objective of financial statements is supply information useful in judging
management‘s ability to utilize enterprise resources effectively in achieving the
primarily enterprise goal.
An objective of financial statements is to provide factual and interpretive
information about transactions and other events that is useful for predicting,
comparing and evaluating enterprise earning power. Basic underlying
assumptions with respect to matters subject to interpretation, evaluation,
prediction or estimation should be disclosed.
An objective of financial statements is to provide information useful for the
predictive process. Financial forecasts should be provided when they enhance
the reliability of users‘ predictions.
An objective of a financial statement for governmental and not-for-profit
organizations is to provide information useful for evaluating the effectiveness of
the management of resources in achieving the organization‘s goals that are
primarily nonmonetary. Performance measures should be expressed in terms of
the not-for profit organization‘s goal.
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An objective of financial statements is to report on those activities of the
enterprise affecting society which can be determined and described or measured
and which are important to the enterprise in its social environment (Belkaoui,
2004).
2.7. Financial Reporting
Financial reporting may be defined as communication of published financial
statements and related information from a business enterprise to third parties (external
users) including shareholders, creditors, customers, governmental authorities and the
public. It is the reporting of accounting information of an entity (individual, firm,
company, government enterprise) to a user or group users. Company financial reporting
is a total communication system involving the company as issuer (preparer); the
investors and creditors as primary users, other external users; the accounting profession
as measures and auditors and the company law regulatory or administrative authorities.
2.7.1 Objective of Financial Reporting
The primary objective of financial reporting is to provide economic information to
permit users of the information to make informed decisions. Users include both the
management of a company (internal users) and others not involved in the daily
operations of the business (external users). The external users usually do not have
access to the detailed records of the business and don‘t have the benefit of daily
involvement in the affairs of the company. They make their decisions based on financial
statements prepared by management. According to the FASB, ―financial reporting
should provide information that is useful to present and potential investors and creditors
and other users in making rational investment, credit, and similar decisions‖ (SFAC,
1978).
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The objective of general purpose financial reporting is to provide financial
information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions in their capacity as capital
providers. Qualitative characteristics are the attributes that make financial information
useful. They can be distinguished as fundamental or enhancing characteristics,
depending on how they affect the usefulness of the information. Regardless of its
classification, each qualitative characteristic contributes to the usefulness of financial
reporting information. However, providing useful financial information is limited by
two pervasive constraints on financial reporting—materiality and cost (IASB, 2008).
The objective of general purpose financial reporting is to provide financial
information about the reporting entity that is useful to existing and potential investors,
lenders and other creditors in making decisions about providing resources to the entity.
Those decisions involve buying, selling or holding equity and debt instruments, and
providing or settling loans and other forms of credit. Many existing and potential
investors, lenders and other creditors cannot require reporting entities to provide
information directly to them and must rely on general purpose financial reports for
much of the financial information they need. Consequently, they are the primary users
to whom general purpose financial reports are directed (IFRS, 2011).
Financial reporting is not an end in itself but is a means to certain objectives. The
objectives of financial reporting and financial statements have been discussed for a long
time. While there is no final statement on objectives, to which all parties (of financial
reporting) have agreed, some consensus has been developing on the objectives of
financial reporting. The following may be described as the primary objectives of
financial reporting: investment decision-making and management accountability.
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a) Investment Decision-Making
The basic objective of financial reporting is to provide information useful to
investors, creditors and other users in making sound investment decisions. The True
Blood Committee stated that, the basic objective of financial statements is to provide
information useful for making economic decisions recently; the FASB (USA) in its
concept No. 1 also concluded that, financial reporting should provide information that is
useful to present and potential investors and creditors and other users in making rational
investment, credit and similar decisions.
It is essential to have an understanding of the investment decision process
applied by external users in order to provide useful information to them. The investors
seek such investment which will provide the greatest total return with an acceptable
range of risk. Investment return is comprised of future interest or dividends and capital
appreciation (or loss). The investors while making investment decision aim to determine
the amount and certainty of a company‘s future earning power in order to estimate their
future cash return in dividends and capital appreciation. Earning power is the ability of a
business firm to produce continuous earnings from the operating assets of the business
over a period of years, which may differ from accounting net income.
The financial statements and other business data are analyzed in relation to the
enterprise‘s environment to project this future earning power. Investors compare returns
on alternative investments relative to risk, which (risk) is the degree of uncertainty of
future returns. In this way, investment funds tend to flow toward the most favorably
situated companies and industries and away from the weaker and less promising
companies.
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b) Management Accountability
A second basic objective of financial reporting is to provide information on
management accountability to judge management‘s effectiveness is utilizing the
resources and running the enterprise. Management of an enterprise is periodically
accountable to the owners not only for the custody and safe-keeping of enterprise
resources, but also for their efficient and profitable use and for protecting them to the
extent possible from unfavorable economic impacts of factors in the economy such as
technological changes, inflation or deflation.
Management accountability covers modern performance issues based on
efficiency and effectiveness notions. The management accountability concept includes
information about future activities, budgets, forecast financial statements, capital
expenditures proposal etc. Accountability is beyond the narrow limits of companies. It
obviously includes the interest of persons other than existing shareholders. Management
accountability is of very great interest not only to existing shareholders and other users
but also to potential shareholders, creditors and users. A company generally offers
shares, debentures etc. to the respective investing public and therefore it should accept
accountability responsibilities to prospective investors also. Certainly annual and other
financial statements are intended to play a major role in this regard.
2.8. Development of Financial Reporting Objectives
The subject of financial reporting objectives has been generally recognized as
very important in accounting area since a long time. Many accounting bodies and
professional institutes all over the world have made attempts to define the objectives of
financial statements and financial reporting which are vital to the development of
financial accounting theory and practice.
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2.9. Benefits of Financial Reporting
The financial reporting, if adequate and reliable, would be useful in many
respects. Benefits of financial reporting may be listed as follows:
2.9.1. Managerial Decision Making
The accounting data published in financial reports may have economic effects
through its impact on the behavior of the managers of corporate enterprises. The
inclusion of accounting numbers in management compensation schemes, or the fear of
market misinterpretation of accounting reports may influence a manager‘s operating and
financing decisions.
2.9.2. Economic Decision Making
Financial reporting can provide information important in evaluating the strength
and weakness of an enterprise and its ability to meet its commitments. It can supply
information about transactions within the business and factors outside the company such
as taxation policy, trade restrictions, technological changes, and market potentialities
etc., which affect the earning power of a business enterprise.
2.9.3. Customers Decision Making
The data presented in financial statements may affect the decision of company‘s
customers and hence have economic consequences. Customers like employees, may use
financial statement data to predict the likelihood and/or timing of a firm going bankrupt
or being unable to meet its commitments. This information may be important in
estimating the value of a warranty or in predicting the availability of supporting services
or continuing supplier of goods over an extended period of time.
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2.9.4. Employee Decisions
Employee decisions may be based on perceptions of a company‘s economic status
acquired through financial statements. In particular prospective and present employees
may use the financial reports to assess risk and growth potential of a company and
therefore, job security and future promotional possibilities. These decisions affect the
allocation of human capital in the economy.
2.9.5. Cost of Capital
Adequate disclosure in annual reports is expected, in the long run, to enhance
market price of company shares in the investment market. Higher prices of company
shares resulting from the full disclosure will have a favorable impact on the company‘s
cost of capital. It also enhances the future marketability of subsequent issue of
company‘s shares.
2.9.6. Keeping Minimizing Fluctuations in Share Price
Adequate disclosure will tend to minimize the fluctuations in company‘s share
prices. Fluctuation is in share prices occur because of the ignorance prevailing in the
investment market. Fluctuations show an element of uncertainty in investment
decisions. If the securities market is in possession of full information, the ignorance and
uncertainty will be reduced and share prices will tend to maintain equilibrium. Besides,
increased disclosure would prevent fraud and manipulations and would minimize
chances of their occurrences. Additionally, all investors would be treated equally as far
as the availability of significant financial information is concerned. Ethics in disclosure
demands that no caste system for release of corporate information-telling the
sophisticated first and the general public later or not at all-should be followed by
corporate managements.
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2.10. Qualitative Characteristics of Financial Information Reporting
As stated earlier, the objectives of financial reporting are concerned, in varying
degree, with decision-making made by various users. However, there is a need to know
that makes financial information useful for decision-making, i.e., what qualities or
qualitative characteristics are needed to make the information useful and to help in
achieving the purposes of financial reporting.
Informational qualities or qualitative characteristics make information reported
through financial reporting a desirable commodity and guide the selection of preferred
accounting methods and policies from among available alternatives. It is those qualities
that distinguish more useful accounting information from less useful information.
The objective of general purpose financial reporting is to provide financial
information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions in their capacity as capital
providers. Qualitative characteristics are the attributes that make financial information
useful. They can be distinguished as fundamental or enhancing characteristics,
depending on how they affect the usefulness of the information. Regardless of its
classification, each qualitative characteristic contributes to the usefulness of financial
reporting information. However, providing useful financial information is limited by
two pervasive constraints on financial reporting—materiality and cost (IASB, 2008).
Qualitative characteristics identify the types of information that are likely to be
most useful to the existing and potential investors, lenders and other creditors for
making decisions about the reporting entity on the basis of information in its financial
report (financial information). If financial information is to be useful, it must be
relevant (i.e. must have predictive value and confirmatory value, based on the nature
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or magnitude, or both, of the item to which the information relates in the context of an
individual entity‘s financial report) and faithfully represents what it purports to
represent (i.e. information must be complete, neutral and free from error). The
usefulness of financial information is enhanced if it is comparable, verifiable, timely
and understandable (IFRS, 2011).
In this regard, conceptual framework for financial reporting (FRS, 2010) to say
that if financial information is to be useful, it must be relevant and faithfully represents
what it purports to represent. The usefulness of financial information is enhanced if it is
comparable, verifiable, timely and understandable.
Chart 2-1 shows the hierarchy of qualitative characteristics of financial reporting.
Chart No.2.1
Hierarchy and Components of Qualitative Characteristics of Financial Reporting
FAITHFUL
REPRESENTATION
Confirmatory
Value
Predictive
Value
Timeliness Understandability Verifiability
DECISION-USEFULNESS
COST MATERIALITY
RELEVANCE
Comparability
Completeness Neutrality Free from
error
CAPITAL PROVIDERS (Investors and Creditors)
AND THEIR CHARACTERISTICS
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Economic phenomena comprise economic resources, claims on those resources,
and the transactions and other events and circumstances that change them. Financial
information reporting reflects economic phenomena (that exist or have already
occurred) in words and numbers in financial reports. For financial information to be
useful, it must possess two fundamental qualitative characteristics—relevance and
faithful representation (IASB, 2008).
2.10.1. Relevance
Relevance is one of the two fundamental qualitative characteristics of financial
information reporting. Chart 2.2 shows the relevance and related ingredients of this
fundamental quality.
Chart No.2.2
Components of relevance
To be useful in making investment, credit, and similar resource allocation
decisions, information must be relevant to those decisions. Relevant information is
capable of making a difference in the decisions of users by helping them to evaluate the
potential effects of past, present, or future transactions or other events on future cash
flows (predictive value) or to confirm or correct their previous evaluations
(confirmatory value) (FASB,2006).
RELEVANCE
Predictive Value Confirmatory Value
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Information is relevant if it is capable of making a difference in the decisions
made by users in their capacity as capital providers. Information about an economic
phenomenon is capable of making a difference when it has predictive value,
confirmatory value or both. Whether information about an economic phenomenon is
capable of making a difference is not dependent on whether the information has actually
made a difference in the past or will definitely make a difference in the future.
Information may be capable of making a difference in a decision and thus be relevant
even if some users choose not to take advantage of it or are already aware of it (IASB,
2008).
a) Predictive value
Conceptual framework for financial reporting (FASB, 2006) says that an item of
financial reporting information has predictive value means that it has value as an input
to a predictive process. It does not mean that the information itself is a prediction or
forecast. Investors, creditors, and others often use information about the past to help in
forming their own expectations about the future. Without knowledge of the past, users
generally will have no basis for a prediction. For example, information about past or
current financial position and performance, generally considered in conjunction with
other information, is often used in predicting future financial position and performance
and other matters, such as future dividend, interest, or wage payments and the entity‘s
ability to meet its commitments as they become due.
Conceptual framework for financial reporting (IASB, 2008) says that Information
about an economic phenomenon has predictive value if it has value as an input to
predictive processes used by capital providers to form their own expectations about the
future. Information itself need not be predictable to have predictive value. Some highly
predictable information may not have any predictive value for a particular purpose. For
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example, straight-line depreciation of plant and equipment may be highly predictable
from year to year but may not be very helpful in assessing an entity‘s ability to generate
net cash inflows. Also, information about an economic phenomenon need not be in the
form of an explicit forecast to have predictive value; it needs only to be a useful input to
predictive processes of use to capital providers.
In this regard, conceptual framework for financial reporting (FRS, 2010) says that
financial information has predictive value if it can be used as an input to processes
employed by users to predict future outcomes. Financial information need not be a
prediction or forecast to have predictive value. Financial information with predictive
value is employed by users in making their own predictions.
b) Confirmatory value
Information that has confirmatory value may serve to confirm the past (or present
expectations) based on previous evaluations or it may change (correct) them.
Information that confirms past expectations decrease the uncertainty (increases the
likelihood) that the results will be as previously expected, If the information changes
expectations, it changes the perceived probabilities of the range of possible outcomes or
their magnitude. In other words, the information changes the degree of confidence in
past expectations. Either way, it is capable of making a difference in users‘ decisions
(FASB, 2006).
(IASB, 2008) explained that information about an economic phenomenon has
confirmatory value if it confirms or changes past (or present) expectations based on
previous evaluations. Information that confirms past expectations increases the
likelihood that the outcomes or results will be as previously expected. If the information
changes expectations, it also changes the perceived probabilities of the range of possible
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outcomes. Although it also, (FRS, 2010) to say that financial information has
confirmatory value if it provides feedback about (confirms or changes) previous
evaluations.
The predictive and confirmatory roles of information are interrelated; information
that has predictive value usually also has confirmatory value. For example, information
about the current level and structure of assets and liabilities helps users to predict an
entity‘s ability to take advantage of opportunities and to react to adverse situations. The
same information helps to confirm or correct users‘ past predictions about that ability
(FASB, 2006).
(IASB, 2008) says that the predictive and confirmatory roles of information are
interrelated; information that has predictive value usually also has confirmatory value.
For example, information about the current level and structure of an entity‘s economic
resources and claims helps users to predict an entity‘s ability to take advantage of
opportunities and to react to adverse situations. The same information helps to confirm
or correct users‘ past predictions about that ability.
(FRS, 2010) explained that the predictive value and confirmatory value of
financial information are interrelated. Information that has predictive value often also
has confirmatory value. For example, revenue information for the current year, which
can be used as the basis for predicting revenues in future years, can also be compared
with revenue predictions for the current year that was made in past years. The results of
those comparisons can help a user to correct and improve the processes that were used
to make those previous predictions.
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2.10.2. Faithful Representation (Reliability)
Faithful representation is one of the two fundamental qualitative characteristics of
financial information reporting. Chart 2.3 shows the faithful representation (reliability)
and related ingredients of this fundamental quality.
Financial reports represent economic phenomena in words and numbers. To be
useful, financial information must represent not only relevant phenomena, but also
faithfully represent the phenomena that it purports to represent. To be a perfectly
faithful representation, a depiction would have three characteristics. It would be
complete, neutral and free from error. Of course, perfection is seldom, if ever,
achievable. The ASC‘s objective is to maximize those qualities to the extent possible
(FRS, 2010).
Chart No.2.3
Components of faithful representation (reliability)
A single economic phenomenon may be represented in multiple ways. For
example, an estimate of the risk transferred in an insurance contract may be depicted
qualitatively (e.g. a narrative description of the nature of possible losses) or
quantitatively (e.g. an expected loss). Additionally, a single depiction in financial
reports may represent multiple economic phenomena. For example, the presentation of
FAITHFUL REPRESENTATION
Completeness Neutrality Free from error
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the item called plant and equipment in a financial statement may represent an aggregate
of all of an entity‘s plant and equipment (IASB, 2008).
Although it also, (IASB, 2008) state that to be useful in financial reporting,
information must be a faithful representation of the economic phenomena that it
purports to represent. Faithful representation is attained when the depiction of an
economic phenomenon is complete, neutral, and free from material error. Financial
information that faithfully represents an economic phenomenon depicts the economic
substance of the underlying transaction, event or circumstances, which is not always the
same as its legal form.
a) Completeness
Completeness means including in financial reporting all information that is
necessary for faithful representation of the economic phenomena that the information
purports to represent. Therefore, completeness, within the bounds of what is material
and feasible, considering the cost, is an essential component of faithful representation.
The importance of completeness is clear in the context of a line item on a financial
statement. For example, to omit some revenues during the period from the item
revenues on a statement of income (or profit or loss) would faithfully represent neither
that item nor subsequent subtotals and totals. Completeness is also important in
developing estimates of economic phenomena, such as in estimating fair value using a
valuation technique. For example, estimating the fair value of a financial instrument
using a pricing model must take into account all of the economic factors that are valid
inputs to the model used. Thus, to omit dividends expected to be paid on the underlying
shares over the term of a call or put option on those shares would not faithfully
represent the fair value of the option (FASB, 2006).
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In this respect, (FRS, 2010) explained that a complete depiction includes all
information necessary for a user to understand the phenomenon being depicted,
including all necessary descriptions and explanations. For example, a complete
depiction of a group of assets would include, at a minimum, a description of the nature
of the assets in the group, a numerical depiction of all of the assets in the group, and a
description of what the numerical depiction represents (for example, original cost,
adjusted cost or fair value). For some items, a complete depiction may also entail
explanations of significant facts about the quality and nature of the items, factors and
circumstances that might affect their quality and nature, and the process used to
determine the numerical depiction.
In this regard, conceptual framework for financial reporting (IASB, 2008) to say that a
depiction of an economic phenomenon is complete if it includes all information that is
necessary for faithful representation of the economic phenomena that it purports to
represent. An omission can cause information to be false or misleading and thus not
helpful to the users of financial reports.
b) Neutral
Neutrality refers to absence of bias to attain a predetermined result or to induce a
particular behavior. Neutrality is an essential aspect of faithful representation because
biased financial information reporting cannot faithfully represent economic phenomena.
Neutrality is incompatible with conservatism, which implies a bias in financial
information reporting. Neutral information does not color the image it communicates to
influence behavior in a particular direction. For example, automobiles might be
produced with speedometers that indicate a higher speed than the automobile actually is
traveling at to influence drivers to obey the speed limit. But those ―conservative‖
speedometers would be unacceptable to drivers who expect them to faithfully represent
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the speed of the automobile. Conservative or otherwise biased financial reporting
information is equally unacceptable (FASB, 2006).
In this respect, (FRS, 2010) explained that a neutral depiction is without bias in
the selection or presentation of financial information. A neutral depiction is not slanted,
weighted, emphasized, de-emphasized or otherwise manipulated to increase the
probability that financial information will be received favorably or unfavorably by
users. Neutral information does not mean information with no purpose or no influence
on behavior. On the contrary, relevant financial information is, by definition, capable of
making a difference in users‘ decisions.
(IASB, 2008) states that the Neutrality is the absence of bias intended to attain a
predetermined result or to induce a particular behavior. Neutral information is free from
bias so that it faithfully represents the economic phenomena that it purports to represent.
Neutral information does not color the image it communicates to influence behavior in a
particular direction. Financial reports are not neutral if, by the selection or presentation
of financial information, they influence the making of a decision or judgment in order to
achieve a predetermined result or outcome. However, to say that financial reporting
information should be neutral does not mean that it should be without purpose or that it
should not influence behavior. On the contrary, relevant financial reporting information
is, by definition, capable of influencing users‘ decisions.
c) Freedom from error
Faithful representation does not imply total freedom from error in the depiction
of an economic phenomenon because the economic phenomena presented in financial
reports are generally measured under conditions of uncertainty. Therefore, most
financial reporting measures involve estimates of various types that incorporate
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management‘s judgment. To represent an economic phenomenon faithfully, an estimate
must be based on the appropriate inputs, and each input must reflect the best available
information. Completeness and neutrality of estimates (and inputs to estimates) are
desirable; however, some minimum level of accuracy is also necessary for an estimate
to be a faithful representation of an economic phenomenon. For a representation to
imply a degree of completeness, neutrality or freedom from error that is impracticable
would diminish the extent to which the information faithfully represents the economic
phenomena that it purports to represent. Thus, to attain a faithful representation, it may
sometimes be necessary to disclose explicitly the degree of uncertainty in the reported
financial information (IASB, 2008).
Faithful representation does not mean accurate in all respects. Free from error
means there are no errors or omissions in the description of the phenomenon, and the
process used to produce the reported information has been selected and applied with no
errors in the process. In this context, free from error does not mean perfectly accurate in
all respects. For example, an estimate of an unobservable price or value cannot be
determined to be accurate or inaccurate. However, a representation of that estimate can
be faithful if the amount is described clearly and accurately as being an estimate, the
nature and limitations of the estimating process are explained, and no errors have been
made in selecting and applying an appropriate process for developing the estimate
(FRS, 2010).
Enhancing qualitative characteristics are complementary to the fundamental
qualitative characteristics. Enhancing qualitative characteristics distinguish more useful
information from less useful information. The enhancing qualitative characteristics are
comparability, verifiability, timeliness and understandability. These characteristics
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enhance the decision-usefulness of financial reporting information that is relevant and
faithfully represented (IASB, 2008).
Chart 2.4 shows the enhancing qualitative characteristics and related ingredients
of these enhancing characteristics.
Chart No.2.4
Components of the enhancing qualitative characteristics
2.10.3. Comparability
Comparability refers to the quality of information that enables users to identify
similarities in and differences between two sets of economic phenomena. Consistency
refers to the use of the same accounting policies and procedures, either from period to
period within an entity or in a single period across entities. Comparability is the goal;
consistency is a means to an end that helps in achieving that goal.
The essence of decision making is choosing between alternatives. Thus,
information about an entity is more useful if it can be compared with similar
information about other entities and with similar information about the same entity for
some other period or some other point in time. Comparability is not a quality of an
FAITHFUL
REPRESENTATI
ON
RELEVANCE
Predictive
Value
Confirmatory
Value
Completeness
Neutrality
Free from
error
Comparability
Verifiability
Timeliness
Understandability
77
individual item of information, but rather a quality of the relationship between two or
more items of information.
Comparability should not be confused with uniformity. For information to be
comparable, like things must look alike and different things must look different. An
overemphasis on uniformity may reduce comparability by making unlike things look
alike. Comparability of financial reporting information is not enhanced by making
unlike things look alike any more than it is by making like things look different.
Some degree of comparability should be attained by maximizing the fundamental
qualitative characteristics. That is to say, a faithful representation of a relevant
economic phenomenon should naturally possess some degree of comparability to a
faithful representation of a similar relevant economic phenomenon by another entity.
Although a single economic phenomenon can be faithfully represented in multiple
ways, permitting alternative accounting methods for the same economic phenomenon
diminishes comparability and, therefore, may be undesirable (IASB, 2008).
Conceptual framework for financial reporting (FASB, 2006) states that
comparability, including consistency, enhances the usefulness of financial reporting
information in making investment, credit, and similar resource allocation decisions.
Comparability is the quality of information that enables users to identify
similarities in and differences between two sets of economic phenomena. Consistency
refers to use of the same accounting policies and procedures, either from period to
period within an entity or in a single period across entities. Comparability is the goal;
consistency is a means to an end that helps in achieving that goal.
The essence of investment, credit, and similar resource allocation decisions is
choosing between alternatives, such as whether to buy shares in Entity A or in Entity B.
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Thus, information about an entity gains greatly in usefulness if it can be compared
with similar information about other entities and with similar information about the
same entity for some other period or some other point in time. Comparability is not a
quality of an individual item of information, but rather a quality of the relationship
between two or more items of information.
In this respect, (FRS, 2010) maintains that, users‘ decisions involve choosing
between alternatives, for example, selling or holding an investment, or investing in one
reporting entity or another. Consequently, information about a reporting entity is more
useful if it can be compared with similar information about other entities and with
similar information about the same entity for another period or another date.
Comparability is the qualitative characteristic that enables users to identify and
understand similarities in, and differences among, items. Unlike the other qualitative
characteristics, comparability does not relate to a single item. A comparison requires at
least two items.
Consistency, although related to comparability, is not the same as the latter.
Consistency refers to the use of the same methods for the same items, either from period
to period within a reporting entity or in a single period across entities. Comparability is
the goal; consistency helps to achieve that goal.
Comparability is not uniformity. For information to be comparable, like things
must look alike and different things must look different. Comparability of financial
information is not enhanced by making unlike things look alike any more than it is
enhanced by making like things look different.
Some degree of comparability is likely to be attained by satisfying the
fundamental qualitative characteristics. A faithful representation of a relevant economic
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phenomenon should naturally possess some degree of comparability with a faithful
representation of a similar relevant economic phenomenon by another reporting entity.
Although a single economic phenomenon can be faithfully represented in multiple
ways, permitting alternative accounting methods for the same economic phenomenon
diminishes comparability.
2.10.4. Verifiability
Verifiability is a quality of information that helps assure users that information
faithfully represents the economic phenomena that it purports to represent. Verifiability
implies that different knowledgeable and independent observers could reach general
consensus, although not necessarily complete agreement, that either: (a) the information
represents the economic phenomena that it purports to represent without material error
or bias; or (b) an appropriate recognition or measurement method has been applied
without material error or bias. To be verifiable, information need not be a single point
estimate. A range of possible amounts and the related probabilities can also be verified.
Verification may be direct or indirect. With direct verification, an amount or other
representation itself is verified, such as by counting cash or observing marketable
securities and their quoted prices. With indirect verification, the amount or other
representation is verified by checking the inputs and recalculating the outputs using the
same accounting convention or methodology. An example is verifying the carrying
amount of inventory by checking the inputs (quantities and costs) and recalculating the
ending inventory using the same cost flow assumption (e.g. average cost or first-in,
first-out) (IASB, 2008).
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2.10.5. Timeliness
Timeliness means having information available to decision makers before it loses
its capacity to influence decisions. Having relevant information available sooner can
enhance its capacity to influence decisions, and a lack of timeliness can rob information
of its potential usefulness. Some information may continue to be timely long after the
end of a reporting period because some users may continue to consider it when making
decisions. For example, users may need to assess trends in various items of financial
reporting information in making investment or credit decisions (IASB, 2008).
2.10.6. Understandability
Understandability is the quality of information that enables users who have a
reasonable knowledge of business and economic activities and financial reporting, and
who study the information with reasonable diligence, to comprehend its meaning.
Relevant information should not be excluded solely because it may be too complex or
difficult for some users to understand. Understandability is enhanced when information
is classified, characterized, and presented clearly and concisely. Comparability also
enhances understandability.
Information cannot influence a particular user‘s decision unless it is presented in a
manner that the user can understand. However, information may be relevant to a
situation even though some people who confront the situation cannot understand it at
least not without help. For example, a traveler in a foreign country may have trouble
ordering from a menu printed in an unfamiliar language. The listing of items on the
menu is relevant to the decision, but the traveler may not be able to use that information
unless it is translated into a language that the traveler understands. Thus, information
may not be useful to a particular user even though it is relevant to the situation the user
faces.
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Similar situations arise frequently in financial reporting. For example, investors or
creditors unfamiliar with actions an entity might take to hedge its exposure to financial
risks might have difficulty understanding a note to the financial statements that explains
its hedging activities and how those activities are reflected in its financial report. That
information, however, is relevant to decisions about the entity and should be
understandable to users who have a reasonable knowledge of hedging activities and
who read and consider the information with reasonable diligence (FASB, 2006).
Although it also, (IASB, 2008) states that the understandability is the quality of
information that enables users to comprehend its meaning. Understandability is
enhanced when information is classified, characterized and presented clearly and
concisely. Comparability can also enhance understandability.
Although presenting information clearly and concisely helps users to comprehend
it, the actual comprehension or understanding of financial information depends largely
on the users of the financial report. Users of financial reports are assumed to have a
reasonable knowledge of business and economic activities and to be able to read a
financial report. In making decisions, users also should review and analyze the
information with reasonable diligence. However, when underlying economic
phenomena are particularly complex, fewer users may understand the financial
information depicting those phenomena. In those cases, some users may need to seek
the aid of an adviser. Information that is relevant and faithfully represented should not
be excluded from financial reports solely because it may be too complex or difficult for
some users to understand without assistance.
In this regard, conceptual framework for financial reporting (FRS, 2010) states
that classifying, characterizing and presenting information clearly and concisely makes
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it understandable. Some phenomena are inherently complex and cannot be made easy to
understand. Excluding information about those phenomena from financial reports might
make the information in those financial reports easier to understand. However, those
reports would be incomplete and therefore potentially misleading. Financial reports are
prepared for users who have a reasonable knowledge of business and economic
activities and who review and analyze the information diligently. At times, even well-
informed and diligent users may need to seek the aid of an adviser to understand
information about complex economic phenomena.
2.11. Constraints on Financial Reporting
In addition to the qualitative characteristics of relevance, faithful representation,
comparability, and understandability, decision-useful financial reporting is subject to
two pervasive constraints: materiality and benefits that justify costs. The two
constraints are linked because each concerns why some information is included in
financial reports and other information, or the same type of information in different
circumstances, is not (FASB, 2006). Chart 2.5 shows the constraints on financial
reporting and related ingredients of these constraints.
Chart No.2.5
Constraints on Financial Reporting
Constraints on Financial Reporting
Materiality Benefits and Cost
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2.11.1. Constraints on Financial Reporting - Materiality
Information is material if its omission or misstatement could influence the
decisions that users make on the basis of an entity‘s financial information. Because
materiality depends on the nature and amount of the item judged in the particular
circumstances of its omission or misstatement, it is not possible to specify a uniform
quantitative threshold at which a particular type of information becomes material. When
considering whether financial information is a faithful representation of what it purports
to represent, it is important to take into account materiality because material omissions
or misstatements will result in information that is incomplete, biased or not free from
error (IASB, 2008).
2.11.2. Constraints on Financial Reporting – Benefits and Cost
The conceptual framework for financial reporting (IASB, 2008) says that, financial
reporting imposes costs; the benefits of financial reporting should justify those costs.
Assessing whether the benefits of providing information justify the related costs will
usually be more qualitative than quantitative. In addition, the qualitative assessment of
benefits and costs will often be incomplete.
The costs of providing information include costs of collecting and processing the
information, costs of verifying it, and costs of disseminating it. Users incur the
additional costs of analysis and interpretation. Omission of decision-useful information
also imposes costs, including the costs that users incur to obtain or attempt to estimate
needed information using incomplete data in the financial report or data available
elsewhere. Preparers expend the majority of the effort towards providing financial
information. However, capital providers ultimately bear the cost of those efforts in the
form of reduced returns. Financial reporting information helps capital providers make
better decisions, which results in more efficient functioning of capital markets and a
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lower cost of capital for the economy as a whole. Individual entities also enjoy benefits,
including improved access to capital markets, favorable effect on public relations, and
perhaps lower costs of capital. The benefits may also include better management
decisions because financial information used internally is often based at least partly on
information prepared for general purpose financial reporting purposes.
2.12. Accounting Standards
Accounting Standards are used as one of the main compulsory regulatory
mechanisms for preparation of general-purpose financial reports and subsequent audit of
the same, in almost all countries of the world. Accounting Standards are concerned with
the system of measurement and disclosure rules for preparation and presentation of
financial statements.
They appear with a set of authoritative statements of how particular types of
transactions, events and other costs should be recognized and reported in the financial
statements. Accounting Standards are devised to furnish useful information to different
users of the financial statements, to such as shareholders, creditors, lenders,
management, investors, suppliers, competitors, researchers, regulatory bodies and
society at large and so on. In fact, such statements are designed and prescribed so as to
improve & benchmark the quality of financial reporting.
Thorell and Whittington (1994) describe accounting as an important language of
commerce. Like all languages, its effectiveness as a means of communication is aided
by precise definition of words and rules as to its structure. Moreover, users‘ costs may
be reduced, and the value of the data for comparative purposes enhanced, if all
companies use the same definitions and rules their financial reports.
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Efforts to achieve this on a national level, by means of company law or the
regulatory activities of professional and other bodies are often referred to as
standardization, the rules being referred to as Accounting Standards.
Littleton (1953) defines; ―A standard is an agreed upon criteria of what is proper
practice in a given situation; a basis for comparison and judgment; a point of departure
when variation is justifiable by the circumstances and reported as such. Standards are
not designed to confine practice within rigid limits but rather to serve as guideposts to
truth, honesty and fair dealing. They are not accidental but intentional in origin; they are
expected to be expressive of the deliberately chosen policies of the highest types of
businessmen and the most experienced accountants; they direct a high but attainable
level of performance, without precluding justifiable departures and variations in the
procedures employed.‖
Bromwich (1985) observes, Accounting Standards are uniform rules for financial
reporting applicable either to all or to a certain class of entity promulgated by what is
perceived of as predominantly an element of the accounting community specially
created for this purpose. Standard setters can be seen as seeking to prescribe a preferred
accounting treatment from the available set to method for treating one or more
accounting problems. Other policy statement by the profession will be referred to as
recommendations.
In the similar line, Harvey and Keer (1981) explain that a standard in accounting
is ―a method or an approach to preparing accounts which has been chosen and
established by the bodies overseeing the profession.‖ Thus, a standard can be viewed as
some form of rule. They further state that ―… the word standard id preferred to principle
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because a standard is pragmatic and it can only do good because it will remove any
inhibition about its replacement with a better standard, if this becomes appropriate‖.
The Canadian Institute of Chartered Accounting (CICA) has given a broad
definition of Accounting Standards. According to it, ―Accounting Standards are solid
principles for financial accounting and reporting developed through a structured
standard setting body (an Accounting Standard Board). Accounting Standards spell out
how transactions and other events are to be recognized, measured, presented and
disclosed in financial statements. The purpose of such standards is to meet the needs of
users of financial statement by providing the information considered necessary to make
informed decisions.‖
Van der Tas (1988) define standards as any financial reporting rule published by
either the government or a private standard setting body. These rules can refer either to
the degree of disclosure or to the accounting method to be applied.
Accounting Standards can be described as a vehicle whereby the wisdom and
experience of the profession emerges as a consensus in a complex and changing
economic and business situation in preference to the views of individual compilers of
financial statements. Accounting as a ―language of business‖ communicates the
financial results and health of an enterprise to various interested parties by means of
periodical financial statements. Like any other language, accounting should have its
grammar (set of rules) and this grammar is said to be encoded in Accounting Standards.
In an effort to generate comparable and reliable accounting information to help
investors, creditors and others, each country has developed its own national financial
Accounting Standards. These standards reflect the culture, history and the
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characteristics of accounting problems facing that country. In some countries, the
professional bodies formulate the financial Accounting Standards.
Nobes (1987)16
observes professional accounting standards are also endowed
with varying degrees of authority in different countries. A standard can range from one
that is legally enforced (e.g., Canada), to one that is usually obeyed and is binding on
auditors (e.g., U.K.), to one that is persuasive (e.g., The Netherlands), to one that is
unimportant (e.g. domestic pronouncement of the accountancy body in West Germany),
to one that is largely unknown to companies or auditors.
Accounting Standards are formulated with a view to harmonize different
accounting policies in use in a country. The objective of Accounting Standard is, to
reduce the accounting alternative in the preparation of financial statements within the
bounds of rationality, thereby ensuring comparability of financial statements of different
enterprises with a view to provide meaningful information to various users of financial
statements to enable them to make informed economic decisions.
2.12.1. International Accounting Standards (IAS)
The concept of establishing international standards of accounting germinated
around the turn of the century when, in 1904, the first international congress of
accountants was held in St. Louis. However, the history of International Accounting
Standards really began in 1966, with the proposal to establish an international study
group comprising the Institute of Chartered Accountants of England and Wales
(ICAEW), American Institute of Certified Public Accountants (AICPA) and Canadian
Institute of Chartered Accountants (CICA). In February 1967, this resulted in the
foundation of the Accountants International Study Group (AISG), which began to
publish papers on important topics every few months and created and appetite for
change. Many of these papers led the way for the standards that followed. In the
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meantime, international accounting diversity was one of topics discussed in the tenth
International Congress of Accountants in 1972. Accounting bodies of some countries
attending the meeting were concerned in reducing the degree of variation in
international accounting practices. As a result, in 1973, the International Accounting
Standards Committee (IASC) was formed. The founders of this Committee included ten
accounting bodies from Australia, Canada, France, Japan, Mexico, Netherlands, West
Germany, the Unites States, United Kingdom and Ireland.
The objectives of the IASC are : 1) to formulate and publish in the public interest
Accounting Standards to be observed in the presentation of financial statement and to
promote their worldwide acceptance and observance; and 2) to work generally for the
improvement and harmonization of regulations, Accounting Standards and procedures
relating to the presentation of financial statements.
Between 1973 and 2001, the IASC promulgated 41standards. With the renaming
of IASC as IASB, the objectives of the latter also changed. At present, the IASB: is
charged with the following objectives: a) to develop, in the public interest, a single set
of high quality, understandable and enforceable global Accounting Standards that
require high quality, transparent and comparable information in financial statement and
other financial reporting to help participants in the world‘s capital market and other
users make economic decisions; b) to promote the use and rigorous application of those
standards; c) to bring about convergence of National Accounting Standards and
International Accounting Standards and International Financial Reporting Standards to
high quality solutions.
To support the effective functioning of the former IASC, the SIC was also
constituted in 1997 to assist the former on tackling the contentious accounting issues
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that needed authoritative guidance to stop widespread variations in accounting practices.
In tune with a change in nomenclature from IASC to IASB, the SIC was renamed as
International Financial Reporting Interpretations Committee (IFRIC). In addition, the
Standards Advisory Council (SAC) was also established. The present status of
International Accounting Standards are presented under; a) Organization Structure of
the IASC Foundation, b) progress of IAS/IFRS,
a) Organization Structure of the IASC Foundation
The salient features of institutional structure of establishing Financial Reporting
Standards are presented under (IASC) Foundation; Standard Advisory Council (SAC);
International Financial Reporting Interpretation Committee (IFRIC); International
Accounting Standards Board (IASB) and International Financial Reporting Standards
(IFRS).
From 1973 until 2001 the body in charge was the International Accounting
Standards Committee (IASC). IASC was created in 1973 between the professional
accountancy bodies in 9 countries and from the year 1982 its membership comprised of
all the accountancy bodies who were members of the International Federation of
Accountants (IFAC). The principle significance of the IASC was to encourage National
Accounting Standard setters around the world to improve and harmonize National
Accounting Standards.
The members of the IASC who were Professional Accountancy Bodies of the
world delegated the responsibility to the IASC Board. The IASC Board was responsible
for all activities including standard setting activity. The Standards adopted by the IASC
Board were known as the International Accounting Standards (IAS).
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b) IASC Foundation
The name of the organization to monitor the promulgation and implementation of
IFRS is the International Accounting Standards Committee Foundation (IASC).
The IASC was approved in its original form by the erstwhile International
Accounting Standards Committee (IASC) in the year 2000 and by the members of the
IASC at a meeting on 24th May 2000.
The erstwhile IASC Board had appointed a nominating committee to appoint the
first Trustees. In execution of its duties the first trustees formed the International
Accounting Standards Committee Foundation on 6th February 2001.
There is a key difference between the erstwhile IASC and the present IASC
Foundation. The members of the IASC were the accounting bodies of the world who
were also the members of the IFAC. The IASC Foundation does not have such a
relationship with these global accounting bodies.
The IASC Foundation is an independent not for profit private sector organization.
Its Governance rests with its 22 Trustees.
It receives funding in the form of donations from organizations, accounting firms,
central banks and capital market regulators amongst others.
The governance structure within IASC foundation comprises its key parts namely:
Monitoring Board, Trustees, International Accounting Standards Board (IASB),
International Financial Reporting Interpretation Committee (IFRIC) and Standards
Advisory Council (SAC).
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Monitoring Board
The Monitoring Board plays a pivotal role as the crucial link between the
Trustees and the Public Authorities that have generally overseen Accounting Standard
setters. This link between the Trustees and the Monitoring Board is established by way
of a Memorandum of Understanding (MoU).
The monitoring board has the authority to participate in the process and the
appointment of Trustees. It has the authority to overlook whether the trustees are
discharging their duties in accordance with the constitution. The Trustees make an
annual written report to the Monitoring Board.
Trustees
The Trustees of the IASC foundation are responsible for its Governance including
funding. The Trustees are publically accountable to the Monitoring Board of the capital
market authorities.
The trustees are, in addition to the governance of the foundation, responsible for
the appointment of the members of the International Accounting Standards Board
(IASB), the International Financial Reporting Interpretation Committee (IFRIC) and the
Standards Advisory Council (SAC). They also have the power to terminate non
performing members of the above board, committee and council.
2.12.2. International Financial Reporting Interpretation Committee (IFRIC)
The interpretative body of the IASC Foundation is IFRIC. It is responsible for
developing guidance on the interpretations of the application of both the IAS and IFRS.
Such guidance on interpretation would be on financial reporting issues not specifically
dealt with in the IAS and IFRS. It would also be on those issues where there are
conflicting or divergent interpretations in the absence of an authoritative guidance.
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IFRIC comprises 14 members appointed by the trustees for a renewable period of
three years. No specific geographical allocations have been spelt out in the constitution.
Going by the profile of the existing members that comprise the IFRIC it is apparent that
the committee does not have representations from India.
The constitution provides that the Trustees, as they deem necessary, appoint
nonvoting observers and representatives of the regulatory authorities who shall have the
right to attend and speak at the meeting. Accordingly, IOSCO (International
Organization of Securities Commission) and European Commission are presently the
observers.
2.12.3. International Accounting Standards Board (IASB)
International Accounting Standards Committee (IASC) was founded in 1973
through an agreement among independent accounting bodies in Australia, Canada,
France, Germany, Japan, Mexico, the Netherlands, the United Kingdom, Ireland, and
the United States, driven by the need to standardize international accounting practices
and terms. Initially, it was composed of volunteer representatives from 13 countries and
three international organizations. Members designated two representatives and one
technical advisor to serve on different committees. Its board of trustees had additional
non-voting observer members from the International Organization of Security
Commissions (IOSCO), the Financial Accounting Standards Board (FASB), and the
European Commission, among others.
IASC had a number of voluntary advisory groups to support its activities, namely
the Consultative Group, Standard Interpretations Committee, Advisory Council, and
Steering Committee. After 25 years, IASC formed the temporary Strategy Working
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Party in 1997 to review process effectiveness. This committee‘s major task was to
merge national and global accounting standards.
The IASC foundation is incorporated and was founded in London England.
Incorporated as a not-for-profit, its mission was and is today to provide the world‘s
integrating capital markets with a common language for financial reporting. It became
the parent entity of the International Accounting Standards Board (IASB), a subsidiary
established as an independent body to set Accounting Standards. This structure
continues today, serving more than 100 member countries which abide by its standards.
The IASB has two principal aims: 1) develop and issue International Financial
Reporting Standards and Exposure Drafts, and 2) approve interpretations developed by
International Financial Reporting Interpretations Committee (IFRIC).
a) Organizational Structure
Currently, IASB has five primary components (the Chart 2-6 shows how they
interact):
International Accounting Standards Committee (IASC) Foundation (22 trustees, no
staff) oversees IASB and its structure and strategy, and is responsible for fundraising.
Since 2005, the trustees represent these regions: North America (6), Europe (6),
Asia/Oceania (6), and other regions (4). The trustees vote by simple majority and
constitutional changes require a three-quarters majority.
International Accounting Standards Board, or IASB (12 full-time and 2 part-time
staff) has sole responsibility for establishing International Financial Reporting
Standards (IFRS).
International Financial Reporting Interpretations Committee, or IFRIC (14
members), develops the interpretations for approval by IASB.
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Standards Advisory Council, or SAC (20 members), provides a forum where IASB
consults individuals and representatives of organizations affected by its work. It is
committed to the development of rigorous International Financial Reporting
Standards (IFRS). The council supports IASB by promoting the adoption of IFRS
world-wide. This includes publishing articles supportive of IFRS and participating in
public meetings.
Working Groups serve as expert task forces for individual projects.
Chart No.2.6
Primary components of IASB
Source: IAS website, www.iasplus.com/restruct/restruct.htm#Top
IASB‘s current organizational structure offers numerous advantages:
The IASC Foundation‘s legal structure enables it to raise funds through
donations, member fees, and government contributions. Fee-paying members
are accounting firms and international corporations.
The IASC Foundation focuses on strategic questions and administrative
functions as separate responsibilities from setting reporting standards.
95
The separate strategic and administrative sections enable it to objectively
assess its effectiveness. There is a process to ensure that SAC and IFRIC fulfill
their support roles effectively.
IASB‘s status as an independent body, while cooperating with national
accounting entities, gives it leverage with the practitioners who are members of
these bodies to enforce compliance with the Accounting Standards.
Trustees are independent experts in accounting and finance. They only provide
information to the industry and are not involved in administration or
governance. They are appointed by the IASC, chosen from its members, and
operate through subsidiary entities.
Through the SAC, IASB can get feedback from the end users of its standards.
It believes that, in order to promote its standards and keep them in line with
current practices, the community must provide ongoing input.
2.12.4. Financial Accounting Standards Board (FASB)
Historically, the Accounting Standards and procedures in the United States were
established by the Accounting Principles Board of the American Institute of Certified
Public Accountants. In 1973, the Financial Accounting Foundation (FAF) was launched
as an independent, private-sector organization to:
Establish and improve financial accounting and reporting standards;
Educate constituents about those standards;
Administer the standard-setting boards Financial Accounting Standards Board
(FASB), Governmental Accounting Standards Board (GASB), and Advisory
Councils;
Select the members of the standard-setting boards and advisory councils; and
Protect the independence and integrity of the standard-setting process.
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FASB is responsible for the development of private sector Accounting
Standards. It is granted all power and authority by FAF to set standards for all non-
governmental, public, private, and not-for-profit enterprises. Its standards are officially
recognized by the Securities and Exchange Commission4 and the American Institute of
Certified Public Accountants.
Its mission is to establish and improve standards of financial accounting and
reporting for the guidance and education of the public, including auditors and users of
financial information. FASB works on accounting concepts and standards, through
research, to gain new insights and ideas. Activities are open to public participation, and
views are actively solicited from membership groups.
In 2002, the Sarbanes-Oxley Act amended the U.S. Securities Act of 1933 by
broadening the scope of FASB, so that it can,
Be organized as a private entity;
Have a board of trustees;
Be funded, per section 109 of the Sarbanes-Oxley Act, by fees from publicly
traded companies, based on market capitalization and sales;
Ensure prompt decisions by adopting procedures with a majority vote; and
Keep standards current for the protection of investors.
These changes effectively made FASB a quasi-governmental agency with ―the
effect of law.‖
a) Organizational Structure
The membership of FASB is composed of industry players, including banks,
public accounting firms, and certified public accountants. The members of its board of
97
trustees are nominated by eight sponsoring organizations: 1) American Accounting
Association, 2) American Institute of Certified Public Accountants, 3) Association of
Investment Management and Research, 4) Financial Executives International,
5) Government Finance Officers Association, 6) Institute of Management Accountants,
7) National Association of State Auditors, Comptrollers, and Treasures, and
8) Securities Industry Association.FAF is a U.S. non-profit organization. It and all of its
subsidiaries are located in Norwalk, Connecticut. Chart 2.7 demonstrates the
relationships among the entities.
Chart No.2.7
Financial Accounting Foundation and component
Source: www.seepnetwork.org
Like IASB, FASB works closely with its end users. It provides a consistent voice
from the private sector which informs and advises on standards. As with IASB, FASB
was intended to be independent of government control, although its budget is now
government mandated. FASB‘s legal and organizational structures are similar to
IASB‘s. Its original organization was an accounting body, which certified members and
promoted high quality, uniform standards.
b) Standards Advisory Council (SAC)
The members of the SAC are appointed by the Trustees. The objective of the SAC
is to advice the IASB on agenda decisions and priorities. The constitution provides that
Financial Accounting Foundation
[FAF]
Financial Accounting
Standard Board
[FASB]
Financial Accounting
Standard Advisory Council
Government Accounting Standards
Board (GASB)
Government Accounting Standards Advisory Council
98
the council may comprise of 30 or more members. No geographical allocations have
been specified. Members appointed on the council would represent a wide group of
organizations and individuals who are affected by or with an interest in international
financial reporting (Devarajan, 2009).
c) Progress of IAS/IFRS
From 1973 until 2001 the International Accounting Standards Committee
(IASC) released a series of International Accounting Standards (IAS). Meanwhile, the
IASB began a program of reviewing major standards with a view to improve the quality
of international standards particularly by removing as many options as possible, by
improving disclosure, and providing more implementation guidance so that IASs
constituted a rigorous set of standards (Pricewaterhousecoopers, 1998).
International Accounting Standards (IAS) initially tended to be too broad,
allowing many alternative accounting treatments to accommodate country differences.
This was a serious weakness in achieving the objective of comparability. To gain
acceptability of its standards, the IASC undertook a project (called the comparability
project) aimed at enhancing comparability of financial statements by reducing the
alternative treatments in 1989. An important part of this effort was its work plan to
produce a comprehensive core set of high-quality standards (Core Standards Project).
The IASC also persuaded the stock exchange institutions, particularly International
Organization of Securities Commissions (IOSCO) and its member the Securities and
Exchange Commission (SEC), to accept financial statements prepared in accordance
with IASs for multinational registration. This effort became successful in 1993 when
IOSCO announced that it would recognize IAS 7 and in the following years‘
announcement, as it would accept 14 IASB standards as they were. Finally, IOSCO
99
recommended acceptance of the use of IAS by its members in may 2000. In June 2000,
the European Commission proposed that all listed companies in the EU should be
required to prepare their consolidated financial statements using IAS.
Taking into consideration the efforts of IASC and acceptance of 41 IAS by the
IASB, it may be construed that the latter has so far issued 47 Exposure Drafts and has
come out with 41 IASs. Further, the IASB has issued 13 IFRSs and also guidelines
titled ―Framework for the Preparation and Presentation of Financial Statements‖.
Sometimes a standard is withdrawn and new standard on the same topic is issued if it
becomes necessary. The lists of IASs, IFRSs, IFRIC and SIC are shown in Table 2.1 -
2.4. At present, the IASB has recognized 41 IAS as its own standards with the old
nomenclature being International Accounting Standards (IAS) and they are to be
considered as IFRS per se and further it has recognized 11 Standing Interpretations
(SIC) of IASC as its own interpretations. Since 2011, IASB has promulgated 13 IFRS.
Table No.2.1
International Accounting Standards (IAS)
IAS TITLE
IAS1 Presentation of Financial Statements
IAS2 Inventories
IAS3 Consolidated Financial Statements – Originally issued 1976, effective 1 Jan 1977.
Superseded in 1989 by IAS 27 and IAS 28
IAS4 Depreciation Accounting – Withdrawn in 1999, replaced by IAS 16, 22, and 38, all of which were issued or revised in 1998
IAS5 Information to Be Disclosed in Financial Statements – Originally issued October
1976, effective 1 January 1997. Superseded by IAS 1 in 1997
IAS6 Accounting Responses to Changing Prices – Superseded by IAS 15, which was withdrawn December 2003
IAS7 Statement of Cash Flows
IAS8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS9 Accounting for Research and Development Activities – Superseded by IAS 38
effective 1.7.99
IAS10 Events After the Reporting Period
IAS11 Construction Contracts
IAS12 Income Taxes
IAS13 Presentation of Current Assets and Current Liabilities – Superseded by IAS 1
IAS14 Segment Reporting
IAS15 Information Reflecting the Effects of Changing Prices – Withdrawn December 2003
IAS16 Property, Plant and Equipment
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IAS17 Leases
IAS18 Revenue
IAS19 Employee Benefits
IAS20 Accounting for Government Grants and Disclosure of Government Assistance
IAS21 The Effects of Changes in Foreign Exchange Rates
IAS22 Business Combinations – Superseded by IFRS 3 effective 31 March 2004
IAS23 Borrowing Costs
IAS24 Related Party Disclosures
IAS25 Accounting for Investments – Superseded by IAS 39 and IAS 40 effective 2001
IAS26 Accounting and Reporting by Retirement Benefit Plans
IAS27 Consolidated and Separate Financial Statements – Superseded by IFRS 10, IFRS 12
and IAS 27 (rev. 2011) effective 2013
IAS28 Investments in Associates – Superseded by IAS 28 (rev. 2011) and IFRS 12
effective 2013
IAS29 Financial Reporting in Hyperinflationary Economies
IAS30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions –
Superseded by IFRS 7 effective 2007
IAS31 Interests In Joint Ventures – Superseded by IFRS 11 and IFRS 12 effective 2013
IAS32 Financial Instruments: Presentation – Disclosure provisions superseded by IFRS 7
effective 2007
IAS33 Earnings Per Share
IAS34 Interim Financial Reporting
IAS35 Discontinuing Operations – Superseded by IFRS 5 effective 2005
IAS36 Impairment of Assets
IAS37 Provisions, Contingent Liabilities and Contingent Assets
IAS38 Intangible Assets
IAS39 Financial Instruments: Recognition and Measurement – Superseded by IFRS 9 effective 2013
IAS40 Investment Property
IAS41 Agriculture
Source: www.iasplus.com
Table No.2.2
International Financial Reporting Interpretation Committee (IFRIC)
IFRIC TITLE
IFRIC1 Changes in Existing Decommissioning, Restoration and Similar Liabilities
IFRIC2 Members' Shares in Co-operative Entities and Similar Instruments
IFRIC3 Emission Rights Withdrawn June 2005
IFRIC4 Determining Whether an Arrangement Contains a Lease
IFRIC5 Rights to Interests Arising from Decommissioning, Restoration and Environmental
Rehabilitation Funds
IFRIC6 Liabilities Arising from Participating in a Specific Market - Waste Electrical and
Electronic Equipment
IFRIC7 Applying the Restatement Approach under IAS 29 Financial Reporting in
Hyperinflationary Economies
IFRIC8 Scope of IFRS 2 Withdrawn effective 1 January 2010
IFRIC9 Reassessment of Embedded Derivatives
IFRIC10 Interim Financial Reporting and Impairment
IFRIC11 IFRS 2: Group and Treasury Share Transactions Withdrawn effective 1 January
2010
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IFRIC12 Service Concession Arrangements
IFRIC13 Customer Loyalty Programmers
IFRIC14 IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements
and their Interaction
IFRIC15 Agreements for the Construction of Real Estate
IFRIC16 Hedges of a Net Investment in a Foreign Operation
IFRIC17 Distributions of Non-cash Assets to Owners
IFRIC18 Transfers of Assets from Customers
IFRIC19 Extinguishing Financial Liabilities with Equity Instruments
IFRIC20 Stripping Costs in the Production Phase of a Surface Mine
Source: www.iasplus.com
Table No.2.3
International Financial Reporting Standards (IFRS)
IFRS TITLE
IFRS1 First-time Adoption of International Financial Reporting Standards
IFRS2 Share-based Payment
IFRS3 Business Combinations
IFRS4 Insurance Contracts
IFRS5 Non-current Assets Held for Sale and Discontinued Operations
IFRS6 Exploration for and Evaluation of Mineral Assets
IFRS7 Financial Instruments: Disclosures
IFRS8 Operating Segments
IFRS9 Financial Instruments
IFRS10 Consolidated Financial Statements
IFRS11 Joint Arrangements
IFRS12 Disclosure of Interests in Other Entities
IFRS13 Fair Value Measurement
Source: www.iasplus.com
Table No.2.4
Standing Interpretations Committee (SIC)
SIC TITLE
SIC 1 Consistency – Different Cost Formulas for Inventories Superseded
SIC 2 Consistency – Capitalization of Borrowing Costs Superseded
SIC 3 Elimination of Unrealized Profits and Losses on Transactions with Associates
Superseded
SIC 5 Classification of Financial Instruments - Contingent Settlement Provisions
Superseded
SIC 6 Costs of Modifying Existing Software Superseded
SIC 7 Introduction of the Euro
SIC 8 First-Time Application of IASs as the Primary Basis of Accounting Superseded
SIC 9 Business Combinations – Classification either as Acquisitions or Uniting of
Interests Superseded
SIC 10 Government Assistance – No Specific Relation to Operating Activities
SIC 11 Foreign Exchange – Capitalization of Losses Resulting from Severe Currency
Devaluations Superseded
SIC 12 Consolidation – Special Purpose Entities
SIC 13 Jointly Controlled Entities – Non-Monetary Contributions by Ventures
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SIC 14 Property, Plant and Equipment – Compensation for the Impairment or Loss of
Items Superseded
SIC 15 Operating Leases – Incentives
SIC 16 Share Capital – Reacquired Own Equity Instruments (Treasury Shares) Superseded
SIC 17 Equity – Costs of an Equity Transaction Superseded
SIC 18 Consistency – Alternative Methods Superseded
SIC 19 Reporting Currency – Measurement and Presentation of Financial Statements
under IAS 21 and IAS 29 Superseded
SIC 20 Equity Accounting Method – Recognition of Losses Superseded
SIC 21 Income Taxes – Recovery of Revalued Non-Depreciable Assets
SIC 22 Business Combinations – Subsequent Adjustment of Fair Values and Goodwill
Initially Reported Superseded
SIC 23 Property, Plant and Equipment – Major Inspection or Overhaul Costs Superseded
SIC 24 Earnings Per Share – Financial Instruments and Other Contracts that May Be
Settled in Shares Superseded
SIC 25 Income Taxes – Changes in the Tax Status of an Enterprise or its Shareholders
SIC 27 Evaluating the Substance of Transactions in the Legal Form of a Lease
SIC 28 Business Combinations – 'Date of Exchange' and Fair Value of Equity Instruments
Superseded
SIC 29 Disclosure – Service Concession Arrangements
SIC 30 Reporting Currency – Translation from Measurement Currency to Presentation
Currency Superseded
SIC 31 Revenue – Barter Transactions Involving Advertising Services
SIC 32 Intangible Assets – Web Site Costs
SIC 33 Consolidation and Equity Method – Potential Voting Rights and Allocation of
Ownership Interests Superseded
Source: www.iasplus.com
2.12.5. Accounting Standards in India
In recent years, there has been an unprecedented increase in the awareness about
the need for and importance of Accounting Standards in India. The Accounting
Standards which lay down sound and wholesome principles for recognition,
measurement, presentation and disclosure of information in the financial statements
improve substantially the quality of financial reporting by an enterprise. The
Accounting Standards tend to standardize diverse accounting practices with a view to
eliminate, to the extent possible, in comparability of information contained in the
financial statements of various enterprises. The Accounting Standards also improve the
transparency of financial statements by requiring enhanced disclosures.
Realizing the significance of Accounting Standards in improving the quality of
financial reporting, the Accounting Standards have been granted legal recognition under
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the Companies Act, 1956, which require Accounting Standards to be followed by all
companies. Apart from the Companies Act, 1956, various regulatory bodies, e.g., the
Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI) and
the Insurance Regulatory and Development Authority (IRDA) also require compliance
with the Accounting Standards issued by the Institute by their respective constituents.
This is a clear manifestation of the significance of the Accounting Standards and high
quality of Accounting Standards being issued by the Institute of Chartered Accountants
of India (ICAI).
The Institute of Chartered Accountants of India (ICAI) is a statutory body
established under the Chartered Accountants Act, 1949 (Act No XXXVIII of 1949) for
the regulation of the profession of chartered accountants in India. During its 61 years of
existence, ICAI has achieved recognition as a premier accounting body not only in the
country but also globally, for its contribution in the fields of education, professional
development, maintenance of high accounting, auditing and ethical standards. ICAI now
is the second largest accounting body in the whole world. It is also a founder member of
various international professional bodies such as the IFAC, CAPA, and SAFA besides a
member of International Accounting Standards Board (IASB). Being a premier
accounting body in the country, the ICAI took upon itself the leadership role in
standards setting process. The developments in India have been presented under:
Accounting Standards in India; and financial reporting regulation in India.
As of 2010, the Institute of Chartered Accountants of India has issued 32
Accounting Standards. These are numbered AS-1 to AS-7 and AS-9 to AS-32 (AS-8 is
no longer in force since it was merged with AS-26). Compliance with Accounting
Standards issued by ICAI has become a statutory requirement with the notification of
companies (Accounting Standards) rules, 2006 by the government of India. Before the
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constitution of the National Advisory Committee on Accounting Standards (NACAS),
the institute was the sole Accounting Standard setter in India. However NACAS is not
an independent body. It can only consider Accounting Standards recommended by ICAI
and advise the government of India to notify them under the companies Act, 1956.
Further the Accounting Standards so notified are applicable only to companies
registered under the companies act, 1956. For all other entities the Accounting
Standards issued the ICAI continue to apply.
Table No.2.5
Accounting Standards issued by the (ICAI) As On December 2011
No AS No
Title of the Accounting Standards Mandatory date
1 AS 1 Disclosure of Accounting Policies 1.4.1991/1.4.1993
2 AS 2 Valuation of Inventories 1.4.1999
3 AS 3 Cash Flow Statements 1.4.2001
4 AS 4 Contingencies and Events Occurring after the Balance Sheet Date
1.4.1995
5 AS 5 Net Profit or Loss for the Period, Prior Period Items and change
in Accounting Policies 1.4.1996
6 AS 6 Depreciation Accounting 1.4.1995
7 AS 7 Construction Contracts(revised 2002) 1.4.2003
8 AS 8 Accounting for Research and Development 1.4.1991/1.4.1993
9 AS 9 Revenue Recognition 1.4.1991/1.4.1993
10 AS 10 Accounting for Fixed Assets 1.4.1991/1.4.1993
11 AS 11 Effects of Changes in Foreign Exchange Rates (revised 2003) 1.4.1991/1.4.1993
12 AS 12 Accounting for Government Grants 1.4.1994
13 AS 13 Accounting for Investments (issued 1993) 1.4.1995
14 AS 14 Accounting for Amalgamations 1.4.1995
15
AS 15 Accounting for Retirement Benefits in the Financial Statements of Employers
1.4.1995
AS 15 Employee Benefits (revised 2005) 1.4.2006
16 AS 16 Borrowing Costs 1.4.2000
17 AS 17 Segment Reporting 1.4.2001
18 AS 18 Related Party Disclosures 1.4.2001
19 AS 19 Leases 1.4.2001
20 AS 20 Earnings per Share 1.4.2001
21 AS 21 Consolidated Financial Statements 1.4.2001
22 AS 22 Accounting for Taxes on Income 1.4.2001
23 AS 23 Accounting for Investments in Associates in Consolidated
Financial Statements 1.4.2002
24 AS 24 Discontinuing Operations 2004-2005
25 AS 25 Interim Financial Reporting 1.4.2002
26 AS 26 Intangible Assets 2003-2004
27 AS 27 Financial Reporting of Interests in Joint Ventures 1.4.2002
28 AS 28 Impairment of Assets 1.4.2004
29 AS 29 Provisions, Contingent Liabilities and Contingent Assets 1.4.2004
105
30 AS 30 Financial Instruments: Recognition and Measurement 1.4.2009-2011
31 AS 31 Financial Instrument: presentation 1.4.2009-2011
32 AS 32 Financial Instruments: Disclosures 1.4.2009-2011 Sources: (1) http://www.saralaccounts.com, (2) http://www.icai.org, and (3) ICAI (2006) Compendium of
Accounting Standards, New Delhi, p 39- 635
2.12.6. International Financial Reporting Standards (IFRS)
The accounting standards board of the Institute of Chartered Accountants of India
(ICAI) was constituted on 21 April, 1977, to formulate Accounting Standards applicable
to Indian enterprises. Initially, the Accounting Standards were recommendatory in
nature and gradually the Accounting Standards were made mandatory. The legal
recognition to the Accounting Standards was accorded for the companies in the
companies Act, 1956, by introduction of Section 211(3C) through the companies
(Amendment) Act, 1999, whereby it is required that the companies shall follow the
Accounting Standards notified by the central government on a recommendation made
by the National Advisory Committee on Accounting Standards (NACAS) constituted
under section 210Aof the said Act.
The government of India, ministry of company affairs (now ministry of corporate
affairs) notified Accounting Standards in companies (Accounting Standards) rules, 2006
by notification no. G.S.R. 739(E), dated 7 December, 2006, prescribing Accounting
Standards 1 to 7 and 9 to 29 as issued by ICAI. It also issued companies (Accounting
Standards) amendment rules, 2008 by notification no. G.S.R. no. 212 (E), dated 27
March, 2008 making some modification in existing rules so as to harmonize them with
Accounting Standards issued by ICAI. These standards are applicable to preparation of
general purpose financial statements for accounting periods commencing on or after 7
December, 2006. It may be mentioned that the Accounting Standards notified by the
government are virtually identical with the Accounting Standards, read with the
Accounting Standards interpretations, issued by ICAI.
106
Reserve Bank of India (RBI) in case of banks, the Insurance Regulatory and
Development Authority (IRDA) in case of insurance companies and the Securities and
Exchange Board of India (SEBI) in case of all listed companies, requires compliance
with the Accounting Standards issued by ICAI.
ICAI, being a full-fledged member of the International Federation of Accountants
(IFAC), while formulating the Accounting Standards (ASs), the ASB gives due
consideration to International Accounting Standards (IASs) issued by the International
Accounting Standards Committee (IASC) or International Financial Reporting
Standards (IFRSs) issued by the IASB, as the case may be, and try to integrate them, to
the extent possible. However, where departure from IFRS is warranted keeping in view
the Indian conditions, the ASs have been modified to that extent.
Further, the endeavor of the ICAI is not only to bridge the gap between ASs and
IFRSs by issuance of new AS but also to ensure that the existing ASs are in line with
the changes in international thinking on various accounting issues. The National
Committee on Accounting Standards (NACAS) constituted by the central government
for recommending Accounting Standards to the Government, while reviewing the AS
issued by the ICAI, considers the deviations in the AS, if any, from the IFRSs and
recommends to the ICAI to revise the AS wherever it considers that the deviations are
not appropriate.
The term International Financial Reporting Standards (IFRSs) includes IFRSs,
IASs and interpretations originated by the IFRIC or its predecessor, the former Standing
Interpretations Committee (SIC). IFRS are increasingly being recognized as global
reporting standards for financial statements. 'National GAAP' is becoming rare. As
global capital markets become increasingly integrated, many countries are moving to
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IFRS. More than 100 countries such as European Union, Australia, New Zealand and
Russia currently permit the use of IFRS in their countries. ICAI / MCA has also
expressed their view that IFRSs should be adopted in India for the public interest
entities such as listed entities, banks and insurance entities and large-sized entities from
the accounting periods beginning on or after 1 April, 2011. As a consequence the Indian
entities will need to start preparing for convergence to IFRS, preferable much earlier.
The next few years will be exciting, but challenging at the same time. We at Astute
Group are committed to help you converge to IFRS as smoothly as possible, and look
forward to teaming with you on this landmark.
What is IFRS?
IFRS stands for ―International Financial Reporting Standards‖ and includes
International Accounting Standards (IASs) until they are replaced by any IFRS and
interpretations originated by the IFRIC or its predecessor, the former Standing
Interpretations Committee (SIC).
IFRSs are developed and approved by IASB (International Accounting Standard
Board).These are standards for reporting financial results and are applicable to general
purpose financial statements and other financial reporting of all profit-oriented entities.
Profit-oriented entities includes those engaged in commercial, industrial, financial and
similar activities, whether organized in corporate or in other forms also includes mutual
insurance companies, other mutual co-operative entities, etc.
Upon its inception the IASB adopted the body of International Accounting
Standards (IASs) issued by its predecessor and as such IFRS includes IAS until they are
replaced by any IFRSs.
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One of the basic features of IFRS is that it is a principle-based standard rather
than rule based.
A separate set of IFRS for Small and Medium-sized Enterprises has been issued
by the IASB in July 2009.
The IFRS for SME represents a simplified set of standards with disclosure
requirements reduced, methods for recognition and measurement simplified and topics
not relevant to SME's eliminated.
Why IFRS?
IFRS are increasingly being recognized as Global Reporting Standards for
financial statements. National GAAP is becoming rare. As global capital markets
become increasingly integrated, many countries are moving to IFRS.
More than 100 countries such as European Union, Australia, New Zealand and
Russia currently permit the use of IFRS in their countries.
The SEC has allowed the use of IFRS without reconciliation to US GAAP in the
financial reports filed by foreign private issuers, thereby, giving foreign private issuers a
choice between IFRS and US GAAP. SEC is proposing that the US issuers begin
reporting under IFRS from 2014 (actually from 2012, if requirements for three year
comparable are considered), with full conversion to occur by 2016 depending on size of
the entity. This is a milestone proposal that will bring almost the entire world on one
single, uniform accounting platform i.e. IFRS (www.astuteconsulting.com).
IFRS in India
International Financial Reporting Standards (IFRS) convergence, in recent
years, has gained momentum all over the world. As the capital markets become
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increasingly global in nature, more and more investors see the need for a common set of
Accounting Standards.
India being one of the key global players, migration to IFRS will enable Indian
entities to have access to international capital markets without having to go through the
cumbersome conversion and filing process. It will lower the cost of raising funds,
reduce accountants' fees and enable faster access to all major capital markets.
Furthermore, it will facilitate companies to set targets and milestones based on a global
business environment, rather than an inward perspective.
Furthermore, convergence to IFRS, by various group entities, will enable
management to bring all components of the group into a single financial reporting
platform. This will eliminate the need for multiple reports and significant adjustment for
preparing consolidated financial statements or filing financial statements in different
stock exchanges.
IFRS is used in many parts of the world, including the European Union, Hong
Kong, Australia, Malaysia, Pakistan, and Gulf Cooperation Council (GCC) countries,
Russia, South Africa, Singapore and Turkey. As in August, 2008, more than 110
countries around the world, including all of Europe, currently require or permit IFRS
reporting. Approximately 85 of those countries require IFRS reporting for all domestic
listed companies.
In India, there will be two set of Accounting Standards:
The existing Indian Accounting Standards (IAS) will be applicable to all companies
which are not required to adopt IFRS converged standards.
Indian Accounting Standards, as converged with IFRS (Ind-AS) will be applicable to
companies operating in India in phased manner beginning from April 1, 2011. In the
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first phase companies forming part of stock exchange index and those with net worth
of above approx 250 million USD will be required to present their financial
statements as per Ind-AS (www.cci.in).
There are conceptual differences between IAS and IFRS. Keeping in view the
extent of gap between IAS, Ind-AS and the corresponding IFRSs – conversion process
would need careful handling. By introducing a new company law, the Indian
Government has initiated the process to amend the legal and regulatory framework.
The conversion would involve, Impact Assessment, Revisiting Accounting
Policies and thereafter changing the Accounting & Operational Systems (including
ERP) in order to be fully compliant with Ind AS or IFRS.
At its 269 meeting the Council of ICAI has decided that public interest entities
such as listed companies, banks, insurance companies and large-sized organizations to
converge with IFRS for accounting period commencing on or after 1 April, 2011.
For small and medium size entities i.e. other than public interest entities, ICAI had
proposed that a separate standard may be formulated based on the IFRS for Small and
Medium-sized Enterprises issued by the IASB after modifications, if necessary.
Even MCA had expressed the view that India should converge to IFRS w.e.f 1 April,
2011.With an objective to ensure smooth transition to IFRS from 1 April, 2011, ICAI is
taking up the matter of convergence with IFRS with National Advisory Committee on
Accounting Standards (NACAS) established by the Ministry of Corporate Affairs,
government of India and other regulators including Reserve Bank of India (RBI),
Insurance Regulatory and Development Authority (IRDA) and the Securities and
Exchange Board of India (SEBI).
111
A recent news article highlights that Core Group for IFRS convergence formed by
Ministry of Corporate Affairs (MCA) has recommended convergence to IFRS as under:
Phase I (opening balance sheet as at 1 April, 2011)
Companies which are part of BSE - Sensex 30 and NSE - Nifty 50;
Companies whose shares or other securities are listed outside India;
Companies whether listed or not, having net worth of more than Rs.1, 000
crores.
Phase II (opening balance sheet as at 1 April, 2013) Companies not covered in Phase 1
and having net worth exceeding Rs. 500 crores.
Phase III (opening balance sheet as at 1 April, 2014)
Listed companies not covered in earlier phases (www.astuteconsulting.com).
Chart No.2.8
Timeline for Convergence IFRS (India)
2.12.7. International Financial Reporting Standards (IFRS) Vs. (IGAAP)
It is very much true that the Indian Generally Accepted Accounting Principles
(IGAAP) is to be promulgated by adopting the International Financial Reporting
Standards (IFRS) as far as possible. However, it is observed that this Indian Generally
Accepted Accounting Principles (IGAAP) vary from the International Financial
• opening balance sheet as at 1 April,
2011
Phase I
• opening balance sheet as at 1 April,
2013
Phase II• opening
balance sheet as at 1 April,
2014
Phase III
112
Reporting Standards (IFRS) with a minimum of difference and wide ranging
differences. Comparing the Indian Generally Accepted Accounting Principles (IGAAP)
and International Financial Reporting Standards (IFRS), list the major differences
between IFRS/ IGAAP are briefly explained below. Table 2.6 & Chart 2.9 summarize
these differences.
Chart No.2.9
Differences between IFRS Vs IGAAP
Table No.2.6
Summary of Major Differences between IFRS Vs IGAAP
Subject IFRS IGAAP
First time adoption
Full retrospective application of
IFRS to PL and BS.
Reconciliation of PL and BS in
respect of last year reported
numbers under previous GAAP
No needs to prepare reconciliation on
first time adoption
Components of
Financial Statements
Comprises of Balance sheet,
Profit and Loss A/c. Cash flow
statement, changes in equity
and accounting policy and notes
to Accounts
Comprises of Balance sheet, Profit
and Loss A/c. Cash flow statement
(if applicable), and Notes to Accounts
Balance Sheet
No particular format, a current/
noncurrent presentation of
Assets and liabilities is used.
As per Format Prescribed in Schedule
VI for Companies, adherence to
Banking Regulation for Banks etc.
Income Statement No particular format prescribed
IAS1
As per Format Prescribed in Schedule
VI (AS1)
Cash Flow
Statements
Mandatory for all entities
(IAS7) Level 3 entities are exempted (AS 3)
Differences
on the basis
of
Conceptual
Accounting
Framework
Content of
Financial
Statements
Accounting
Differences
113
Depreciation Over the useful life of the asset.
(IAS16)
Over the useful life of the asset, or
Schedule XIV rates whichever is
higher. (AS10)
Dividends
Liability to be recognized in the
period when dividend is
declared. (IAS10)
Recognized as an appropriation
against the profit, and recorded as
liability at BS date even if declared
subsequent to reporting period but
before the approval of Financial
statements (AS4)
Cost of major
repairs and overhaul
expenditure on fixed
assets
Recognized in carrying amount
of the assets (IAS16)
Expensed off. Only expenses which
increase the FEB are to be
capitalized. (AS10)
Revaluation
Revaluation (if done) to be
updated periodically so that
carrying amount does not differ
from fair value at the end
period. Revaluation to be done
for entire class of assets
(IAS16)
No specific requirement for
revaluation. Revaluation can be done
on systematic basis like for one
location leaving aside the assets of
other location. (AS10)
Change in the
method of
depreciation
Considered as a change in
accounting estimate. To Be
applied prospectively. (IAS16
and IAS 8)
Considered as change in accounting
policy, retrospective computation and
excess or deficit is adjusted in same
period. Required to be
disclosed(AS6)
Earnings Per Share
Disclosure to be made in only
consolidated financials of the
parent Co. (IAS33)
Disclosure of EPS in both
consolidated and separate financials.
(AS20)
Component
Accounting
Required each major part of
PPE with a cost that is
significant in relation to total
cost, should be depreciated
separately (IAS16)
No such requirement (AS10)
Intangible Assets
Intangible assets can have
indefinite useful life and hence
such assets are tested for
impairment and not amortized.
There is no concept of indefinite
useful life. Assets have definite life.
(usually 10 years)
114
Reporting Currency
Requires the measurement of
profit using the functional
currency. Entities may,
however, present financial
statements in a different
currency. (IAS21)
Schedule VI to the Companies Act,
1956 specifies Indian Rupees as the
reporting currency. (AS11)
Key Management
Personnel (KMP)
Includes Executive as well as
non executive directors (IAS24)
Excludes non executive directors.
(AS18)
Compensation to
KMP
Disclosure to be made for total
compensation such as short
term employee benefits and
post employment benefits
AS18 does not require the breakup of
compensation cost.
Fringe Benefits Tax
Included as part of related
expense (fringe benefit) which
gives rise to incurrence of the
tax.
Disclosed as a separate item after
profit before tax on the face of the
income statement
Uniform Accounting
Policies
Prepared using uniform
accounting policies across all
entities in a group. (IAS27)
Policies may differ due to
impracticability. (AS21)
Disclosure of extra
ordinary items
Prohibits such disclosure
(IAS1).No such term in IFRS Disclosure to be made in notes (AS5)
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