1
|
AS-1
DISCLOSURE
OF ACCOUNTING POLICIES
scope
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 portray the effect of
past events and transactions. Accounting policies and methods adopted by an
enterprise, in turn, influence the effect of past events and transactions.
Users must be able to compare the:
•
financial statements of any one
enterprise through time so that trends and movements in performance
and position can be identified, and
•
status of different
enterprises for an evaluation of relative financial
position and performance.
The disclosure by an entity of its accounting
policies, enable users to-
•
understand
the past
•
extrapolate
to the future
A critical qualitative characteristic of
“comparability” is that users be informed of not merely the accounting
principles and methods adopted by the enterprises, but the changes in such policies
introduced and the monetary effect of such changes, as well.
This standard deals with the disclosure of
significant accounting policies followed in preparation and presentation of
financial statements. The purpose is to promote a better understanding of
financial statements by establishing through an Accounting Standard (AS), a
mandatory requirement that all significant accounting policies ought to be
disclosed as also the manner in which such accounting policies are to be
disclosed in the financial statements.
Accounting Policies
Accounting policies refer to:
a)
Specific
accounting principles, and
b) Methods
adopted by enterprises, in applying these principles in the preparation and
presentation of financial statements.
Accounting
Policy Components
|
||
Principle
|
Method of applying principle
|
|
Providing depreciation
|
on an
|
Straight line,
|
First Lessons in Accounting
Standards
|
||
asset to
account for loss in value
|
Written down value basis or any other
appropriate method
|
|
Disclosure needs arise because
accounting policies can differ
Accounting principles and methods can differ
between one enterprise and another, in the areas of recognition, treatment or
valuation of assets, or recognition of transactions or events. An illustrative
list of examples is given below:
i.
|
Accounting conventions followed
|
x.
|
Recognition of
a liability for
|
|||||||
ii.
|
Basis of
accounting—Historical
|
or
|
retirement benefits
|
|||||||
Current cost
|
xi.
|
Recognition of profit on long-term
|
||||||||
iii.
|
Valuation of inventory
|
contracts
|
||||||||
iv.
|
Valuation of investments
|
xii.
|
Absorption
|
of
|
costs incurred
on
|
|||||
research and development
|
||||||||||
v.
|
Valuation of
|
fixed
|
assets
|
including
|
||||||
Treatment of preliminary, or,
capital
|
||||||||||
revaluation
|
xiii.
|
|||||||||
issue expenses
|
||||||||||
vi.
|
Policies relating
|
to
|
depreciation
of
|
|||||||
fixed assets
|
xiv. Treatment of Lease rental
income or
|
|||||||||
lease rental payment
|
||||||||||
vii.
|
Translation
|
of
|
foreign
|
currency
|
||||||
Treatment
|
of
|
expenditure during
|
||||||||
transactions or items
|
xv.
|
|||||||||
construction
|
||||||||||
viii.
|
Treatment of Government grants
|
|||||||||
xvi.
|
Treatment of contingent liabilities
|
|||||||||
ix.
|
Treatment of goodwill
|
|||||||||
Fundamental Accounting Concepts
AS-1 highlights three important practical
rules. [The term “rules” is used consciously to focus on the fact that over
time, these are capable of variation and evolve as the depth and profundity
of accounting practice increases].
•
Going Concern Concept
We apply this concept on the basis that the
reporting entity is normally viewed to be continuing in operation in the
foreseeable future, and without there being any intention or necessity for it
to either liquidate or curtail materially its scale of business operations.
•
Accrual Concept
This is relevant in the area of revenue and
costs. These are accrued, i.e., recognised, as they are earned or incurred (and
not as cash is received or paid). Also, they are recorded in the period to
which they relate.
•
Consistency Concept
There should be consistency of accounting
treatment of comparable (similar) items, not only within each accounting
period, but also from one period to another.
3
|
These concepts, which are fundamental to
accounting, are the broad-based assumptions, underlying preparation of
financial statements periodically. Financial statements are assumed to be
prepared by adhering, among others, to these concepts.
Unless any contrary position is unequivocally
brought to notice, the user can validly presume that these principles have been
followed. Consequently, if any one of these principles is not adhered to, such
a fact ought to be disclosed.
Selection of appropriate accounting
policies
Financial statements (e.g., annual accounts)
are internationally recognised as a “composite whole” with, Balance Sheet,
Statement of Profit and Loss, Notes on accounts, and cash flow picture, as its
constituent elements. Entities governed by the provisions of Companies Act, or
other Statutes while complying with the detailed provisions in the relevant
statues, should also ensure that the accounts do give a true and fair view of
the financial position and performance. A remote possibility of a conflict
between compliance with detailed provisions in the Statues and the achievement
of truth and fairness cannot perhaps be taken as entirely non- existing. In
such a situation, there is an overriding obligation to provide a “true and fair
view” to users of financial statements.
It is this overriding obligation that
constitutes the “major consideration” in the determination and selection of
accounting policies that are appropriate to an entity, event or transaction.
Rightly, therefore, AS-1 lays emphasis on true and fair view being kept in
primary focus for adoption of any accounting policy.
Consider an entity using projector lights,
the useful life of which is governed by the number of hours it is in use. The
basis for an appropriate accounting policy for depreciating such an asset would
be the actual number of hours such an asset is put to use. Selection of a
straight-line method, allowing for a five-year life would apparently be
inappropriate. Consider another case of usage of a machinery wear and tear of
which is higher in initial years, relative to later years. Selection of written
down value method of depreciation would be appropriate in this case, as opposed
to a straight-line method. Viewed in this backdrop, true and fair principle would
get vitiated if the accounting policy selected is inappropriate.
An enterprise has, therefore, to exercise
scrupulous care in the selection and application of accounting principles and
methods. Such a selection is guided by “three major considerations”.
(a)
Prudence
Prudence is the inclusion of a degree of
caution in the exercise of judgements needed in making estimates required under
conditions of uncertainty.
By exercising prudence, an enterprise does
not recognise profits on the basis of anticipation. These are recognised only
when realised though not necessarily in cash. However, all known losses are
anticipated and provided for.
For example, in determining the carrying
amount of inventory, the profit margins are ignored and yet, the realisable
value if less than cost is taken cognizance of.
(b)
Substance
over form
If information is to represent faithfully the
transactions or events, it is essential that they are accounted for and
presented in accordance with their substance and economic reality and not
merely their legal form.
For example, where rights and interests in a
property stands transferred while legal documentation for the transfer is yet
to be completed, the transaction should be recorded as a sale in the books of
transferor and acquisition in the books of transferee. While distinguishing an
amalgamation in the nature of merger, from one that of purchase, we do look at
the substance of the transaction (i.e. whether the shareholders come together
in a substantially equal partnership to share risks and benefits), over its
form. Under AS-7(R) Construction Contracts, this concept of substance over form
has been fittingly adopted in the determination of “what constitutes a single
contract” for recognition of costs and revenues,
(c)
Materiality
The relevance of information is affected by
its materiality. Information is material if its misstatement, i.e. omission or
erroneous statement, could influence the economic decisions taken by the user,
based on such financial statements. Accordingly, financial statements should
disclose all material items, i.e., knowledge of which might influence the
decision of the user of financial statements.
Three major considerations in selecting
accounting policies are highlighted in the Standard. Other qualitative
characteristics of accounting information, such as (i) relevance, (ii)
neutrality, (iii) completeness, and (iv) reliability are equally critical to
users in order that financial statements are meaningful. In the selection and
adoption of accounting policies these aspects should also be kept in view.
(also see Chart at the end of this Chapter)
Disclosure of
Accounting Policies
All significant policies adopted in the preparation and
presentation of financial statements should be disclosed at one place and
should form part of the financial statements.
It is customary to furnish a summary of the accounting
policies in respect of the following areas:
•
|
Accounting Convention
|
•
|
Proposed Dividend
|
•
|
Basis of Accounting
|
•
|
Retirement Benefits
|
•
|
Fixed Assets
|
•
Lease Rentals (Lease Income)
|
|
•
|
Depreciation
|
•
Research and Development Costs
|
|
•
|
Revaluation of Assets
|
•
|
Taxes on income
|
•
|
Investments
|
•
|
Foreign currency translation
|
•
|
Inventories
|
•
|
Claims
|
•
|
Revenue Recognition
|
•
|
Segment Reporting
|
•
|
Investment Income
|
• Financial and Management Information
|
|
•
|
Borrowing Cost
|
Systems
|
|
5
|
•
Intangible assets
Changes in the Accounting Policies -
Dealt with in AS- 5.
a)
An enterprise is free to change its
accounting policies, unless it violates any statutory provisions, or codes laid
down in a mandatory Accounting Standard, and provided of course such a change
leads to better and more meaningful presentation of accounting information. If,
however, such a change may have a material effect on the financial statements
of the current accounting period or later periods, such changes should be
disclosed.
b)
Where a change in the accounting policies
carries with it a material impact on the performance and operations in the
current period, the amount by which any item in the financial statement is
affected by such change should also be disclosed to the extent ascertainable.
Where such amount is not ascertainable wholly or partly, the fact should be
indicated. If a change in the accounting policy has material effect only on the
financial statements of a subsequent period, the fact of such change should be
appropriately disclosed in the period in which the change is adopted.
Comparison of AS 1 with IAS and US GAAP
AS 1
|
IAS 1
|
US GAAP
|
|||||||||||||
Defines
|
accounting
|
policies,
|
Defines
|
overall
|
Defines
|
accounting
|
policies as
|
||||||||
as
|
specific
|
accounting
|
considerations
|
for
financial
|
specific accounting
principles that
|
||||||||||
principles
|
and
|
methods
|
of
|
statements,
|
besides
|
are judged by the management of
|
|||||||||
applying
|
these
|
principles
|
prescribing
|
minimum
|
the enterprise
to be the
most
|
||||||||||
adopted
|
by enterprises
|
in
|
structure
|
and
|
content
|
of
|
appropriate in the circumstance to
|
||||||||
preparation
|
and
|
presentation
|
financial
statements.
|
present
|
fairly
financial position,
|
||||||||||
of financial statements
|
In
|
addition,
|
a
|
statement
|
and
results of operations
in
|
||||||||||
showing changes in
equity is
|
accordance with GAAP
and are
|
||||||||||||||
also to be presented as a
|
accordingly adopted for preparing
|
||||||||||||||
part of financial statements
|
financial statements.
|
||||||||||||||
Choice
|
of
|
appropriate
|
Require
|
specific
|
disclosure
|
Unusual or innovative applications
|
|||||||||
accounting
|
policies
|
calls
|
for
|
for
|
departure
|
from IFRS,
|
of generally accepted
|
accounting
|
|||||||
considerable
judgement by the
|
critical judgement
|
made
|
by
|
principles are
additionally to be
|
|||||||||||
management of the enterprise
|
management
|
in
|
applying
|
disclosed
|
|||||||||||
accounting policies.
|
|||||||||||||||
True
and fair view,
going
|
No item should be disclosed
|
||||||||||||||
concern,
consistency, accrual,
|
as extraordinary
item.
|
||||||||||||||
prudence,
|
materiality
|
and
|
|||||||||||||
substance
|
over
|
form
|
are
|
||||||||||||
highlighted.
|
|||||||||||||||
Supplemental information
(i)
The Standard is mandatorily applicable to and
is required to be complied with by, all enterprises.
(ii)
ICAI
has constituted a Study Group for revision of AS-1.
For
a better appreciation of AS-1, readers should also refer to AAS 13 (Audit
Materiality), AAS 16 (Going Concern), Provisions of Sub section (3) of Section
209 of the Companies Act (books of accounts to be maintained on accrual basis),
Parts I, II and III of Schedule VI
to
the Act (legal requirement as to the format and materiality element of
disclosure) and 217(2AA) of the Act (legal relevance of selection and
application of accounting policies).
7
|
QUESTION
BANK
Review of Policies
1.
Comment
on the appropriateness of the following accounting policies. Where
inappropriate, give reasons.
a)
Amount
of exchange differences arising on translation on Balance Sheet date is taken
to profit and loss account excepting in case of gain on current assets and
liabilities in a country from where, on account of restrictions, the ability of
the overseas unit is seriously impaired in transferring funds. In addition, as
a matter of abundant prudence, gain on long-term liabilities is held as a
reserve in order to meet any translation loss that may arise in one or more
subsequent periods.
b)
Construction
contracts entered into on or after 1st April 2003, and the entire duration of which falls within
one single accounting year, are accounted for on completed contract method, and
all other construction contracts are accounted for on percentage of completion
method.
c) In the area of construction contracts, revenue from
fixed price construction contracts is recognised on the percentage of
completion method, measured by reference to the percentage of labour hours
incurred up to the reporting date, to estimated total labour hours for each
contract.
d)
Effective
1st April 2003, the Company has adopted and applied the prescriptions under
AS-26 (Intangible Assets), and expenses incurred on intangible items from the
said date are recognised as Intangible Assets, only if future economic benefits
from such items flow to the enterprise and the costs are measurable. Keeping
materiality of items in view, all expenses recognised as Intangible Assets are
written off, where the initial cost of recognition is Rs.5,000 or less, even if
they do not meet the criteria.
e)
The
company have prepared and reported segment information in conformity with the
accounting policies adopted for preparing and presenting financial statements
of the company as a whole. In the case of assets, which are used jointly by two
business segments, values are apportioned between the two on a rational and
realistic basis, while the joint revenues, which do not pertain to either, are
taken on Head Office account.
Solution
Evaluation of accounting policies:
a)
Inappropriate. Unrealised gains on long term
liabilities cannot be held as a reserve, but should be credited to P&L from
year to year.
b)
Inappropriate. Even in cases where the
contract duration is less than one single accounting year, it is essential to
adopt only Percentage Completion method. Such a need arises, for Interim
Financial Reporting (AS 25 – where an interim period is treated as an
accounting period, shorter than one full accounting year).
c)
Appropriate.
d)
Appropriate. However, an item to be
recognised as an intangible asset, should pass both (a) definition and (b)
recognition criteria. The policy talks only about recognition criteria.
Further, the policy cannot cite, materiality and value being less than Rs. 5000
as reasons for write off, in cases where an item cannot be in the first place
recognised as an IA.
e)
Inappropriate. In the case of assets, which
are used jointly by two business segments, values can be apportioned
between the two only if the revenues generated from the assets are similarly
apportioned.
Change in Accounting Policy
2.
Western
CK Ltd., have been consistently following a method of assigning costs to
inventories using Standard Cost system, with an in built normal overhead
absorption rate on labour-hour basis. During the year ended 31st March 2004, the company modified the
absorption basis from labour-hour rates, to machine hour rates. The method of
assigning costs was allowed to remain undisturbed on Standard Cost system.
Comment if this is tantamount to a change in accounting policy within the
meaning of AS 2 (Revised), effective from 1st April 1999.
Solution
AS 2 provides for two cost formulae, namely,
FIFO and Weighted Average. In paragraph 18, the Standard refers to Standard
Cost method as a technique of measuring cost, if results approximate values as
per FIFO or weighted average. It may appear that Western CK Ltd. has not
changed the accounting policy, and the cost formula used in the valuation of
inventories. Going by the spirit behind the prescriptions in the Standard, it
is but appropriate to reckon a change in the basis of “Standard Cost” of a
unit, as a change in “cost formula”, and to make a disclosure, together with
the accounting effect thereof, as a part of accounting policy under AS 2.
Appropriatness of going concern
assumption
3.
Preparation
of financial statements in a situation where going concern assumption is
inappropriate.
A
joint venture company promoted by a government undertaking and a private
promoter has two manufacturing units. The management of the day-to-day affairs
of the company was vested with the private promoter until 17.2.1997 which was
subsequently taken over by the government undertaking owing to large-scale
misappropriations committed by the private promoter. The company is now being
run by the board of directors who are the nominees of the government
undertaking. Due to the large-scale misappropriations, the resources of the
company had drained and the bankers had also frozen the limits resulting in the
eventual suspension of the operations of the company from September 1998. The
company's case was referred to Board for Industrial and Financial
Reconstruction (BIFR) and BIFR, vide its order dated 26.7.2000 had pronounced
that the company was fit to be wound up. BIFR has accordingly advised the
Hon'ble High Court of Chennai to appoint the official liquidator for winding up
of the company.
The
company is in the process of compiling its accounts for the 18 months period
from 1.10.1998 to 31.3.2000 and has been advised by certain experts that the
principle of 'going concern' would not apply to the company, which has been
endorsed by the company's board of directors also. However, there are
conflicting views on compilation of accounts in the case where the principle of
'going concern' does not apply. One view
9
|
is
that the company should prepare the profit and loss account and disclose all
known liabilities and provide for the same, Whereas the other view is that the
company should only prepare the receipt and payments account and quantify the
liabilities and disclose the same by way of explanatory note in the notes to
accounts. During the period under question, the company had a marginal turnover
of Rs.3.84 lac from existing inventory.
Advice
:
(a)
Whether
the fundamental accounting assumption of going concern would be valid for the
company.
(b)
If
the principle of 'going concern' does not apply to the company, whether the
company should prepare a receipts and payments account or profit and loss
account.
(c)
If
the company is required to prepare a receipts and payments account, how the
liabilities should be disclosed and provided for.
(d)
Whether
the company would be justified in imputing a value to the inventory and sundry
debtors despite the fact that the company is not in operation since September,
1998.
(e)
If
the answer to the above question is in the negative, whether the company would
be justified in writing off the entire imputed value of debtors and inventory.
Solution :
(a)
The fundamental accounting assumption of
going concern would not be appropriate in the facts and circumstances of the
company for the preparation and presentation of financial statements.
(b)
The company should prepare the balance sheet
and profit and loss account on liquidation basis and the basis for preparation
of such financial statements should be disclosed.
(c)
In view of (b) above, receipts and payments
accounts should not be prepared. Liabilities should be valued on liquidation
basis. I,e., how much would be payable to the creditors in the event of
liquidation.
(d)
The company should value all assets and
liabilities including inventories and sundry debtors on the basis used for
preparation of financial statements, i.e., liquidation basis (realisable
value).
(e)
Since
the answer to (d) is not in the negative, the question does not arise.
No comments:
Post a Comment