Accounting Standards 1 and 4

Indian Audit and Accounts DepartmentCourseware on Financial Audit of Autonomous BodiesSession: 3 – Introduction to Accounting Standards and AS 1 and AS 4

Introduction to Accounting Standards and Accounting Standard 1 and Accounting Standard 4

Session Overview

In the previous sessions we had a look at the legal mandate for audit of autonomous bodies and authorities and ‘objective and scope of audit’ of such institutions. We are also aware that objective of audit of an autonomous institution is to examine the utilization of financial assistance provided to that institution by the Government as per sanction and to ensure that the financial statements prepared by the institution present a true and fair view of the accounts.

In order to ensure that the financial statements prepared by autonomous bodies/authorities present a true and fair view of the accounts, the preparers of financial statements are guided by the ‘generally accepted accounting standards’. Auditors also ensure during the audit of financial statements that ‘generally accepted accounting standards’ have been followed and applied by the entity while preparing or presenting their financial statements. Accounting is the process of collecting and recording economic data relating to an enterprise, processing this data to produce useful information to those who need it. Every profession develops a body of knowledge consisting of principles, which are considered as standard to be attained. Accounting is no exception. In India, the Institute of Chartered Accountants of India has developed Accounting Standards; based on the ‘generally accepted accounting standards’ to be used in preparation of financial statements.

During this session, we will learn:

the importance of the accounting standards in preparation of financial statements; and

application of AS 1 relating to ‘Disclosure of Accounting Policies’, and

application of AS 4 relating to ‘Events Occurring After the Balance Sheet Date’ for preparation of financial statements.

Learning Objective

At the end of the session, the learner will be able to state the importance of accounting standards in the preparation of financial statements and application of AS 1 relating to ‘Disclosure of Accounting Policies’ and AS 4 relating to ‘Events Occurring After the Balance Sheet Date’ in the preparation of Financial Statements.

Importance of Accounting Standards in the preparation of financial statements

Financial statements are prepared on the basis of certain fundamental assumptions. One is the concept of ‘going concern’ and another is the concept of accrual basis of accounting. Besides, the numerous financial transactions of an enterprise are classified into various heads depending on their impact. Expenditure incurred on operations of the current year are charged to profit and loss account of that year, while as expenditure not relating to that period is taken to balance sheet. Similarly any income generated from current year’s operation are credited to profit and loss account of that year, while as any income not relating to current year is carried forward in balance sheet. These are

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Courseware designed and prepared by: Regional Training Institute, Jammu

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fundamental assumptions on the basis of which financial statements are prepared. On the basis of these and other assumptions certain ‘standards’ have evolved and have been grouped into ‘generally accepted accounting standards’. The users of the financial statements need an assurance that the entities preparing their financial statements follow the accepted standards while presenting their financial information in the financial statements.

Formation of Accounting Standard Board

Recognizing the need to harmonize the diverse accounting policies and practices in use, the Institute of Chartered Accountants of India constituted an Accounting Standards Board (ASB) in April 1977.

Scope and functions of the ASB

The main function of the ASB is to formulate standards so that the Council of the ICAI may establish such standards, to be followed by all the entities while preparing and presenting their financial statements. The Accounting Standards, prescribed by the ICAI follow the standards set by the International Accounting Standards Committee.

Accounting Standards have to be in conformity with the provisions of the applicable laws, customs, usage and business environment in the country. If due to subsequent amendments in the law, a particular Accounting Standard is found to be not in conformity with such law, the provisions of such law will prevail and the financial statements should be prepared in conformity with such law.

The Accounting Standards cannot and do not override the local regulations, which govern the preparation and presentation of financial statements in our country. Where a certain Accounting Standard is not followed while presenting information in a financial statement, a disclosure to that effect has to be made in the form of appropriate notes explaining the treatment of particular item. The Accounting Standards are intended to apply only to items that are material.

ICAI has issued 29 Accounting Standards till date. These are give in annexure A to this note.

Accounting Standard (AS 1) – Disclosure of Accounting Policies

This Accounting Standards deals with the disclosure of significant accounting policies followed in preparing and presenting the financial statements.

The view presented in the financial statements of an enterprise of its financial state of affairs and of the profit and loss can be significantly affected by the accounting policies followed in preparation of the financial statements. The accounting policies followed vary from enterprise to enterprise. Disclosure of significant accounting policies followed is necessary if the view presented is to be properly appreciated by the users of the financial statements.

The disclosure of some of the accounting policies followed in the preparation and presentation of the financial statements is required by law in some cases.

The purpose of this standard is to promote better understanding of financial statements by establishing the disclosure of significant accounting policies and the

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manner in which accounting policies are disclosed in the financial statements. Such disclosure would also facilitate a more meaningful comparison between financial statements of different enterprises.

Fundamental Accounting Assumptions

Certain fundamental accounting assumptions underline the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed.

The following have been generally accepted accounting assumptions:

a. Going concern

The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operation.

b. Consistency

It is assumed that accounting policies are consistent from one period to another.

c. Accrual

Revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recorded in financial statements of the period to which they relate.

Nature of Accounting Policies

The accounting policies refer to the accounting principles and the methods of

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

The various statements of the Institute of Chartered Accountants of India combined with the efforts of government and other regulatory agencies and progressive managements have reduced in recent years the number of acceptable alternatives particularly in the case of corporate entities. While continuing efforts in this direction in future are likely to reduce the number still further, the availability of alternatives accounting policies and methods of applying those principles is not likely to be eliminated altogether in view of the differing circumstances faced by the enterprises.

Areas in which differing accounting Policies are encountered

The following are the examples of the areas in which different accounting policies may be adapted by different enterprises. The list is not intended to be exhaustive:

Methods of depreciation, depletion and amortization;

Treatment of expenditure during construction;

Conversion or translation of foreign currency items;

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Valuation of inventories; Treatment of goodwill; Valuation of investments; Treatment of retirement benefits; Recognition of profit on long-term

contracts; Valuation of fixed assets; Treatment of contingent liabilities.

Considerations in the selection of Accounting Policies

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

1. Prudence

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

2. Substance over form

The accounting policies and presentations in financial statements of transactions and events should be governed by their substance and not merely by legal form.

3. Materiality

Financial statements should disclose all material items, i.e., items the knowledge of

which might influence the decision of the user of the financial statements

Disclosure of Accounting Policies

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

Such disclosure should form part of the financial statements.

Examples of matters in respect of which disclosure of accounting policies adopted will be required are listed in these notes. Any change in an accounting policy, which has a material effect, should be disclosed. The amount by which any item in the financial statement is affected by such change should also be disclosed to the extent ascertainable, wholly or in part. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted. Disclosure of accounting policies or of change therein cannot remedy a wrong or inappropriate treatment of an item in the accounts.

Accounting Standard

The following is the text of the Accounting Standard 1- Disclosure of Accounting Policies:

All significant accounting policies adopted in preparation and presentation of financial statements should be disclosed.

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The disclosure of significant accounting policies as such should form part of the financial statement and the significant accounting policies should normally be disclosed in one place.

Any change in the accounting policies which has a material, affect in the current period or which is reasonably expected to have a material affect in later periods should be disclosed. In the case of a change in accounting policies, which has a material affect 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 in part, the fact should be disclosed.

If the fundamental accounting assumptions, viz., going concern, consistency and accrual are followed in financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.

Accounting Standard (AS) 4 - Contingencies and Events Occurring After the Balance Sheet Date

This Statement deals with treatment in financial statements of

(a) Contingencies; and

(b) Events occurring after the balance sheet date.

The following subjects, which may result in contingencies, are excluded from the scope of this Statement in view of special considerations applicable to them:

(a) Liabilities of life assurance and general insurance enterprises arising from policies issued;

(b) Obligations under retirement benefit plans; and

(c) Commitments arising from long-term lease contracts.

Definitions

The following terms are used in this Statement with the meanings specified:

A contingency is a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence or non-occurrence of one or more uncertain future events.

Events after the balance sheet date are those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company, and by the corresponding approving authority in the case of any other entity.

Two types of events can be identified:

(a) those which provide further evidence of conditions that existed at the balance sheet date; and

(b) those, which are indicative of conditions that arose subsequent to the balance sheet, date.

Explanation

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Contingencies

The term ‘contingencies’ used in this statement is restricted to conditions or situations at the balance sheet date, the financial effect of which is to be determined by future events which my or may not occur.

Estimates are required for determining the amounts to be stated in the financial statements for many on going and recurring activities of an enterprise. One must, however, distinguish between an event and one, which is uncertain. The fact that an estimate is involved does not, of itself, create the type of uncertainty, which characterizes an uncertainty. For example, the fact that estimates of useful life of an asset are used to determine depreciation does not make depreciation a contingency; the eventual expiry of the useful life of the asset is not uncertain.

Accounting treatment of contingent losses

The accounting treatment of a contingent loss is determined by the expressed outcome of the contingency. If it is likely that a contingency will result in a loss to the enterprise, then it is prudent to provide for that loss in the financial statement.

The estimation of the amount of contingent loss to be provided in the financial statement may be based on the information available.

If there is conflicting or insufficient evidence for estimating the amount of contingency loss, then disclosure is made of the existence of the contingency.

A potential loss to an enterprise may be reduced or avoided because a contingent liability is matched by related counter

claim or claims against a third party. In such cases, the amount of provision is determined after taking into account the probable recovery under the claim if no significant uncertainty as to its measurability or collectablility exists. Suitable disclosure regarding the nature and gross amount of the contingent liability is also made.

The existence and amount of guarantees, obligations arising from discounted bills of exchange and similar obligations undertaken by an enterprise are generally disclosed in financial statements by way of note, even though the possibility that a loss to the enterprise will occur is remote.

Provisions for contingencies are not made in respect of general or unspecified business risks since they do not relate to conditions or situations existing at the balance sheet date.

Accounting treatment of contingent gains

Contingent gains are not recognized in financial statements since their recognition may result in the recognition of revenue, which may never be realized. However, when the realization of a gain is virtually certain, then such gain is not a contingency and accounting for the gain is appropriate.

Determination of the Amounts at which Contingencies are included in Financial Statements

The amount at which a contingency is stated in the financial statements is based on the information, which is available at the date on which the financial statements are approved. Events occurring after the balance sheet date that indicate that an asset may have been impaired, or that a liability may have existed, at the balance

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sheet date are, therefore, taken into account in identifying contingencies and in determining the amounts at which such contingencies are included in financial statements.

In some cases, each contingency can be separately identified, and the special circumstances of each situation considered in the determination of the amount of the contingency. A substantial legal claim against the enterprise may represent such a contingency. Among the factors taken into account by management in evaluating such a contingency are the progress of the claim at the date on which the financial statements are approved, the opinions, wherever necessary, of legal experts or other advisers, the experience of the enterprise in similar cases and the experience of other enterprises in similar situations.

If the uncertainties, which created a contingency in respect of an individual transaction, are common to a large number of similar transactions, then the amount of the contingency need not be individually determined, but may be based on the group of similar transactions. An example of such contingencies may be the estimated uncollectable portion of accounts receivable. Another example of such contingencies may be the warranties for products sold. These costs are usually incurred frequently and experience provides a means by which the amount of the liability or loss can be estimated with reasonable precision although the particular transactions that may result in a liability or a loss are not identified. Provision for these costs results in their recognition in the same accounting period in which the related transactions took place.

Explanation

Events Occurring after the Balance Sheet Date

Events, which occur between the balance sheet date and the date on which the financial statements are approved, may indicate the need for adjustments to assets and liabilities as at the balance sheet date or may require disclosure.

Adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date. For example, an adjustment may be made for a loss on a trade receivable account, which is confirmed by the insolvency of a customer, which occurs after the balance sheet date.

Adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. An example is the decline in market value of investments between the balance sheet date and the date on which the financial statements are approved. Ordinary fluctuations in market values do not normally relate to the condition of the investments at the balance sheet date, but reflect circumstances, which have occurred in the following period.

Events occurring after the balance sheet date which do not affect the figures stated in the financial statements would not normally require disclosure in the financial statements although they may be of such significance that they may require a disclosure in the report of the approving authority to enable users of financial

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statements to make proper evaluations and decisions.

There are events, which, although they take place after the balance sheet date, are sometimes reflected, in the financial statements because of statutory requirements or because of their special nature. Such items include the amount of dividend proposed or declared by the enterprise after the balance sheet date in respect of the period covered by the financial statements.Events occurring after the balance sheet date may indicate that the enterprise ceases to be a going concern. A deterioration in operating results and financial position, or unusual changes affecting the existence or substratum of the enterprise after the balance sheet date (e.g., destruction of a major production plant by a fire after the balance sheet date) may indicate a need to consider whether it is proper to use the fundamental accounting assumption of going concern in the preparation of the financial statements.

Disclosure

The disclosure requirements herein referred to apply only in respect of those contingencies or events, which affect the financial position to a material extent.

If a contingent loss is not provided for, its nature and an estimate of its financial effect are generally disclosed by way of note unless the possibility of a loss is remote (other than the circumstances mentioned in paragraph 5.5). If a reliable estimate of the financial effect cannot be made, this fact is disclosed.

When the events occurring after the balance sheet date are disclosed in the report of the approving authority, the information given comprises the nature of

the events and an estimate of their financial effects or a statement that such an estimate cannot be made.

Accounting Standard

The following is the text of the Accounting Standard 4-1- Contingencies and Events Occurring After the Balance Sheet Date:

Contingencies

The amount of a contingent loss should be provided for by a charge in the statement of profit and loss if:

a. it is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the balance sheet date, and

b. a reasonable estimate of the amount of the resulting loss can be made.

The existence of a contingent loss should be disclosed in the financial statements if either of the conditions is not met, unless the possibility of a loss is remote.

Contingent gains should not be recognized in the financial statements

Events Occurring after the Balance Sheet Date

Assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to

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conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption of going concern (i.e., the continuance of existence or substratum of the enterprise) is not appropriate.

Dividends stated to be in respect of the period covered by the financial statements, which are proposed or declared by the enterprise after the balance sheet date but before approval of the financial statements, should be adjusted.

Disclosure should be made in the report of the approving authority of those events occurring after the balance sheet date that represent material changes and commitments affecting the financial position of the enterprise

Disclosure

If disclosure of contingencies is required by this Statement, the following information should be provided:

a. the nature of the contingency;

b. the uncertainties which may affect the future outcome;

c. an estimate of the financial effect, or a statement that such an estimate cannot be made.

If disclosure of events occurring after the balance sheet date in the report of the approving authority is required by paragraph 15 of this Statement, the following information should be provided:

a. the nature of the event;

b. an estimate of the financial effect, or a statement that such an estimate cannot be made.

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(C) LIST OF ACCOUNTING STANDARDS(As on 1st July 2003)

Sl.No Accounting

Standard (AS) No.

Title of the Accounting Standard

Date from which Mandatory accounting Periods commencing on or after)

Mandatory

1 AS 1 Disclosure of Accounting Policies

1-4-1991- for companies governed by the Companies Act, 1956, as well as for enterprises other than those specified in Note 1.1-4-1993- for all enterprises, including those specified in Note1.

For all enterprises

2 AS 2 (Revised) Valuation of Inventories 1-4-1999 For all enterprises3 AS 3 (Revised) Cash flow Statements 1-4-2001 See Note 2

* As 8 stands withdrawn with effect from the date AS 26, ‘ Intangible Assets’, becomes mandatory for the concerned enterprises (See also Note 11 to this Table).

4 AS 4 (Revised) Contingencies and Events Occurring After the Balance Sheet Date

1-4-1995 For all enterprises

5 AS 5 (Revised) Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies


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6 AS 6 (Revised) Depreciation Accounting 1-4-1995 For all enterprises

7 AS 7 Accounting for Construction Contracts

As in case of AS 1 above (See also Note 3)

For all enterprises

8 AS 8 Accounting for Research and Development

As in case of AS 1 above For all enterprises

9 AS 9 Revenue Recognition As in case of AS 1 above For all enterprises

10 AS 10 Accounting for Fixed Assets

As in case of AS 1 above For all enterprises

11 AS 11(Revised 1994)

Accounting for the Effects of Changes in Foreign Exchange Rates

1-4-1995(See also Note 4)

For all enterprises(See also Announcement IX above)

12 AS 12 Accounting for Government Grants


As 8 stands withdrawn with effect form the date AS 26, ‘Intangible Assets’, becomes mandatory for the concerned enterprises(See Note 11 to this Table).

13 AS 13 Accounting for Investments 1- 4 -1995 For all enterprises14 AS 14 Accounting for Amalgamations 1- 4 -1995 For all enterprises15 AS 15 Accounting for Retirement

Benefits in the financialStatements of Employers

1- 4 -1995 For all enterprises

16 AS 16 Borrowing Costs 1- 4 -2000 For all enterprises

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17 AS 17 Segment Reporting 1- 4-2001 See Note 218 AS 18 Related Party Disclosures 1- 4-2001 See Note 219 AS 19 Leases In respect of all assets leased

during accounting periods commencing on or after 1-4-2001

For all enterprises

20 AS 20 Earnings Per Share 1-4-2001( See also Note 5) See Note 521 AS 21 Consolidated

Financial Statements1-4-2001 (See also Note 6) See Note 6

22 AS 22 Accounting for Taxes on Income See Note 7 See Note 723 AS 23 1-4-2002 (See also Note 8) See Note 824 AS 24 Discontinuing Operations See Note 9 See Note 925 AS 25 Interim Financial Reporting 1-4-2002 (See also Note 10)_ See Note 1026 AS 26 Intangible Assets See Note 11 See Note 1127 AS 27 Financial Reporting of Interests

in Joint Ventures1-4-2002 (See also Note 12) See Note 12

28 AS 28 Impairment of Assets See Note 13 See Note 1329 AS 29 Provisions, contingent Liabilities

and Contingent Assets1-4-2004

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Documents

Accounting Standards 1 and 4