CHAPTER II ACCOUNTING STANDARDS AND FINANCIAL REPORTING...

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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).


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.


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

87

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.

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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

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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

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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

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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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http://www.iasplus.com/standard/ias27_2011.htm

http://www.iasplus.com/standard/ias28_2011.htm








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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


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


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


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

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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.

http://www.saralaccounts.com/

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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).

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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

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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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