Written policies, rules, and guidelines meant to standardise the preparation and presentation of financial statements are known as Accounting Standards.
Among several companies and sectors, they offer a structure for guaranteeing consistency, openness, and comparability in accounting practice. Because companies run in several industries and could employ several accounting techniques, these standards offer uniformity by specifying how certain transactions should be recorded, measured, and presented.
In India, under the Companies Act, 2013, the ICAI develops accounting standards to ensure a proper reflection of financial statements with respect to relevant events. Important topics covered by accounting standards are consolidation, depreciation, inventory valuation, revenue recognition, and disclosure requirements. Accounting standards build stakeholder trust and help commercial and financial decision-making by reducing subjectivity and mandating a minimum legal and regulatory standard.
What is Accounting Standard 1 (AS-1)?
Framed by the Institute of Chartered Accountants of India (ICAI), AS-1 (Accounting Standard – 1) addresses the disclosure of important accounting methods used in financial report preparation and presentation. Financial reporting’s main goal is to offer openness, consistency, and comparability.
AS-1 mandates the consideration of necessary accounting assumptions, such as Going Concern, Consistency, and Accrual, to be taken as met unless otherwise stated. It also identifies the concept of prudence, substance over form, and materiality in making choices among policies.
Companies have to disclose significant policies in their accounts notes, including depreciation methods, inventory valuation, revenue recognition, foreign currency treatment, and provisions. If the policy changes, the nature, reason, and financial impact need to be disclosed.
Thus, AS-1 ensures that financial statements are accurate and fair and thus useful for stakeholder decision-making.
Accounting Policies – Meaning And Nature
Accounting policies are the basic structure of principles and methods that are used by organisations for financial reporting. They have a dual nature of being flexible and regulated, which ensures that the financial statements provide a true and fair view while also being useful to the stakeholders.
Accounting policies comprise the unique principles, approaches, guidelines, and procedures used by an organisation to present and prepare its financial reports. These policies outline how transactions and occurrences are recognised, quantified, and reported. Accounting regulations and principles provide numerous alternatives, forcing companies to choose policies that best reflect their financial situation and performance.
Examples include methods of depreciation (e.g., straight line method or written down value), valuation of inventories (i.e., FIFO and weighted average), revenue recognition (either cash or accruals basis), accounting treatment for goodwill, foreign currency transactions, and provisions.
In India, AS-1 (Disclosure of Accounting Policies), published by the ICAI, governs disclosure and format regarding these policies.
Nature of Accounting Policies:
- Varied and flexible: Various organisations have different policies for identical transactions in accordance with their operating environments and conditions.
- Financial reporting is based on key assumptions, i.e., going concern, consistency, and accrual.
- Prudence, Substance, and Materiality influenced: The policies must stress prudent reporting (prudence), reporting the substance of transactions (substance over form), and concentrating on material items.
- Industry and Regulation Driven: Some industries have particular practices (for example, the construction sector using the percentage of completion method). Policies should also be compliant with statutory and accounting rules.
- Dynamic in Nature: While consistency is essential, policies can change due to legal mandates, standards, or to improve the quality of financial reporting.
- Disclosure Oriented: Significant accounting policies must be clearly disclosed in financial statements to ensure transparency and comparability.
Selection of Accounting Policies
Accounting policies are the specific accounting rules and procedures a company follows in order to prepare its financial statements. Since financial reporting should reflect an accurate and fair view, the choice of accounting policies is of prime importance. As per AS-1 (Disclosure of Accounting Policies), the selection of policies should be determined by considering a number of important factors. An effective choice ensures that financial reports present a faithful and true view, increase comparability, and assist in stakeholders’ decision-making.
- Prudence: Financial statements must not overstate assets or revenue, or understate liabilities or expenses. Allowances for doubtful debts need to be made even in the case of an uncertain loss. Misleading appearances must be avoided.
- Substance over Form: Events and transactions are to be accounted for by their economic substance and not by their form. For example, an asset under finance leasing is carried in the accounts of the lessee, though the lessor retains legal ownership. This indicates the genuine financial consequence of the transaction.
- Materiality: Policies must focus on those items that are material and pertinent to the financial statements. Minor details can be omitted if they do not impact decision-making. Low-value assets, such as calculators, may be expensed during the year they are acquired rather than capitalised.
- Industry Practices: Industry-wide practices can shape policy decisions. For instance, construction companies may use the percentage of completion method of recognising revenue to ensure consistency across the industry.
- Statutory and Regulatory Requirements: Policies have to comply with applicable laws, accounting principles, and regulatory requirements (like the Companies Act, ICAI standards, and SEBI regulations). This assists in evading penalties and ensures uniformity.
- Consistency: Policies, once formulated, must be uniformly applied throughout various accounting periods. Any changes must be revealed, along with their nature, purpose, and financial effects. This aids in ensuring the reliability and comparability of financial statements.
Disclosure of Accounting Policies
The Institute of Chartered Accountants of India has issued accounting standard (AS)-1: Disclosure of Accounting Principles, which requires companies to clearly disclose the significant accounting principles used in the preparation and presentation of their accounts. Proper disclosure leads to transparency, comparability, and reliability for the stakeholders.
Basic Principles of AS-1:
1. Basic Assumptions:
Unless otherwise stated, financial statements are presumed to be prepared on:
- Going Concern: The enterprise will continue to operate in the near future.
- Consistency: Application of policies is consistent across periods.
- Accrual: A transaction is recognised at its occurrence and not at the time when cash is collected or paid.
2. Main Policy Choice Criteria:
- Prudence
- Substance over form
- Materiality
Disclosure requirements include –
- Inventory costing techniques like FIFO, Weighted Average, etc. Depreciation techniques (e.g., SLM, WDV)
- Handling of goodwill and intangible assets.
- Revenue recognition techniques (completion of contract vs. percentage of completion)
- Foreign Currency Transactions.
- Handling of borrowing costs.
- Investments: Cost or Fair Value?
- Retirement Benefits: Gratuity, Pension, and Leave Encashment.
- Financial reports normally include disclosure, usually as notes to the accounts.
- Emphasise policies that have a major influence on presentation.
- Any alteration in accounting policies has to be made public.
- Reversal of nature, cause, and financial impact has to be made known.
Why is Disclosing Accounting Policies Important?
Disclosure of accounting policies is vital to guarantee transparent and accurate financial reporting. Accounting policies are the exact rules, assumptions, conventions, procedures, and customs a firm employs to create and display financial statements. Disclosure helps stakeholders to properly assess financial statements and make wise decisions since different businesses could have different accounting systems for the same activities.
- Facilitates transparency: Transparent disclosure explains the grounds for reporting financial results and positions. For example, how depreciation is computed using either the Straight Line Method (SLM) or the Written Down Value (WDV) method may have a considerable impact on earnings and asset values.
- Encourages comparability: Companies’ financial statements are usually compared by investors, analysts, and regulators. Policy disclosure allows meaningful comparisons between different entities even if they use different accounting practices.
- Encourages consistency and reliability: Disclosure of policies helps organisations ensure consistent application in the long term. In case any modifications are made, the reasons and implications should be disclosed, hence increasing the reliability of financial reports to stakeholders.
- Supports development of true and fair views: Accounting practices affect earnings, asset valuations, and liabilities. Proper disclosure ensures that financial statements properly reflect the company’s performance and position.
- Protects stakeholder interests: Stakeholders such as investors, lenders, creditors, and employees rely on financial statements to make decisions. Disclosure of information minimises asymmetry and encourages confidence in financial reporting.
- Complying with Legal and Professional Standards: Indian AS-1 calls for the disclosure of major accounting policies. Omission can lead to non-compliance, penalties, or even loss of reputation.
- Makes Decision Making Better: Determining a clear understanding of policies assists investors in analysing risk, predicting future performance, and making investment decisions. Creditors and banks also use these disclosures to determine creditworthiness.
Finally, financial statement credibility, consistency, comparability, and transparency are all promoted by accounting policy disclosure. Besides being a regulation compliance, it also builds confidence among stakeholders by guaranteeing fair presentation and bias-free financial information.
Conclusion
Not only a legal requirement, accounting policy disclosures are vital for accurate and open financial reporting. Consequently, users of financial statements will be able to understand the ideas and methods used to find, measure, and display financial information.
Opening up such actions helps companies to be more consistent over time, enable corporate comparison, and increase confidence in financial reporting. It also protects the interests of investors, lenders, governments, and staff by allowing them to make wise decisions informed by trustworthy data and analysis. Honest financial condition of the firm description. Every adjustment to an accounting policy has to be stated along with its nature, justification, and financial impact. Honest accounting policy revelation ultimately boosts trust, reduces ambiguity, and enhances the general credibility of corporate governance and financial reporting.
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