Wednesday, August 15, 2012

Preparation of Financial Statements including IFRS

Unit – 1: Introduction to Financial Accounting
Meaning of Accounting
Accounting is the analysis and interpretation of book-keeping records. It includes not only maintains of accounting records but also the preparation of financial and economic information Which involves the measurement of transaction and other events pertaining to a business.
According to the American institute of certified public accounts” The arts of recordings, classifying and summarizing in a significant manner and in terms of money transaction and events which in parts, at least of a financial charter and interpreting the result there of”.
The main advantages of accounting are mentioned below:
a)      Accounting information is used by the management in taking various managerial decision.
b)      It shows the financial position of business on a particular data.
c)       Accounting data are accepted by the tax authorities as authentic and reliable. Hence they can be used as the basis for discharging tax liabilities.
d)      Accounting supplies financial data which are accepted by the insurance company as reliable figure for settlement of insurance claim.
Following are the limitations of accounting:
a)      According to records only those transactions which can be measured in monetary terms. There may be certain important non-monitory transaction but are not recorded.

b)      Effects of price level changes are not considered.
c)       Personal bias of accountant affects the accounting statement.
Meaning of Financial Statements
Financial statements are the summarized statements of accounting data produced at the end of accounting process by an enterprise through which accounting information are communicated to the internal and external users. A set of financial statements includes (Types):
a)      Balance sheet
b)      Profit and loss account
c)       Schedules and notes to accounts.
The American Institute of Certified Public Accountants states the nature of financial statements as “Financial Statements are prepared for the purpose of presenting a periodical review of report on progress by the management and deal with the status of investment in the business and the results achieved during the period under review. They reflect a combination of recorded facts, accounting principles and personal judgments.”
In the words of Myer,” The financial statements provide a summary of accounts of a business enterprise, the balance sheet reflecting the assets, liabilities and capital as on a certain date and income statement showing the result of operations during a certain period”.
Nature of Financial Statements:
a)      Recording facts of a business transactions;
b)      Accounting Conventions;
c)       Accounting Concepts;
d)      Personal judgments used in the application of conventions and postulates.
a)      Recorded Facts: The Financial statements are statements prepared on the basis of recorded facts; they do not depict the unrecorded facts. Recorded facts means recording of transactions based on evidence in the accounting books.
b)      Accounting Conventions: Certain accounting conventions are followed while preparing financial statements such as convention of ‘Conservatism’, convention of ‘Materiality’, convention of ‘Full disclosure’, convention of ‘Consistency’. According to convention of ‘Conservatism’, provisions are made of expected losses but expected profits are ignored. This means that the real financial position of the business may be better than what has been shown by the financial statements. The use of accounting conventions makes financial statements simple, comparable, and realistic.
c)       Accounting Concepts: While preparing financial statements the accountants make a number of assumptions known as accounting concepts such as going concern concept, money measurement concept, realisation concept, etc. According to the going concern concept, it is assumed that the business of the concern shall be continued indefinitely. The assets are shown in the balance sheet at their book value rather than their market value.
d)      Personal Judgement: Personal judgement also has an important bearing on financial statements. For example, selection of one method out of various methods of charging depreciation, inventory valuation etc., depends on the personal judgement of the accountant.
Characteristics/Essentials of Financial Statements
Financial statements are regarded as indices of an enterprise‘s performance and position. As such, extreme care and caution should be exercised while preparing these statements. Financial statements generally reflect the following observable characteristics:
a) Internal Audience: financial statements are intended for those who have an interest in a given business enterprise. They have to be prepared on the assumption that the user is generally familiar with business practices as well as the meaning and implication of the terms used in that business.
b) Articulation: The basic financial statements are interrelated and therefore are said to be articulated‘. Example: Profit and Loss account shows the financial results of operations and represents an increase or decrease in resources that is reflected in the various balances in the balance sheet.
c) Historical Nature: Financial statements generally report what has happened in the past. Though they are used increasingly as the basis for the future by prospective investors and creditors, they are not intended to provide estimates of future economic activities and their effect on income and equity.
d) Legal and economic consequences: Financial statements reflect elements of both economics and law. They are conceptually oriented towards economics, but many of the concepts and conventions have their origin in law. Example: Conventions of disclosure and materiality
e) Technical Terminology: Since financial statements are products of a technical process called accounting‖, they involve the use of technical terms. It is, therefore, important that the users of these statements should be familiar with the different terms used therein and conversant with their interpretations and meanings.
f) Summarization and Classification: The volume of business transaction affecting the business operations are so vast that summarization and classification of business events and items alone will enable the reader to draw out useful conclusions.
g) Money Terms: All business transactions are quantified, measured and related in monetary terms. In the absence of this monetary unit of measurement, financial statements will be meaningless.
h) Various Valuation Methods: The valuation methods are not uniform for all items found in a Balance Sheet. Example: Cash is stated at current exchange value; Accounts receivable at net realizable value; inventories at cost or market price whichever is lower; fixed assets at cost less depreciation. 7
i) Accrual Basis: Most financial statements are prepared on accrual basis rather than on cash basis i.e., taking into account all incomes due but not received and all expenses due but not paid.
j) Need for Estimates and judgement: Under more than one circumstance, the facts and figures to be presented through financial statements are to be based on estimates, personal opinions and judgements. Example: Rate of depreciation, the useful economic life of a fixed asset, provision for doubtful debts are all instances where estimates and personal judgements are involved.
k) Verifiability: it is essential that the facts presented through financial statements are susceptible to objective verification, so that the reliability of these statements can be improved.
i) Conservatism: Wherever and whenever estimates and personal judgements become essential during the course of preparation of financial statements, such estimates, should be based moderately on a conservative basis to avoid any possibility of overstating the assets and incomes.
j) Understandability: Financial statements should be prepared following the accepted accounting principles for better understanding of the users.
k) Comparable: Financial statements should disclose the information in such a manner that they are conformable for inter-firm and intra-firm comparison.
Users of Financial Statements
Users of accounting information may be categorised into (1) Internal Users; and (2) External Users.
(1) Internal Users:
(i) Owners: Owners contribute capital in the business and they are always exposed to risk. In view of risk involved, the owners are always interested in knowing the profitability and financial strength of the company.
(ii) Management: Managers has the responsibility to not only safeguard the owner’s investment but also to increase the value of business. Financial statements help the management to find out the overall as well as segment-wise efficiency of the business. It helps them in decision making as well as in controlling and self evaluation.
(iii) Employees and Workers: Employees and workers are entitled to bonus at the year end besides the salary and wages which is directly linked with the profits of the enterprise. Therefore, the employees and workers are interested in financial statements.
(2) External Users:
(i) Banks and Financial Institutions: Banks and Financial Institutions provide loans to the businesses. They watch the performance of the business to ensure the safety and recovery of the loan advanced.
(ii) Investors and Potential Investors: Investors uses financial statements to assess the earning capacity of the enterprise and ensure the safety of their investment.
(iii) Creditors: Creditors supply goods and services on credit. Before granting credit, Creditors satisfy themselves about the creditworthiness of the business. The financial statement helps them in making such assessment.
(iv) Government authorities: The government makes use of financial statements to compile national income accounts and other information. The information so available to it enables them to take policy decisions.


(v) Consumers: Customers have an interest in information about the continuance of an enterprise, especially whey they have a long-term with the enterprise. Sometime, prices of some products are fixed by the government, so it needs accounting information to fix fair prices so that consumers and producers are not exploited.
PURPOSES AND OBJECTIVES OF FINANCIAL STATEMENTS
Financial statements are very useful as they serve varied affected group having an economic interest in the activities in the business entity. Let us analyse the purpose served by financial statement:
a) The basic purpose of financial statement is communicated to their interested users, quantitative and objective information are useful in making economic decisions.
b) Secondly, financial statements are intended to meet the specialized needs of conscious creditors and investors.
c) Thirdly, financial statements are prepared to provide reliable information about the earning of a business enterprise and it ability to operate of profit in future. The users who are interested in this information are generally the investors, creditors, suppliers and employees.
d) Fourthly, financial statements are intended to provide the base for tax assessments.
e) Fifthly, financial statement are prepare in a way a provide information that is useful in predicting the future earning power of the enterprise.
f) Sixthly, financial statements are prepares to provide reliable information about the changes in economic resources.
g) Seventhly, financial statements are prepares to provide information about the changes in net resources of the organization that result from profit directed activities.
Thus, financial statement satisfy the information requirements of a wide cross-section of the society representing corporate managers, executives, bankers, creditors, shareholders investors, labourers, consumers, and government institution.
Limitations of financial statements
Financial Statements suffers from various limitations which are given below:
(i) Historical Records: Persons like shareholders, investors etc., are mainly interested in knowing the likely position in future. The financial statements are not of much help as the information given in these statements is historic in nature and does not reflect the future.
(ii) Ignores Price Level Changes: Price level change and purchasing power of money are inversely related. Different assets are shown at the historical cost in financial statements. It, therefore, ignore the price level change or present value of the assets.
(iii) Qualitative aspect Ignored: Financial statements considered only those items which can be expressed in terms of money. Financial Statements ignores the qualitative aspect such as quality of management, quality of labour force, Public relations.
(iv) Suffers from the Limitations of financial statements: Since analysis of financial statements is based on the information given in the financial statements, it suffers from all such limitations from which the financial statements suffer.
(v) Not free from Bias: Financial statements are largely affected by the personal judgement of the accountant in selecting accounting policies. Therefore, financial are not free from bias.
(vi) Variation is accounting practices: Different firms follow different accounting practices. For example, depreciation can be provided either on SLM basis or WDV basis. Profits earned or loss suffered will be different when different practices are followed. Therefore, a meaningful comparison of their financial statements is not possible.
ACCOUNTING STANDARDS
Accounting Standards are the policy documents or written statements issued, from time to time, by an apex expert accounting body in relation to various aspects of measurement, treatment and disclosure of accounting transactions for ensuring uniformity in accounting practices and reporting. These standards are prepared by Accounting Standard Board (ASB). Accounting Standards are formulated with a view to harmonies different accounting policies and practices in use in a country.
Objectives or Purposes of Accounting Standards:
The  whole  idea  of  accounting  standards  is  centered  around  harmonization   of   accounting  policies  and practices  followed  by  different  business  entities   so  that  the  diverse  accounting  practices  adopted  for   various  aspects   of  accounting  can be  standardized. Accounting   standards   standardizes diverse accounting policies   with a view to:
a.      To provide information to the users as to the basis on which the accounts have been prepared and the financial statements have been presented.
b.      To serve the statutory purpose of eliminating the impact of diverse accounting policies and practices and to ensure uniformity in accounting policies & practices, i.e., to harmonize the diverse accounting policies & practices which are in use the preparation & presentation of financial statements.
c.       To make the financial statements more meaningful and comparable and to make people place more reliance on financial statements prepared in conformity with the accounting standards.
d.      To guide the judgment of professional accountants in dealing with those items, which are to be followed consistently from year to year.
e.       To provide   a  set  of  standard  accounting  policies, valuation  norms  and  disclosure  requirements.
Procedure adopted in formulation of Accounting Standards:
The Institute of Chartered Accountants of India (ICAI), recognising the need to harmonies the diverse accounting policies and practices, constituted an Accounting Standards Board (ASB) on April 21, 1977. The main function of ASB is to formulate accounting standards so that such standards may be mandated by the Council of ICAI. While formulating the standards in India, ASB will take into consideration the applicable laws, customs, usages and business environment.
Following procedure will be adopted for formulating Accounting Standards:
a.      Identification of the broad areas by the ASB for formulating the Accounting Standards.
b.      Constitution of the study groups by the ASB for preparing the preliminary drafts of the proposed Accounting Standards.
c.       Consideration of the preliminary draft prepared by the study group by the ASB and revision, if any, of the draft on the basis of deliberations at the ASB.
d.      Circulation of the draft, so revised, among the Council members of the ICAI and 12 specified outside bodies such as Standing Conference of Public Enterprises (SCOPE), Indian Banks’ Association, Confederation of Indian Industry (CII), Securities and Exchange Board of India (SEBI), Comptroller and Auditor General of India (C& AG), and Department of Company Affairs, for comments.
e.       Meeting with the representatives of specified outside bodies to ascertain their views on the draft of the proposed Accounting Standard.
f.        Finalisation of the Exposure Draft of the proposed Accounting Standard on the basis of comments received and discussion with the representatives of specified outside bodies.
g.      Issuance of the Exposure Draft inviting public comments.
h.      Consideration of the comments received on the Exposure Draft and finalisation of the draft Accounting Standard by the ASB for submission to the Council of the ICAI for its consideration and approval for issuance.
i.         Consideration of the draft Accounting Standard by the Council of the Institute, and if found necessary, modification of the draft in consultation with the ASB.
j.        The Accounting Standard, so finalised, is issued under the authority of the Council.
Benefits and Limitations of Accounting Standard:
Accounting  standard  seek to  describe the  accounting  principles, the valuation  techniques  and  the  methods  of  applying  the accounting  principles   in the  preparation  and  presentation of  financial  statements  so that  they  may  give  a true  and  fair   view  .
By setting the accounting standards, the accountant has following benefits:
a.       Standards  reduce  to a reasonable  extent or  eliminate  altogether  confusing   variations   in   the  accounting  treatments  used  to prepare  financial  statements.
b.      There are certain areas where important information is not statutorily required to be disclosed. Standards may call for disclosure beyond that required by law.
c.       The  application   of  accounting standards  would ,to  a  limited  extent, facilitate  comparison  of  financial  statements  of  companies  situated in  different parts  of  the  world  and also of  different   companies  situated  in  the  same  country. However, it  should  be  noted  in  this  respect  that  differences in the institutions, traditions  and  legal  systems  from  one  country  to  another give rise  to  differences   in  accounting   standards  adopted  in  different  countries.
However, there are some limitations   of setting of accounting standards:
                (i)Alternative solution to certain   accounting problems may   each have   arguments to recommend them. Therefore, the choice between   different alternative   accounting   treatments may   become difficult.
                (ii)there may  be  a   trend  towards  rigidity  and  away  from  flexibility in   applying  the  accounting  standards.
                (iii)Accounting standards cannot override the statute. The  standards  are  required   to be  framed  within  the  ambit  of  prevailing  statutes.


LIST OF ACCOUNTING STANDARDS                  
AS 1
Disclosure of Accounting Policies
AS 2
Valuation of Inventories
AS 3
Cash Flow Statement
AS 4
Contingencies & Events occurring after Balance Sheet date
AS 5
Net profit or Loss for the Period, Prior period items & changes in accounting policies
AS 6
Depreciation Accounting
AS 7
Accounting for Construction Contracts
AS 8
Accounting for Research & Development
AS 9
Revenue Recognition
AS 10
Accounting for Fixed Assets
AS11
Accounting for effects in changes in Foreign Exchange Rates
AS 12
Accounting for Government Grants
AS 13
Accounting for Investments
AS 14
Accounting for Amalgamations
AS 15
Accounting for Retirement benefits in the Financial Statements of employers
AS 16
Borrowing Cost
AS 17
Segment Reporting
AS 18
Related Party Disclosure
AS 19
Leases
AS 20
Earnings Per Share
AS 21
Consolidated Financial Statements
AS 22
Accounting for taxes on income
AS 23
Accounting for Investments in Associates in consolidated financial statements
AS 24
Discontinuing Operations
AS 25
Interim Financial Reporting
AS 26
Intangible Assets
AS 27
Financial Reporting of Interests in Joint Ventures
AS 28
Impairment of Assets
AS 29
Provisions, Contingent Liabilities and Contingent assets
Accounting Policies
Accounting policies refer to:
a) Specific accounting principles, and
b) Methods adopted by enterprises, in applying these principles in the preparation and presentation of financial statements.
There is no single list of accounting policies which are applicable to all circumstances. The differing circumstances in which enterprises operate in a situation of diverse and complex economic activity make alternative accounting principles and methods of applying those principles acceptable. The choice of the appropriate accounting principles and the methods of applying those principles in the specific circumstances of each enterprise call for considerable judgment by the management of the enterprise.
Areas in Which Differing Accounting Policies are Encountered
The following are examples of the areas in which different accounting policies may be adopted by different enterprises.
a.      Methods of depreciation, depletion and amortization
b.      Treatment of expenditure during construction
c.       Conversion or translation of foreign currency items
d.      Valuation of inventories
e.       Treatment of goodwill
f.        Valuation of investments
g.      Treatment of retirement benefits
h.      Recognition of profit on long-term contracts
i.         Valuation of fixed assets
j.        Treatment of contingent liabilities.

Disclosure of Accounting Policies:
This statement deals with the disclosure of significant accounting policies followed in preparing and presenting financial statements. The view presented in the financial statements of an enterprise of its state of affairs and of the profit or loss can be significantly affected by the accounting policies followed in the preparation and presentation of the financial statements. The accounting policies followed vary from enterprise to enterprise. Disclosure of significant accounting policies followed is necessary if the view presented is to be properly appreciated.
Need for Disclosure of Accounting Policies
a) To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Such disclosure should form part of the financial statements.
b) It would be helpful to the reader of financial statements if they are all disclosed as such in one place instead of being scattered over several statements, schedules and notes.
c)  Any change in an accounting policy which has a material effect should be disclosed. The amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated.
If a change Is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.
Considerations in the Selection of Accounting Policies
The primary consideration in the selection of accounting policies by an enterprise is that the financial statements prepared and presented on the basis of such accounting policies should represent a true and fair view of the state of affairs of the enterprise as at the balance sheet date and of the profit or loss for the period ended on that date. For this purpose, the major considerations governing the selection and application of accounting policies are:
a. Prudence In view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.
b. Substance over Form The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form.
c. Materiality Financial statements should disclose all “material” items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements.
CHANGE IN   ACOUNTING POLICIES
A   change   in accounting policies should be made   in the following condition:
(a)It is required by some Statute or for compliance   with an Accounting standard.
(b)change  would  result  in  more  appropriate  presentation    of  financial  statement.
Change   in   accounting  policy  may  have  a   material  effect  on  the  items  of  financial  statements. For   example, if  depreciation    method  is   changed  from straight   -line   method   to  written  -down  value  method, or  if  cost  formula  used  for  inventory   valuation  is   changed   from  weighted    average  to  FIFO, or   if  interest  is  capitalised  which  was   earlier   not in  practice,  or  if  proportionate   amount   of  interest  is changed  to   inventory  which  was  earlier  not  the  practice , all these may  increase   or  decrease  the  net  profit. Unless   the  effect   of  such   change in  accounting   policy   is  quantified ,the  financial  statements  may  not  help  the  users  of  accounts. Therefore, it is   necessary  to  quantify  the  effect of  change  on  financial  statements  items  like  assets, liabilities ,profit  / loss  .
Fundamental Accounting Assumptions (Fundamental Accounting Concept)
AS-1 highlights three important practical rules. Certain fundamental accounting assumptions underlie the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed. The following have been generally accepted as fundamental accounting assumptions:
a.      Going Concern Concept: This concept is applied on the basis that the reporting entity is normally viewed to be continuing in operation in the foreseeable future, and without there being any intention or necessity for it to either liquidate or curtail materially its scale of business operations.
b.      Accrual Concept: This is relevant in the area of revenue and costs. These are accrued, i.e., recognised, as they are earned or incurred (and not as cash is received or paid). Also, they are recorded in the period to which they relate.
c.       Consistency Concept: There should be consistency of accounting treatment of comparable (similar) items, not only within each accounting period, but also from one period to another.
These concepts, which are fundamental to accounting, are the broad-based assumptions, underlying preparation of financial statements periodically. Financial statements are assumed to be prepared by adhering, among others, to these.
Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles are the rules and concepts which have been accepted by accounting community for sound accounting practice. Their usefulness depends on ‘general acceptability’ rather than ‘individual acceptability’ of accounting concepts.  They (GAAP) have been formalised on the basis of usage, reason and experience.  
Simply, Generally Accepted Accounting Principles (GAAP) comprises a set of rules, concept and Conventions used in preparing financial accounting reports.
Essential features of Accounting Principles
(i)      Man made: Accounting principles are manmade. They are not tested in a laboratory.


(ii)    Objectivity: It means accounting principles must be based on facts and free from personal bias or judgment of the individuals who prepares the statements.
(iii)   Usefulness/relevance: Accounting principles must be relevant and useful to the person who is using financial statements.
(iv)  Feasibility: The accounting principles should be practicable or feasible.
(v)    Axiom: It denotes a statement of truth which cannot be questioned by anyone.
Need and Significance of GAAP
1) Consistency: Corporations, non-profits and government organizations must prepare their financial statements in accordance with generally accepted accounting principles (GAAP) set by the Indian Accounting Standards Board (IASB). Accounting principles are important because they establish a consistency that allows for more accurate and efficient viewing of company statements and reports.
2) Standards: The generally accepted accounting principles represent a complex, important set of accounting definitions, methods and assumptions that create a standard method of reporting the financial details of a business. With the GAAP, a hierarchy exists that dictates which standard should be used and when.
3) Industry Comparisons: Potential investors who want to direct funds to a certain type of industry without a particular company in mind will find accounting principles an important tool as individual businesses are reviewed. Standards allow the investor to compare and contrast companies across a singular industry or multiple industries quickly through balance sheet, income statement and annual report reviews.
4) Company Performance: Because of the long-term consistency in key accounting definitions and methods, standard company performance measures listed on financial statements and annual reports provide a realistic view of the company's growth or lack of growth over a period of years.
Accounting principles to be followed while preparing financial statements are divided into two parts:
a)      Accounting concepts and
b)      Accounting Conventions
Accounting concepts
The term ‘concept’ is used to denote accounting postulates, i.e., basic assumptions or conditions upon which the accounting structure is based. The following are the common accounting concepts adopted by many business concerns.
i) Business Entity Concept: Business entity concept implies that the business unit is separate and distinct from the persons who provide the required capital to it. This concept can be expressed through an accounting equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself owns the assets and in turn owes to various claimants.
ii) Money Measurement Concept: According to this concept, only those events and transactions are recorded in accounts which can be expressed in terms of money. Facts, events and transactions which cannot be expressed in monetary terms are not recorded in accounting. Hence, the accounting does not give a complete picture of all the transactions of a business unit. 2006
iii) Going Concern Concept: Under this concept, the transactions are recorded assuming that the business will exist for a longer period of time. Keeping this in view, the suppliers and other companies enter into business transactions with the business unit. This assumption supports the concept of valuing the assets at historical cost or replacement cost.      
iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction has a two-fold aspect, Viz., 1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry system is that every debit has a corresponding and equal amount of credit. This is the underlying assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or Capital = Assets – Liabilities, will further clarify this concept, i.e., at any point of time the total assets of the business unit are equal to its total liabilities.
V) Periodicity Concept: Under this concept, the life of the business is segmented into different periods and accordingly the result of each period is ascertained. Though the business is assumed to be continuing in future, the measurement of income and studying the financial position of the business for a shorter and definite period will help in taking corrective steps at the appropriate time. Each segmented period is called “accounting period” and the same is normally a year.
vi) Historical Cost Concept: According to this concept, the transactions are recorded in the books of account with the respective amounts involved. For example, if an asset is purchases, it is entered in the accounting record at the price paid to acquire the same and that cost is considered to be the base for all future accounting.
vii) Matching Concept: The essence of the matching concept lies in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business.
viii) Realisation Concept: This concept assumes or recognizes revenue when a sale is made. Sale is considered to be complete when the ownership and property are transferred from the seller to the buyer and the consideration is paid in full.
ix) Accrual Concept: According to this concept the revenue is recognized on its realization and not on its actual receipt. Similarly the costs are recognized when they are incurred and not when payment is made. This assumption makes it necessary to give certain adjustments in the preparation of income statement regarding revenues and costs.
Accounting Conventions: Accounting conventions are common practices, which are followed in recording and presenting accounting information of a business. They are followed like customs in a society. The following conventions are to be followed to have a clear and meaningful information and data in accounting:
i) Consistency: The convention of consistency implies that the same accounting procedures should be used for similar items over periods. It is essential for clear and correct understanding and interpretation of the financial statements. It is also important for inter-period comparison.
ii) Full Disclosure: According to this principle, all accounting statements should be honestly prepared and all information of material interest to proprietors, creditors, investors, etc. should be disclosed in the accounting statements. Moreover, books of accounts should be prepared in such a way that they become reliable, informative and transparent.
iii) Conservatism or Prudence: This convention follows the policy of caution or playing safe. It takes into account” all possible losses but not the possible profits or gains”. The implication of this principle is to give a pessimistic view of the financial position of the business.
iv) Materiality: Materiality deals with the relative importance of accounting information. In order to make financial statements more meaningful and to economize costs, accountants should incorporate in the financial statements only that information which is material and useful to users. They should ignore insignificant details.
Difference between Accounting Standard and Accounting Principles
Accounting Standard is the set of rules that should be applied for measurement, valuation, presentation and disclosure of a subject matter. For example, measurement of deferred tax, valuation of assets, intangibles and financial instruments etc. and presentation and disclosure of such measurements and valuations.
Accounting Principles however, are the fundamental principles providing a framework within which accounting should be done. These principles also govern the formulation of Accounting Standards. For example, Accrual accounting, Substance over legal form, Prudence etc.
Difference between GAAP and IFRS
1)      GAAP stands for Generally Accepted Accounting Principles. IFRS is an abbreviation for International Financial Reporting Standard.
2)      GAAP is a set of accounting guidelines and procedures, used by the companies to prepare their financial statements. IFRS is the universal business language followed by the companies while reporting financial statements.
3)      Financial Accounting Standard Board issues GAAP (FASB) whereas International Accounting Standard Board (IASB) issued IFRS.
4)      Use of Last in First out (LIFO) is not permissible as per IFRS which is not in the case of GAAP.
5)      Extraordinary items are shown below the statement of income in case of GAAP. Conversely, in IFRS, such items are not segregated in the statement of income.
6)      Development Cost is treated as an expense in GAAP, while in IFRS, the cost is capitalised provided the specified conditions are met.
7)      Inventory reversal is strictly prohibited under GAAP, but IFRS allows inventory reversal subject to specified conditions are fulfilled.
8)      IFRS is based on principles, whereas GAAP is based on rules.
Meaning of Financial Reporting, its components and objectives
Basically, financial reporting is the process of preparing, presenting and circulating the financial information in various forms to the users which helps in making vigilant planning and decision making by users. The core objective of financial reporting is to present financial information of the business entity which will help in decision making about the resources provided to the reporting entity and in assessing whether the management and the governing board of that entity have made efficient and effective use of the resources provided. Financial reporting is of two types – Internal reporting and external reporting. The financial report made to the management is generally known as internal reporting and the financial report made to the shareholders and creditors is generally known as external reporting. The internal reporting is a part of management information system and they uses MIS reporting for the purpose of analysis and as an aid in decision making process.
 The components of financial reporting are:
a)      The financial statements: Balance Sheet, Profit & loss account, Cash flow statement & Statement of changes in stock holder’s equity
b)      The notes to financial statements
c)       Quarterly & Annual reports (in case of listed companies)
d)      Prospectus (In case of companies going for IPOs)
e)      Management Discussion & Analysis (In case of public companies)
Objectives of Financial Reporting
The following points sum up the objectives & purposes of financial reporting:
a)      Providing information to management of an organization which is used for the purpose of planning, analysis, benchmarking and decision making.
b)      Providing information to investors, promoters, debt provider and creditors which is used to enable them to male rational and prudent decisions regarding investment, credit etc.
c)       Providing information to shareholders & public at large in case of listed companies about various aspects of an organization.
d)      Providing information about the economic resources of an organization, claims to those resources (liabilities & owner’s equity) and how these resources and claims have undergone change over a period of time.


e)      Providing information as to how an organization is procuring & using various resources.
f)       Providing information to various stakeholders regarding performance of management of an organization as to how diligently & ethically they are discharging their fiduciary duties & responsibilities.
g)      Providing information to the statutory auditors which in turn facilitates audit.
h)      Enhancing social welfare by looking into the interest of employees, trade union & Government.
Qualitative Characteristics of Financial Reports
The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. The Qualitative characteristics of useful financial reporting identify the types of information which are likely to be most useful to users in making decision about the reporting authority on the basis of information in its financial report. Financial information is useful when it is relevant and presented faithfully. Some of the qualitative characteristics which makes the financial reports useful to its users are given below:
a)      Relevance: Information is relevant if it would potentially affect or make a difference in users’ decisions. A related concept is that of materiality i.e. information is considered to be material if omission or misstatement of the information could influence users’ decisions.
b)      Faithful Representation: This means that the information is ideally complete, neutral, and free from error. The financial information presented reflects the underlying economic reality.
c)       Comparability: This means that the information is presented in a consistent manner over time and across entities which enables users to make comparisons easily.
d)      Materiality: Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to which the information relates in the context of an individual entity's financial report.
e)      Verifiability: This means that different knowledgeable and independent observers would agree that the information presented faithfully represents the economic phenomena it claims to represent.
f)       Timeliness: Timely information is available to decision makers prior to their making a decision.
g)      Understandability: This refers to clear and concise presentation of information. The information should be understandable by users who have a reasonable knowledge of business and economic activities and who are willing to study the information with diligence.
h)      Transparency: This means that users should be able to see the underlying economics of a business reflected clearly in the company’s financial statements.
i)        Comprehensiveness: A framework should encompass the full spectrum of transactions that have financial consequences.
j)        Consistency: Similar transactions should be measured and presented in a similar manner across companies and time periods regardless of industry, company size, geography or other characteristics.
International Financial Reporting Standards (IFRS)
IFRS is a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements. IFRS are generally principles-based standards and seek to avoid a rule-book mentality. Application of IFRS requires exercise of judgment by the preparer and the auditor in applying principles of accounting on the basis of the economic substance of transactions. IFRS are issued by the International Accounting Standards Board (IASB). IASB issued only thirteen (13) IFRS which are as follows:
IFRS 1 - First-time adoption of International Financial Reporting Standards
IFRS 2 - Share-based payment
IFRS 3 - Business combinations
IFRS 4 - Insurance contracts
IFRS 5 - Non-current assets held for sale and discontinued operations
IFRS 6 - Exploration for and evaluation of mineral resources
IFRS 7 - Financial instruments: disclosures
IFRS 8 - Operating segments
IFRS 9 - Financial instruments
IFRS 10 - Consolidated financial statements
IFRS 11- Joint arrangements
IFRS 12- Disclosure of interests in other entities
IFRS 13- Fair Value measurement
Need and Importance of IFRS
The goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements. IFRS provides general guidance for the preparation of financial statements, rather than setting rules for industry-specific reporting. Having an international standard is especially important for large companies that have subsidiaries in different countries. Adopting a single set of world-wide standards will simplify accounting procedures by allowing a company to use one reporting language throughout. A single standard will also provide investors and auditors with a comprehensive view of finances. 
Merits of IFRS
1. IFRS brings improvement in comparability of financial information and financial performance with global peers and industry standards. This will result in more transparent financial reporting of a company’s activities which will benefit investors, customers and other key stakeholders in India and overseas.
2. The adoption of IFRS is expected to result in better quality of financial reporting due to consistent application of accounting principles and improvement in reliability of financial statements. 
3. IFRS provide better access to the capital raised from global capital markets since IFRS are now accepted as a financial reporting framework for companies seeking to raise funds from most capital markets across the globe.
4. IFRS minimize the obstacles faced by Multi-national Corporations by reducing the risk associated with dual filings of accounts.
5. The impact of globalization causes spectacular changes in the development of Multi-national Corporations in India. This has created the need for uniform accounting practices which are more accurate, transparent and which satisfy the needs of the users.
6. Uniform accounting standards (IFRS) enable investors to understand better the investment opportunities as against multiple sets of national accounting standard.
7. With the help of IFRS, investors can increase the ability to secure cross border listing.
Limitations of IFRS
1. The perceived benefits from IFRS’ adoption are based on the experience of IFRS compliant countries in a period of mild economic conditions. Any decline in market confidence in India and overseas coupled with tougher economic conditions may present significant challenges to Indian companies.
2. IFRS requires application of fair value principles in certain situations and this would result in significant differences in financial information currently presented, especially in relation to financial instruments and business combinations.
3. This situation is worsened by the lack of availability of professionals with adequate valuation skills, to assist Indian corporate in arriving at reliable fair value estimates.
4. Although IFRS are principles-based standards, they offer certain accounting policy choices to preparers of financial statements.
5. IFRS are formulated by the International Accounting Standards Board (IASB) which is an international standard body. However, the responsibility for enforcement and providing guidance on implementation vests with local government and accounting and regulatory bodies, such as the ICAI in India. Consequently, there may be differences in interpretation or practical application of IFRS provisions, which could further reduce consistency in financial reporting and comparability with global peers.
Explanation of Some Important IFRS
IFRS 1 – First-time adoption of International Financial Reporting Standards: The IASB issued the IFRS 1 on June 19, 2003. It applies to all those business concerns which are going to converge their accounting statements with IFRS from the first time. The IFRS1 has come into with effect from 1st January 2004. The main purpose of IFRS1 is to set out the basic rules or regulations for preparing and presenting first IFRS financial statements and interim financial statements by business concerns. The IFRS1 applies to first IFRS complied financial statements and each interim  report which is presented under IAS 34 for part of the period is covered by first IFRS financial statements of a business concern
IFRS 2 - Share-based payment: The major objective of this IFRS is to reflect the effect of share based transitions in the financial statements of an entity, including expenses associated with transactions in which share options are granted to employees. It is entailed for an entity to mention all the transactions which are associated with employees or other parties to be settled either in cash or other equity instruments of the business entity.
IFRS 3 - Business combinations: The major objective of this IFRS is to specify all requirements for an entity when it undertakes a business. Business combination means combining two separate entities in to a single economic entity. As a result of this, an enterprise obtains the control over the net assets or operations of other enterprises.
IFRS 4 - Insurance contracts: An insurance contract is that where one party (the insurer) accepts the insurance risk of another party (the policy holder) by agreeing to reimburse the amount of policy to the policy holder if any specified uncertain future events occur and adversely affect the policy holder. The primary objective of this IFRS for an entity is to determine the financial reporting for the issued insurance contracts (described in this IFRS as an insurer) until the Board completes the second phase of its project on insurance contracts.
IFRS 5 - Non-current assets held for sale and discontinued operations: The main purpose of this IFRS is to measure the accounting for the assets held for sale, and the preparation and disclosure of discontinued operations in the financial statements of an entity. Particularly, the IFRS requires those assets which can be categorized as held for sale to be measured at the lower degree of carrying amount and fair value less costs to sell, and the amount of depreciation on such assets to cease.
IFRS 6 - Explorations for and evaluation of mineral resources: The primary objective of this IFRS is to specify the effects of exploration for and evaluation of mineral resources in the financial reporting of an entity. This IFRS state that initially an entity should measure mineral resources assets on cost and subsequently measurement can be at cost or revalued amount. The IFRS demands for an entity to perform an impairment test when there are indications that the carrying amount of exploration and evaluation assets exceeds recoverable amount.
IFRS 7 - Financial instruments disclosures: The main purpose of this IFRS is to compel entities to prescribe disclosures that enable financial statements users to measure the significance of financial instruments for the entity’s financial position and performance; the nature and extent of their risk and how the entity manage these risks. This IFRS applies to all type of entities, either that have few financial instruments or those that have many financial instruments. This IFRS does not apply to those financial instruments which are associated with insurance contracts and financial instruments, contracts and obligations under share based payment transactions.
IFRS 8 - Operating segments: The primary objective of this IFRS is to disclose such information that enables the users of financial statements to evaluate the nature and financial effects of the business activities in which it is engaged and the economic environments in which it operates. This IFRS applies to the separate or individual financial statements of an entity and to the consolidated financial statements of a group with a parent whose debt or equity instruments are traded in a public market. If the parent company presents both separate and consolidated financial statement in a single financial report then segment information should be presented only on the basis of consolidated financial statements.
IFRS 9 - Financial instruments: This IFRS is replacement of IAS 39 and its major objective is to set some principles for the financial reporting of financial assets and financial liabilities of an entity’s financial statements and providing useful information to the users of these financial statements so that they can take rational decisions. This IFRS prescribes general guidelines such as how an entity should classify and determine the financial assets and financial liabilities.

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