Ms Fin Semeste (Financial Accounting) UM, INTING INTRODUCTION OF GAAP, ACCOU STANDARDS (AS) AND IFRS 2.1. [ACCOUNTING PRINCIPLES) INTRODUCTION OF GAAP (GENERALLY ACCEPTED) 2.1.1, Meaning and Definition of GAAP ‘The ‘Principle’ may be defined as “The fundamental generalisation that is accepted as true ‘and that can te ‘used as a basis for conduct”. However, in the present context ‘Accounting Principles’ means the rules and guidelines that companies are required to follow while reporting financial data, Such principles differ from one country to another around the world, and each country usually has its own version of Generally Accepted Accounting Principles (GAAP). American Institute of Certified Public Accountants (AICPA) in their Accounting Terminology Bulletin defines the Principles as “A general law or rule adopted or proposed as a guide to action, a settled ground or basis of conduct or practice”. Accounting principles may be defined as, “Those rules of action or conduct which are adopted by the accountants universally while recording accounting transactions”. This is also known as ‘Generally Accepted Accounting Principles’ (GAAP). Generally Accepted Accounting Principles may be defined as, “Those rules of action or conduct which are derived from experience and practice and when they prove useful, they become accepted as principles of accounting”. ‘the accounting principles or practices are acceptable if they fulfil the following basic criteria: 1)_ Relevance: Application of a principle should be relevant to the interested users of accout itis meaningful and practical. 2) Objectivity: ‘Objectivity’ is another criterion for the acceptance of an accounting principle. It means the presence of ‘dependability and integrity’ and absence of ‘subjectivity (personal prejudices)’. Further, there should be some way to ensure the validity and accuracy of the reported financial data. 3) Feasibility: The feasibility of an accounting principle is ascertained on the basis cost-effectiveness and convenience with which it may be implemented. 2.1.2. Features of GAAP Alll the accounting principles/GAAP essentially display following features: 1) Based on General Rules: The foundation of accounting principles are “general rules’, ‘conventions’, and ‘certain assumptions’ recognised by all the stakeholders, viz. accountants, auditors, managers, regulators, and various Government agencies. It is worthwhile to highlight the fact that the accounting principles cannot be considered perfect and there is no way to ensure their correctness, 2) Launched on the Basis of Logic and Experience: “Accounting Principles’ have no statutory background and, as mentioned earlier, they are based on general ‘logic’, ‘conventions’ and ‘certain assumptions". Formulation of accounting principles are dependent upon the practical expectationvrequirements of all the stakeholders, viz creditors, shareholders, regulators, tax-authorites, law enforcement and other Government agencies, 3) Widely Accepted: One ofthe most important features of accounting principles is their acknowledgement recognition by all the stakeholders. Its very common for an organisation to have some deviations from the ‘common accounting practices to suit its requirements, which is accepted by all ig information ifIntroduction of GAAP, Accounting Standards (AS) and IFRS (Module 2) 25 For example, a ‘Hire-Purchase’ company has an option to use either ‘Asset Accrual Method’ or ‘Total Cash Price Method! for accounting hire-purchase transactions. Not ‘Asset Accrual Method means, “The revenue a company earns over a period of time but has not collected by the end of a reporting period. In its financial statement, the company would list that amount as its accrued assets”. ‘Total Cash Price Method means, “Cash costs are costs that businesses pay for when using cash, or a cheque, but not credit, On a cash accounting basis, the costs paid for by using credit would not be recorded in the ‘general ledger until the actual cash has been paid”, 2.1.3. Need/Utility of Accounting Principles ‘The accounting principles are necessary in view of the following advantages 1) Accounts and financial data prepared on the basis of accounting principles depict the accurate and authentic picture of a business. 2) Accounting process carried out on the foundation of the accounting principles make it a science. 3) Accounting statements prepared on the basis of these principles (accounting principles) are more authentic, significant, candid and comparable. 4) Financial results of two companies can be compared only, if both of them have prepared their accounts on the basis of the same accounting principles. 2.1.4. Classification of GAAP ‘Accounting rests on a small set of fundamental assumptions and principles. These fundamentals are referred to as the ‘Generally Accepted Accounting Principles’ (GAAP). Understanding the principles gives context and makes accounting practices easier to implement. The underlying objective of ‘Accounting Statements’ is the tme, fair and authentic reflection of the business operations and its results. This objective is achieved through the support of ‘Accounting Concepts’ and ‘Accounting Conventions’, which are the two components of the accounting principles. GAAP/Accounting principles can be categorised into two parts: 1) Accounting Concepts, and 2), Accounting Conventions. PMs) oa a eee ‘The word ‘Concept? may be defined as “a general idea or understanding of thought”. It is an idea of what thought is or how it works. “Accounting concepts” are the necessary assumptions, conditions or postulates upon which the accounting is based. They are developed to facilitate communication of the accounting and financial information to all the readers of Financial Statements, so that all readers can interpret the statements with the same meaning and context. Following are the accounting concepts, which have been broadly accepted by accountants: ‘Accounting Concepts Separate Entity Concept [-] Going Concem Concept ‘Money Measurement Concept L[ Accounting Period Concept ‘Cost Concept [{ Dust Aspect Concept ‘Acerual Concept Matching Concept Realization Concept‘MMS First Semester (Financial Accounting) 2.2.1. Separate Entity Concept ai the ‘0 J Tie is «pec i “SopateBnhy Concept hata fa 8s accountng is concered the “owes of busines organisation’ and the “business organisation ise? ae two independent and separale ent pusiness transactions undertaken bythe owner are altogether separate from the personas ct omy Hae ty him, For example. he capital invested by the owner in business rcorded asa Liability fo" Oe Bsn, Simlry if any anset Gacldng cash or goods belonging tothe business taken y the ownes fo" i ty ay use, it is not considered as business expenditure, instead it is treated as ‘withdraw: be) owner. This is the comerstone of “Accounting Concepts’. 2.2.2. Going Concern Concept : ds Going concem is Se oft fundamental es in accounting on the basis of which financial statemen are prepared, The assumption is that a business entity will continue to operate in the foreseeable future without the need or intention on the part of management to liquidate the entity and it will realise its assets and settle ity obligations in the normal course of the business. In simple words, it means that every business entity hag ‘continuity of life and it will not be dissolved in the near future. “The assumption of going concem is the basis of al the financial transactions of a business entity like entering ing Jong-term contracts with other parties, obtaining loans from banks/financial institutions, extending loans, investing in {ong-term securities, purchasing bonds/debentures, tc. This concept also enables a business entity to defer some of their costs like prepaid expenditure, closing stocks, etc. which are required to be charged against future incomes, 2.2.3. Money Measurement Concept In accounting, every transaction is recorded in terms of money, i.e. rupees and paise in India. Receipt of income, ayiment of expenses, purchase and sale of assets, et. are monetary transactions and therefore are recorded inthe books of accounts. The assumption under money measurement concept enables to have a common measure, in terms ‘of money, for all the transactions, assets and liabilities, which facilitate the preparation of financial statements, 2.2.4. Accounting Period Concept g ‘An accounting period is the interval of time at the end of which the financial statements are prepared to ascertain the financial performance of a company. This is known as accounting period concept. Although the “going concer Concept emphasises the continuing nature of an organisation its necessary to review its performance. The preparation of financial statements (balance sheet and profit & loss account) at periodic intervals (known as accounting period) helps in taking timely corrective action and developing appropriate strategies. The accounting period is generally of | twelve months (which may be a calendar year or a financial year), although it may be for three months of six ‘months 8s well in case of new startup. Preparation of financial statements also serves some other purposes like calculation of Profit, tax calculation, submission of reports to regulators and other Government agencies, tc. 2.2.5. Cost Concept As per this concept, cost ofan asset is recorded in the books of accounts at the price paid to acquie it (including Overheads like transportation and installation charges, if any) and not at the market price. Fixed assets, e.g, and, building, plants, machinery, furniture, fixtures, etc, are taken in the record at the price paid for acquiring them, which is also termed as ‘Historical Cost’. However, the cost of assets recorded at the time of purchase may be systematically reduced through depreciation. 2.2.6. Dual Aspect Concept ‘This isthe fundamental concept of accounting. This concept follows from the Entity Concept, All entities own. certain assets. Such assets are acquired through contributions of those who have provided the funds for the purpose. Funds are made available ether through the surplus ofthe entity or loans. Logically such providers of funds are claimants tothe assets. At any pont of time, the asets will be equal to the claims. It may thus be Concluded that each and every transaction, a business entity enters into, has a dual effet With every erence a the money owed to others, there has to be an equal increase in assets or loss, This concept supports the accounting equation, ie, Assets = Owner's Funds (Capital and Reserves) + Liabilities Or Owner's Funds = Asset ~ LiabilitiesJOM ofa ‘ken less, onal ents out cits has imto ‘gin eof, a the tion siod) yof ‘nths mot own the sof in Inwoduction of GAAP, Accounting Standards (AS) and IFRS (Module 2) a 2.2.7. Accrual Concept ‘Under the cash system of accounting, the incomes and expenditures are recorded only if there is actual receipt ‘of payment in cash, irespective of the accounting period to which they belong. But, under the accrual concept, ‘occurence of claims and obligations in respect of incomes or expenditures, assets or liabilities, diminution in | values, etc., are recorded even though actual receipts or payments of money may not have taken place. This concept depicts that incomes and expenses need to be recognised as and when they are earned and incurred respectively, notwithstanding the fact whether the money is actually received or paid inthis regard. 2.2.8. Matching Concept The matching concept isan outcome drawn from the accrual concept. It emphasises thatthe revenue eared and the expenditure incurred must belong tothe same accounting period. To ascertain the surplus or deficit made by ‘a business entity during an accounting period, it is necessary that the costs incurred are matched with the revenue earned by the entity during that accounting period. Therefore, once the revenue is realised or expenditure incurred, they need to be allocated to the relevant accounting period. The matching concept is different under ‘Cash System and ‘Accrual Systems" of accounting: 1) In ‘Cash System’ of accounting only actual receipts and payments are recognised for any accounting year. Revenues are recognised when realised in cash and expenditures are recognised when actually paid in cash. “The period during which the goods were supplied or services were rendered does not matter. The cheque received or issued is as good as the cash realised or cash paid, 2) In ‘Accrual System’ of accounting, revenues are recognised for the accounting period during which the sale is made or service is rendered irrespective of the fact whether realised in cash or not. Similarly, expenditures are recognised for the accounting period during which they are incurred (on due basis), i whether paid in eash or not. This process of recognising and relating expenses with revenves is called matching concept. 2.2.9, Realisation Concept ‘According to this concept, revenue needs to be accounted for only when it is actualy realised or it has become certain thatthe revenue will be realised. However, in order to recognise revenue, actual receipt of cash is not necessary. What is important is that the organisation should be legally entitled to receive the amount for the services rendered or the goods sold. Revenue is said to have been realised when cash has been received or right to receive cash on the sale of goods or services or both has been created. It means that selling goods is realisation, whereas receiving order is not, 2.3. CONVENTIONS USED IN ACCOUNTING ‘Accounting Conventions’ are the guidelines that arise from the practical application of accounting principles. ‘They are nota legally binding practice, rather they are generally accepted practices based on customs, and are designed to help accountants to overcome practical problems faced by them during the preparation of financial statements, : As customs change, so will accounting conventions. Accounting Conventions Coney FullDiscowue Comenon of Coser (or enc) Mate 2.3.1. Consistency \ “The convention of consistency emphasises thatthe accounting principles/practices fll : : lowed by an enti \ be consistently applied by it over the years so as to achieve compatibility It facilitates common of Geen perfomance of an entity from one accountng period to another. pas anc| ‘MMS First Semester (Financial Accounting) UOM This convention may be understood in a better way by an example, there are a number of ctiots 2 the valuation of inventories, viz. ‘First In First Out’ (FIFO), ‘Last In First Out’ (LIFO), or "Weighted Average Method! I an organisation has adopted one method of valuation say “Weighted Average Method’ during one accounting year, the same method needs to be followed during the subsequent accounting years. Any chang¢ ‘the method of inventory valuation would distort the financial results in a substantial manner. In case a change is | made, it should be disclosed. 2.3.2, Full slosure The term “disclosure” implies that there must be a sulicient exposure of information which is of material ni editors, lenders, investors, public, etc. terest to all the stakeholders, viz. owners, creditors, ; The « financial statement ofan entity should disclose fll and fair information to the beneficiaries in order to enable them to form a correct opinion on the performance of such entity, which in tun would allow them to take informed and correct decisions. ion of the Financial Statements , the Accounting Principles that have been followed for preparation of n ein esaigans aca eee oe sca ai ee Further, any other information relevant to the users of the financial statements should also be disclosed, Such formation may pertain to the period covered by the financial statement or may even those pertain to the period subsequent to the finalisation of the balance sheet. 2.3.3. Convention of Conservatism (or Prudence) : This convention means a cautious approach or policy of having a conservative approach. According to this | convention, the anticipated profits need to be ignored but all anticipated losses need to be provided for in the books of accounts of an entity. In other words, all the prospective losses are taken into consideration, while no doubtful income is taken into consideration in recording of transactions by an entity. ‘Some examples are stated in the following poi 1) Providing for ‘Discount’ on debtors. 2) Valuation of the ‘Stock-i hand’ at the ‘Market Price’ or *Cost Price’, whichever is lower. 2.3.4, Materiality : The term material refers to the relative importance of an item or event. An item should be regarded as material, it there is a sufficient reason to believe th iat knowledge of it would influence the decision of informed creditors, | faders investors, public and other stakeholders. The accounts and the financial statements, should impart importance of all material information so that true and fair view of the state of affairs of the entity is given to its beneficiaries, ‘The concept of materiality is relative. What is material for a small com Prati fr cost of small tools may be material fora small vehicle repair workshop, but the seme may not be. the "Marecatae® manufacturers of vehicles. Similarly, the nature ofa transaction is lso important ra deciding ne austerity’. A difference of 21,000 in cash would be considered ‘Material wherees ite difference of the ‘Same amount (%1,000) otherwise would be considered ‘Immaterial" pany may not be material for a large LeU ioe Gy Git (AS) 2.4.1. Meaning of Accounting Standards Accounting Standards comprise accounting guidelines and rules which are required t i nts. Accounting Standards are elosel, Tequired to be followed while ind homogeneity in internal purpose. ‘These standards xe ty in intemal as well as exteral Accounting bodies or governmeastniroduetion of GAAP, Accounting Standards (AS) and IFRS (Module 2) | ‘The main purpose of Accounting Standards is to provide guidelines to the accounting professionals in the of Accounting process of identifying, computing, presenting and releasing financial trades. The primary aim ‘Standards is to help bringing about universal consistency in reporting. Following Accounting Standards also help to fill the difference in accounting practices and make these reports comparable. [At the very same time, it should be made absolutely clear that Accounting Standards are not meant to bring ‘bout inflexibility. These standards only offer guidelines with the aim of making financial statements easy ‘0 understand, 2.4.2. Features of Accounting Standards ‘Aecounting Standards are feleased by the joint collaboration between the Couneil of Institute of Chartered ‘Accountants of India (CAD, National Advisory Committee on Accounting Standards (NACAS) and the Government of India. These standards are obligatory on the companies and are required to be followed for the preparation of financial repors, statements and accounts. The main characteristics of Accounting Standards are as follows: 1) Accounting Standards is an on-paper policy document. 2) Accounting Standards are issued by the recognised expert authorities in the field of accountancy. 3) In India, Accounting Standards are issued by Accounting Standards Board (ASB). This board has been ‘created by the Institute of Chartered Accountants of India (ICAD. 4 Accounting Standards are issued by a recognised apex body, which keeps in view the implication of the matter in hand. 5) Accounting Standards are designed to provide elaborate guidance regarding various issues such as (quantification, handling and reporting of financial transactions. 9 Accounting Standards serve an important purpose of being the language of companies and help presenting the information in more coherent manner. 7) Accounting Standards are malleable and may be adjusted to meet the changing legal, technological and socio-economical requirements. 8) Accounting Standards help in reducing superfluous accounting practices, 9) One of the most important features of Accounting Standards is to bring about w rmity. 2.4.3. Objectives/Needs of Accounting Standards ‘Accounting Standards are intended to standardise accounting procedures and reporting methods. At the Very dine time: these standards are also flexible enough to change in tune with the change in the environment. Following are the main objectives of Accounting Standards: 1). Accounting Standards seek to harmonise myriad of practices followed to record and present financial transactions, which help in comparison among companics 2) Ithelps in making financial statements more consistent and comparable. 3). Increases the utility of financial statements. 4) Helps in producing judicious and timely information for various stakeholders. 2.4.4. Benefits of Accounting Standards ‘Accounting Standards have following main advantages: 1) Deeresses Deviations: Accounting Standards help to decrease the nstances of deviation between the reamrast sf various accounting transactions, which are helpful for making uniform financial statements, 2) Better Reporting: Accounting Standards help in providing better picture of financial situation of the concern, It generally provides wider disclosure than required by law. 3) Makes Comparison Easier: Since Accounting Standards help in homogenising, recording and reporting of Tinanclal carpactions it also makes comparison easier between similar occurrences of companies located at cae ial Meferent countries. However, it should be observed that the reporting may differ due to different legal requirements followed in different countries,poi] Ba MMS First Semester (Financial Accounting) UOM 2.4.5. Arguments Against Setting Accounting Standards Accounting Standards have some drawbacks as well, which are as follows: | 1) Reduces Alternatives: Accounting Standards Provide a fixed treatment of accounting transactions, This | reduces the number of altematives for professionals to record the financial transactions, 2) Inflexibility: Accounting Standanis also make accounting practices more inflexible as the transactions are required to be reported or recorded in the prescribed way, regardless oftheir peculiar nature. 3) Subordinate to the Law: Accounting Standards cannot override the legal requirements set by the authorities. INDIAN ACCOU ING STANDARDS (IND AS) 2.5.1. Accounting Standards Board of India Accounting Standards Board of India, was established by The Institute of Chartered Accountants of India AICAD, in April 1977. The Board was constituted to bring about uniformity in Indian accounting procedures, Accounting Standards Board is primarily responsible for ensuring that its formulated standards are established by the Council of Institute of Chartered Accountants of India. 2.5.2. Procedure for Issuing Accounting Standards Accounting Standards are established by following procedure: ‘Step 1: Identify the wide areas which require the formulation of accounting standards and their relative priority Step 2: Communicate and collaborate with Government, Industry, Public Sector undertakings and other organisations to have their perspectives. Step 3: Create study groups then prepare preliminary drafts (through conversations with various authorities and Professional bodies). Then put forward the draft for opinion to the council of the institute and general public. Step 4: Finalise the draft after proper deliberations. Step 5: Submit the final draft to the Council of the Institute of Chartered Accountants for approval. ‘The Council of ICAI goes through the final draft and may suggest changes. After proper deliberations, the standards may be issued under the direction of the Council. 2.5.3. Objectives and Functions of Accounting Standards Board of India Accounting Standards Board of India has following objectives: 1) To identify and propose areas which require Accounting Standards to grow. 2) Formulation of Accounting Standards to aid the Council of ICAI in the forma in India. 3) To study International Accounting Standards as well as Reporting Standards to determine their applicability in Indian scenario. 4) Review Accounting Standards to keep them relevant to changed scenarios. 5) Offer interpretation and guidance on Accounting Standards. 6) Workout other related functions to Accounting Standards, n of Accounting Standards 2.5.4. Important Accounting Standards Issued by ICAI ; Following are the Accounting Standards issued by Institute of Chartered Accountants of India: indatory from accounting period ASN Ti ee ASI Disclosure of Accounting Policies 14,1991 AS2 Valuation of Inventories. 14,1999 ‘AS 3 (Revised) | Cash Flow Statements. 1.4.2000 ‘AS4 (Revised) | Contingencies and Events occurring after Balance 14,1995 Sheet Datea Introduction of GAAP, Accounting Standards (AS) and IFRS (Module 2) ‘ASS Prior Period and Extraordinary Tems and Changes T1996 (Revised) in Accounting Policies. « AS6 Depreciation Accounting. 14,1995 (Revised) AS7 ‘Accounting for Construction Contracts ASS ‘Accounting for Research and Development. ASO Revenue Recognition. ‘AS 10 ‘Accounting for Fixed Assets. ASI ‘Accounting for the Bifects of Changes in Foreign (Revised 2003) | Exchange Rates. AS 12 ‘Accounting for Government Grants. AS 13 ‘Accounting for Investments. ASi4 ‘Accounting for Amalgamations. AS 15 ‘Accounting for Retirement Benefits in Employer's Financial Statements. AS16 Borrowing Costs. AS17 ‘Segment Reporting. ASI8. Related Party Disclosures. AS19 Leases. AS 20 Eamings Per Share, AS21 Consolidated Financial Statements. AS 22, ‘Accounting for Taxes on Income. AS23 ‘Accounting for Investments in Consolidated Financial Statements. AS24 Discontinuing Operations. AS 25 Interim Financial Reporting. AS 26 Intangible Assets. S27 Financial Reporting of Interest in Joint Ventures, AS28 Impairment of Assets. A829 Provisions, Contingent Liabilities & Contingent Assets. S30 Financial Instruments: Recognition and “Measurements AS31 Financial Instruments: Presentation AS32 Financial Instruments: Disclosure Notes: bodies having their equity or debt securities listed on recognised 1) AS 3 and AS 17 are obligatory for the ‘tock exchanges in India and for the companies which are in the progression to issue equity or debt seurties which will be listed n a recognised stock exchange in India. These Accounting Standards are flso mandatory for the concems with over 50 crores of turnover in an accounting period. 'AS 20 is obligatory for the enterprises with equity shares listed or eligible to be listed on exchanges in India. 3) AS 21 is obligatory fo or not required by law. 4) AS 22s applicable to account i) All the concerned compan exchanges in India and for t 2 recognised stock the enterprises which report their financial statements in consolidated form, whether {ng periods commencing on or after 1.4.2001. It is obligatory for: ies which have their equity or debt instruments listed on recognised stock fhe companies which are in the progression to issue equity or debt securities Which will be listed on a recognised stock exchange in In ii) Ihis also obligatory for the concern, part ofa group, which is subjected to stipulations made in (i). iil) If the companies are not covered by (i) and (ii) above, these Accounting Standards will still be ing periods commencing on or after 1.4.2002. applicable for all the account iv) Fer all the other enterprises, the Accounting Standards are applicable for all the accounting periods ‘commencing on or after 1.4.2003. erMMS First Semester (ranancias ewww tae a 2 2.6. INTERNATIONAL STANDARDS (IFRS) FINANCIAL 2.6.1. Introduction : Imernational Financial Reporting Standards (IFRS) were introduced by the International Accounting deserts Board (IASB), which took over the job of harmonisation of accounting standards throughout the seat from the International Accounting Standards Committee (TASC) in the year 2001. The standardisation of or ronal accounting practices was necessitated in view of the growing phenomenon of globalisation and irith a view to fulfil the day to day need; IASC was brought into existence in the year 1973. TASB which replaced IASC, is also ‘not for profit” and independent body, the primary objective of which is to develop a set of quality standards pertaining to the financial reporting, which is easy “ understand and is, eveptable all over the globe forthe preparation of financial statements. IFRS is, thus, quite different from the TAS (International Accounting Standards), which were developed by the erstwhile IASC. ide a common structure and guidelines for the entire world as to financial statements with necessary disclosures in a transparent pemnes The guidelines framed under IFRS for the preparation of financial statements are genera} in nature, and ae such applicable to all kinds of business and industries; there are no industry-specific rules. Such standards are ae ennerte significance for those business entities, which have their businesses spread over a number of eon aenstross the globe or those who have future plan to expand globally. A single set of widely accepted Faanettt standard facilitates integration and simplification of financial statements preparation by the branches spread over various parts of the world. Other stakeholders also find it convenient to understand the overall performance and financial health of a company and take appropriate decisions, IFRS have been developed with a view to provi how the public companies need to prepare theit 2.6.2. Features of IFRS ‘The salient features of IFRS are as follows: 1) Principle Based Approach: ‘The rules framed under IFRS are broad based and not very elaborative, prescriptive or inflexible in nature, They are basically founded upon various principles and some of the fegulatory outcomes. This approach does not envisage micro-management at any level, and the business Cutities are free to use their commercial judgement/discretion within the overall framework of IFRS. It has tgiven a long rope to the management of a business entity for taking decision with regard to: i) The accounting methodology to be adopted by them, and ii) Assessment of recounting figures, during the preparation of financial statements. Principle-based approach is diametrically opposite to the rule-based approach inasmuch as the latter lacks ity as far as alignment of business objectives and processes with regulatory outcomes are concerned. ased) entails specific course of action, if certain conditions are fulfilled. 2) Fair Value Accounting: The accounting based upon the historical cost-based principles suffers from umber of shortcomings. IFRS encourages the fair value accounting principles, which are considered forward-looking and a superior one as compared with the historical cost-based principles (ie. GAAP). Financial reporting based upon the fair-value accounting principles is most suitable for the potential investors, who get preference over other stakeholders under the IFRS. The logic behind this is very simple; the investors/potental investors believe in the power of market forces and market-based valuation of assets js acceptable to them for taking decisions with regard to buying or selling of stocks. Under IFRS, a number of items appearing in the financial statements are based upon the principles of fair-value accounting. 3) Comprehensive Income: The concept of comprehensive income is of recent origin in the evolution process of accounting standards and it occupies an important place in the agenda of IFRS. Comprehensive ia provides transparency in showing all revenve expenses, gains, losses, etc. to be recognised during a specific vrvafame. Their summary is recorded in a special financial statement, termed as the atom ead vae comprehensive income’. ent of ‘Under the consolidation technique, which is a part of IFRS, th ; diaries are required to be valued at their fair value as on the ‘date of the soqusiioa, As 2 4) Consolidation: company's subsiIntroduction of GAAP, Accounting Standards (AS) and IFRS (Module 2) 33 sequel to this, the minority interest (also referred to as non-controlling interest) is also valued as at fair value on the same date. This is a significant departure from the traditional GAAP standards, under which the minority interest is excluded from the fair value adjustments, 5) Transparency: Transparency is yet another striking feature of IFRS. Transparency in accounting, and especially in the preparation of financial statements, comes from the underlying and strong faith in the market forces; it is presumed that the markets are competent enough, and as such the information ‘communicated to various stakeholders through the financial statements, are reflected in the stock prices of a company also in an accurate and reliable manner. ‘This feature of IFRS, which is qualitative in nature, enables stakeholders of a company, particularly the investors, to take necessary decisions on the basis of relevant information. 2.6.3. Objectives of IFRS IFRS were developed and recommended while considering following objectives in mind: 1) To make available, in the public interest, a single set of financial reporting standards on the basis of principles, which are of high quality, easy to understand, enforceable and acceptable to the entire global community. These standards, inter-alia, require the financial statements and other reports prepared by a company to be of high quality and transparent, which provide comparable information for various stakeholders including the investors, the player in the world’s capital markets, and other users, 0 as to enable them to take necessary decisions; To encourage the application of the standards under the IFRS amongst various stakeholders to the ‘maximum possible extent; To take into account suitably, the requirements of an array of sizes and types of entities in different economic settings prevailing in the world; and 4) As the standards and interpretation thereof were originated from IASB, one of the objectives of IFRS is to facilitate its adoption by various business entities spread over the globe. For this, it is necessary to integrate ‘the national accounting standards of a country with the IFRS. 2.6.4. Needs for IFRS Followings are the arguments in favour of adopting IFRS: 1) Level of Confidence: The main advantage of adopting IFRS, which is considered to be a stable, transparent, and fair accounting system across the world, would be that the confidence level of investors ~ domestic as well as foreign - would be boosted. Risk Evaluation: If the financial data and other statements are not prepared in terms of international standards, the investors generally assign some premium. Introduction of IFRS would rule out such hurdle to cross-border listings and as such the investors would be the gainers. Merger and Takeover Activity: As the introduction of IFRS would eliminate the need to redesign the financial statemeats, the way to cross-border mergers and acquisitions would be facilitated. Investments: If the IFRS are introduced in a country, and various business entities become IFRS compliant, the comfort level of foreign investors would be enhanced and they would find such destinations 2 a 2 3 4) ‘more lucrative, 2.6.5. Composition of IFRS IFRS include, in addition to the main IFRS developed and recommended by the International Accounting Standards Board (IASB), standards recommended by various committees from time to time (1973 to 2001), e.g. IASC (Intemational Accounting Standard Commitiee) and interpretations derived from IFRIC (Intemational Financial Interpretation Committee). 2.6.6. Scope of IFRS Financial reporting standards, recommended by International Accounting Standards Board (IASB) subsequent. to its formation in 2001, are referred to as International Financial Reporting Standards (IFRS), the scope of Which is furnished in the following points: 1) The provisions of all the International Accounting Standards (IASs) and interpretations thereof by the erstwhile [ASC and SIC would remain valid, unless their formal amendment or withdrawal is notified:[MMS First Semester (Financial Accounting) UOM| Ea licat financial statements and other reporting by tho ele papers those who are engaged in the| 2) Toe nanai cov eS a ene ‘business entities, which are formed with the sole purpose of profit: making, emthermsaing): i i i vities (their legal form business of commercial, industrial, financial and such activities ( orm nots 4 Entities in existence with no motive of making profit (non-profit making entities) may also, find it > convenient nd sufablto embrace PRS: city a tements, prepared on the basis of standards recommended under IFRS, serves » eer the muvsrcnents of various sakeholdrs such as shareholders, lenders, other ereditos, employer existing and prospective investors, as also the common people. Further, the financial health of a IFRS compliant organisation, and its performance on various-parameters are revealed through various financial statements in a lucid and transparent manner; 5) The information, other than those already incorporated in the financial statements, becomes part of ‘othed financial reporting’. Such additional information enables the users in interpreting different issues in a betted ‘manner and taking appropriate economic decisions; ©) IFRS are applicable to individual companies for the preparation of their standalone financial statements, well as preparation of consolidated financial statements of the group / subsidiary companies; 7) Following statements form a complete set of financial statements in accordance with the standards of IFRS 1) Statement of financial statements; ii) Statement of comprehensive ineome; ili)Statement of cashflow; iv) Statement of changes in equity; -) Summary of the accounting policies; vi)Explanatory notes; and vii) Separate income statement, in case itis presented, in terms of IAS (2007); 8) While developing IFRS, the intention of IASB was to leave little option in accounting treatment, so that ‘number of those options gets reduced to the bare minimum. However, the Board is open to reconsider tht ‘options available under the current IAS, 9) Under the IFRS, the core principles are presented in ‘Bold Face Type’ (Black Letters), whereas the oth guidelines are presented in ‘Non-bold Type’ (Grey Letter). However, there is no distinction between th levels of authority under both the categories. Assets = Liabilities + Shareholders Equity (Capital) AzL+C Where, A= Assets, L= Liabilities, and C = Capital (Shareholders Equity)Invrodoction of GAAP, Accounting Standards (AS) and IFRS (Module 2) The balance sheet is a complex display of the above equation, showin a co ig that the total assets of a company are equal to the total of liabilities and shareholders’ equity. Any purchase or sale by an accounting entity has an equal effect on both sides of the equation, or offsetting effects on the same side of the equation. Assets are the resources or things a company owns, e.g., land, building, machinery, equipment, cash, debts receivable, inventory, investments, prepaid insurance, etc. It also includes intangible assets, like goodwi trademarks, preliminary expenses, etc. Lisbilities are the obligations of a company of the amounts a company owes to others, e.g., borrowings, ‘account payable, salaries/wages payable, interest payable, dues of Government authorities like income tax, sale tax, service tax, etc. Liabilities may be categorised under two heads: 1) "Claims by creditors against a company’s assets, and 2) A source of a company's assets (owners’ funds). Capital, also known as owner’s equity of stockholders’ equity, is the residual amount after deducting liabilities from the assets: ‘Assets — Liabilities = Owner's Equity or Capital “Owner's Equity’ or ‘Capital’ comprises of the “Paid-up Capital’ and the ‘Profit’ eared and accumulated over the years (‘Net Income’ not withdrawn or distributed as ‘Dividend’) kept either as it is or in the form of ‘Reserves’. As the ‘Accounting Equation’ reveals the basic relationship between various constituents of the ‘Balance Sheet’, itis also referred to as the “Balance Sheet Equation’. Balance Sheet of a company is statement of its ‘Owner's Equity’ and various items of its ‘Assets’ and ‘ jes’. An event impacting any of the “Balance Sheet’ components (‘Owner's Equity’, ‘Assets’ or ‘Liabilities’) is termed as a ‘Transaction’. Before recording a transaction in the books of accounts, it is necessary to identify two “Heads of Accounts’, which would be ‘Credited’ or ‘Debited’. 2.8.2. Accounting Equation Based on Classification of Accounts of Recounts Meaning, Example Ty Assets TAsseis Accounts” of a company represents all] Tangible Assets: Land, Building, Plant/Machinery,| ‘Accounts the "Tangible" as well as ‘Intangible’ asset| Cash/Bank balance, ec. stems ofthe balance shect. intangible Assets: Goodwill, Patents, Trademarks, ete. 3) Liabilities | Liabilities Accounts” of a company are its| Sundry Creditors, Outstanding Expenses (including ‘Accounts, | financial obligations it owes towards outsiders. |tax liabilities), Bank Borrowings (Overdraft, Cash (Credit or Term Loans), etc. 3) Capital Tapital Accounts" of a company represents its| Capital ale, Drawings a, et. ‘Accounts "| ‘Inside Liabilities’, Le. its abilities towards fa) Revenue ‘Revenue Accounis” represents the amoont| Sales a/c, Discount Received we, Dividend ‘Accounts [charged for goods sold or services rendered or [Received a/c, Royalty Received a, Interest tllowing others to use enterprise resources| Received ae, ete. ielding intrest, royalty or dividend. Expenses Expenses Accounts” are the expenses incured| Purchases a/e, Discount Allowed we, Royalty Paid ‘Accounts {inthe conduct of business in the normal course afc, Interest Payable a/c, Loss by Fire/Flood/Theft| for losses suffered due to some unforeseen |a/, etc causes like fire, flood, theft ec. 2.8.3. Procedure for Developing an Accounting Equation Following steps play a major role in the development of an ‘Accounting Equation’: Step 1) Identific a transaction. jon of the variable-items of the balance sheet, ic., Assets, Liabilities or Capital impacted by Step 2) Ascertaining the impact (increase or decrease) of the transaction on the variable-items of the balance sheet. ‘Step 3) Showing the impact of the transaction on the appropriate variable-items of the balance sheet and ensuring that both the sides of the balance sheet, viz. Assets and Liabilities remain matched. In other words, the total of ‘Assets Side’ of the balance sheet needs to be equal to the total of the ‘Liabilities Side’.36 [MMS First Semester (Financial Accounting) UOM ‘The above procedure of ‘Accounting Equation’ would be better understood with the help of the following examples: ‘Mr. Rahul has introduced capital of €1,00,000 in a new business. There are two aspects of the transaction. ‘The business has received cash of %1,00,000, Its its asset but on the other hand it has to pay a sum of %1,00,000 to Rahul (proprietor). Thus: Capital and Liabiides [© ‘Assets = Capital 1,00,000, Cash 100,000 Rahul has bought furniture of €20,000 for cash. The position of his business will be as follows: Capital and Liabilities | © ‘Assets © Capital 17,00,000 | Cash 30,000 Furniture 20,000 700,000, 7,00,000, Example 1: Prepare accounting equations for the following transaction 1) Started business with cash %4,00,000 and machine 10,000. ~ 2) Purchased goods for 1,00,000 by paying 50% in cash immediately. 3) Cash withdrawn from bank 70,000. 4) Salary payable %60,000 of which 60% is outstanding, 5) Sold goods costing %70,000 for %80,000. Solution: : ‘S.No. ‘Transactions: Liabilities + Capital 1) | Started business with cash %4,00,000 0+ 410,000 and machine €10,000 oF 0 2) | Purchased goods for %1,00,000 50,000 + 0 and paying 50% cash immediately o+ 0 ‘New Equation 30,000 + -4,10,000 3) | Cash withdrawn from bank 70,000 o + 0 oF 0 —— ‘New Equation 30,000 + _4,10,000 4) | Salary Payable 260,000 of which 60% is outstanding 36,000_+ _ (-) 60,000 5 : ‘New Equation 86,000 + 3,50,000, 5) | Sold goods costing £70,000 '80,000 0 + 10,000 for ®80,000, (70,000 o+ 0 New Equation |" 4,46,000 = 86,000 + 3,60,000 \ Example 2: Show the effect of the following business transactions on assets, liabilities and capital through accounting equation: 1) Commenced business with cash 820,000. 2) Goods purchased on credit 27,000. 3) Furniture purchased %3,000. 4) Paid to creditors %2,000. 5) Amount withdrawn by the proprietor %4,000. 6) Creditors accepted a bill for €1,500. 7) Interest on capital 81,000. 8) Transfer from capital to loan 25,000. 9) Allotted shares to creditors %1,000. Soutien (eRe “Transactions ‘Assets = Liabilities + Capital IF] Covance business with ash €20000 | 20,000 = 0+ 20,000 2) | Goods Purchased on eet 7,000 7,000 7000+ 0 ‘New Equation | 27,000 "7000+ 20,00Introduction of GAAP, Accounting Standards (AS) and IFRS (Module 2) 37 ‘3)_] Furninare Purchased €3,000, 3000 = 0+ o (-)3000_= o+ 0 New Equation |" ~27,000 = 7,000 + 20,000, 44) | Paid o creditors €2,000 (2.000 = (2200+ 0 ‘New Equation |" 25,000 = 5000+ 20,000 5) | Amount withdrawn by the proprietor 84,000 | (=) 4,000 _= 0+ @)4000 ‘New Equation | 21,000 = 3000+ 16,000 6) | Creditors accepted a bill for 81,500, O= 1500 + 0 500+, 0 New Rquatton FeO 7) | toterest om capital €1,000 0 + 1,000 o_+ «1,000 ‘New quatlon 500+ 16,000 18) | Transfer from capital to loan £5,000 5,000_+ _(-)5.000 New Equation 70,000 + 11,000 9) | Attoned shares to creditors £1,000 (1,000 + 1,000 ‘New Equation. 9,900_+ 12,000 Example 3: Show the accounting equation on the basis of the following transactions: 1) Yunus started business with cash %90,000. 2) Purchased goods on credit %50,000. 3) Purchased furniture for cash 10,000. 4) Sold goods costing 20,000 for £40,000. '5) Sold goods costing 20,000 on credit for %42,000. 6) Bought goods worth 320,000 (815,000 paid in cash and balance on credit) 7) Withdrawal of cash for personal use %5,000. 8) Paid for rent 71,000. 9). Paid to creditors 40,000. 10) Paid for salaries %3,000. 11) Received from debtors €12,000. ‘Solution: ‘S.No “Transactions 1) | Yonus started business with cash £90,000 2) | Purchased goods on credit for 250,000 New Equation 3) | Purchase furniture for eash 210,000 New Equation 4) | Sold goods consisting £20,000 for £40,000 ‘New Equation 5) | Sold goods consisting £20,000 on credit for €42,000, New Equation 6) | Bought goods worth £20,000 New Equation 1) | Drawn for personal use £5,000 New Equation 8) | Paid for rent €1,000 New Equation, 9) | Paid to ereditors £40,000 New Equation 10) | Paid for salaries £3,000 [New Equation 11) | Received from debtors £12,000 ‘New Equation3 ing transactions: Example 4: Show the accounting equation on the basis of the following 1) Shri Ram commenced business with %50,000. 2). Paid rent in advance %2,000. 3) Purchased a typewriter for °7,000, 4) Bought furniture from Mohan Furniture on credit for 83,000. 5) Purchased goods from Sohan for cash 235,000. ) Sold goods to Shyam for cash %40,000 (costing €30,000).. 7) Bought goods from Ramesh for €30,000. 8) Sold goods to Shyam costing %30,000 for £50,000. 9) Purchased household goods for 815,000 giving 25,000 in cash and the balance through @ loan. 10) Goods destroyed by fire (Cost 8500, Sale Price 2600). 11) Paid half the amount owed to Mohan Furniture. 12) Paid cash 8500 for loan and 8300 for Interest. 13) Withdrew goods for personal use (cost &500, sale price 2600). 14) Received £49,500 from Shyam in full settlement. 15) Paid %29,700 to Ramesh in full setlement. 16) Paid salary %500 and salary outstanding £100, 17) Charged depreciation of 2300 on furniture and £100 on typewriter. Solution: SNe remains 1) | Si Ram commenced babes shea 2 | Panencinatrance New Eqoation 2) | Pots ypeerer New Equation 4 | Bonet amir rom Mohan Furie on cei New Equation 5) | ctased gods fer cash New Equation 6) | soit goods for ash 000 costing £30,000 New Equation 7) | Boupt gods fom Ramesh New Equation 8 | soi good shyam a €5,00(cosing £30.00) New Equation 9 |Pustased household goad for 5.000 giving 25000 ean Salas doh an New Equation 10) | coats desvoye by fi (cos £50, sl rie 600) New Equation 10) } Pid a te amount ed to Mohan Fumie New Equation 12) _| Paid cash %500 for loan and %300 for interest = New Baton 13) | wittew sons for pron se cost 500, ale price RON New Equation 14) _| Received %49,500 from Shyam in full settlement New Equation 15) _| Paid 29,700 to Ramesh in full settlement bes New Equation 16) | Paidsaary £500 and sary oustanding 100 New Equation 17) | charged depresiaton 200 on frit nd £100 on pense New EquationoM Introduction of GAAP, Accounting Standard (AS) and TFRS (Module 2) po. EXERCISE 2.9.1. Theoretical Questions 4) Define GAAP. Explain the features of GAAP. 2). Explain the concepts and conventions used i >» 4 ‘ceounting in brief. ‘What are the funetions of Indian accounting standards? '5) Whatis the procedure of issuing Indian accounting standards? 66) Explain the features and benefits of accounting standards, 2) Give the important Accounting Standards issued by ICAL. 8) Define IFRS with the help of thei need and objectives. 9). What do you mean 2. Practical Questions ‘Asan bad the following transactions. Use the Accounting 23 » capital: j) Invested €15,000 in cash as capital. ii) Purchased furniture for cash 27,500. iii) Purchased a building iv) Sold furniture costing 21,000 for 21,500. ¥)_ Purchased on old car for 2,800 cash. vi) Received cash as rent €3,600. “¥il) Paid cash 8500 for loan and 2300 for interest. ay ‘iil Paid cash for household expenses €300. ix) Received cash for dividend on securities €200. Ans: Assets = €28,200; Liabilities = €9,500; Capital = £18,700] 2). Bitoo had the following transactions: 4). Commenced business with cash of £50,000. 4) Purchased goods for cash £20,000 and on credit £30,000. “ if) Sold goods for cash 40,000 (costing £30,000) jv) Rent paid £500. ¥ Rent outstanding €100. 4) Bought furniture €5,000 on credit. vil) Bought refiigerator for personal use £5,000. vii)Purchased building for cash £20,000. ‘Use Accounting Equation to show the {Ansz Assets ~ £89,500; Liabilities = €35,100Capital = €54,400] 13). Show the Accounting Equation on the basis of the following transactions Robit and Mohit entered into a partnership agreement to d capital respectively, Other transactions were as under: i) Timber purchased of ®40,000. })_ Wages paid to carpenters €30,000. iii) Fumitute sold for €50,000 (Costing £40,000). iv) Fumiture sold on credit 210,000 (Costing £9,000) 3). Amount received from debiors £9,900 and Discount allowed €100. ‘Timber purchased on credit %6,000. vii) Furniture purchased 85,000. vii) Payment to creditors €5,950 in ful settlement. ix); Amount withdrawn: Rohit © Mohit €1,000 Ans: Assis = €1,27:950; and Copital 1.2790) ‘What do you mean by accounting equation? What isthe procedure for developing an accounting equation? by accounting standards? What are the objectives of accounting standards? or £15,000, giving €5,000 in cash and the balance through loan. 1 effect of the above transactions on the assets, liabilities and capital eal in furniture. 39 ‘Equation to show their effect on his assets, abilities and “They contributed 70,000 and £50,000 asi 4) ” (MMS First Semester (Financial Account ‘Show the Accounting Equation on the basis of the following transactions, i) Mohan commenced business 70,000. Purchased goods on credit 814,000, Withdrew for private use 21,700, iv) Goods purchased for cash 710,000. ¥) Paid wages 7300, vi) Paid to creditors %10,000, }) Sold goods for cash 4,000 (cost price was 83,000), ix) Purchased furniture for 2500. Ans: Assets = %73,000; Li ies = %4,000; Capital = £69,000] ‘Show the Accounting Equation on the basis of the following transactions, 4) Zeenat started business with cash 21,50,000. ii) "He purchased a building and furniture for 21,00,000. iil) He purchased goods from Ram on credit ®50,000. iv) He paid carriage 500, He sold to Y on credit for 29,000 (goods costing 6,000). Received rent from tenants €1,000. Received security deposit from tenants &1,500. ) Purchased stationery for cash 2100, ix) Invested in shares (personal) %50,000, x) Received interest in cash £200, xi) Introduced fresh capital 825,000. xii) Goods destroyed by fire €500. Ans: Assets = 21,79,600; Liabilities = €51,500; Capital = 31,28,100)