CHAPTER II ACCOUNTING STANDARDS AND FINANCIAL REPORTING INFORMATION

Transcription

1 CHAPTER II ACCOUNTING STANDARDS AND FINANCIAL REPORTING INFORMATION 2.1. Introduction 2.2.Meaning of Accounting 2.3.Objectives of Accounting Accounting Concepts Accounting Principles Accounting Conventions 2.4. Limitations of Accounting 2.5. Branches of Accounting Financial Accounting (FA) Cost Accounting (CA) Management Accounting (MA) 2.6. Financial Statement Objectives of Financial Statement 2.7. Financial Reporting Objective of Financial Reporting 2.8. Development of Financial Reporting Objectives 2.9. Benefits of Financial Reporting Managerial Decisions Making Economic Decisions Making Customers Decisions Making Employee Decisions Cost of Capital Keeping Minimizing Fluctuations in Share Price Qualitative Characteristic of Financial Reporting Information Relevance Faithful representation (Reliability) Comparability Verifiability Timeliness Understandability Constraints on Financial Reporting Constraints on Financial Reporting Materiality Constraints on Financial Reporting Benefits and Cost Accounting Standards International accounting standards (IAS) International Financial Reporting Interpretation Committee (IFRIC) International Accounting Standards Board (IASB) Financial Accounting Standards Board (FASB) Accounting Standards in India International Financial Reporting Standards (IFRS) International Financial Reporting Standards (IFRS) Vs. (IGAAP) 50

2 CHAPTER II ACCOUNTING STANDARDS AND FINANCIAL REPORTING INFORMATION 2.1. Introduction Historically, accounting and financial reporting evolved themselves independently and often very differently in different countries. Practice, regulation and especially the mode of regulation differed often vary greatly in these countries. Accounting, especially appropriate and relevant accounting, is a critical tool and an information source in any country's efforts towards economic growth and development (Kapaya, 2000). The end product of accounting is financial reporting. Initially, financial reporting was mainly confined to internal reporting. It provided company owners with a vehicle to manage the company. Later on, in the early 1800s, private capital alone was insufficient to finance business activities. Capital was gathered from source outside the company and the owners delegated to managing function to directors and provided them with the necessary authority to run the business activity. This resulted in the extension of accounting from internal financial reporting system to external financial reporting system. Nowadays, the external financial reporting provides a means of reporting the results and accounts to the owners. On the other hand, the structure of annual reports and financial reporting has changed dramatically in recent years. Today, annual reports are no longer restricted to the financial statements, but encompass a broad array of additional matters that must also be disclosed. No longer focused on historic results, it now includes prospective elements, such as guidance on future revenue and earnings targets. Moreover, disclosure of a growing number of non-financial performance metrics is being required, together with an ever-increasing number of financial metrics. 51

3 2.2. Meaning of Accounting There is no single or unanimously accepted definition of accounting, but some of the definitions presented below: American Institute of Certified Public Accountants (AICPA, 1953) definition: accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character and interpreting the results thereof. This institute also definition accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making reasoned choices about the alternative course of action. The American Accounting Association (AAA, 1966) initiated a paradigm shift in the role of accounting by defining it as accounting refers to the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information Objectives of Accounting The main objectives of accounting are systematic recording of transactions, ascertainment of results of recorded transactions and the financial position of the business, providing information to the users for rational decision-making and to know the solvency position. The functions of accounting are measurement, forecasting, and decision-making, comparison & evaluation, control, government regulation and Taxation. On the other hand the general objectives of accounting according to the Accounting Principles Board (APB) are: To provide quantitative financial information about a business enterprise that's useful to the users, particularly the owners and creditors, in making economic decisions. 52

4 To provide reliable financial information about economic resources and obligations of a business enterprise. To provide reliable information about changes is not resources of an enterprise that result from its profit directed activities. To provide other needed information that assists in estimating the earning potential of the enterprise. To provide other needed information about changes in economic resources and obligation. To disclose, to the extent possible, other information related to the financial statements that is relevant to the user s needs Accounting Concepts Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared. Certain concepts are perceived, assumed and accepted in accounting to provide a unifying structure and internal logic to accounting process. The word concept means idea or notion, which has universal application. Financial transactions are interpreted in the light of the concepts, which govern accounting methods. Concepts are those basic assumptions and conditions, which form the basis upon which the accountancy has been laid. Unlike physical science, accounting concepts are only result of broad consensus. These accounting concepts lay the foundation on the basis of which the accounting principles are formulated Accounting Principles Accounting principles are a body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practices and 53

5 as a guide for selection of conventions or procedures where an alternative exists. Accounting principles must satisfy the following conditions: They should be based on real assumptions; They must be simple, understandable and explanatory; They must be followed consistently; They should be able to reflect future predictions; They should be informational for the users Accounting Conventions Accounting conventions emerge of accounting practices, commonly known as accounting, principles, adopted by various organizations above a period of time. These conventions are derived by usage and practice. The accountancy bodies of the world may change any of the convention to improve the quality of accounting information. Accounting conventions need not have universal application Limitations of Accounting The financial statements are prepared on the basis of the above-mentioned assumptions, conventions and the accounting principles which the accountant chooses to adopt. These bring in lot of subjectivity to the financial statements and hence these basis assumptions conventions and principles become the limitation of accounting. The financial statements as the name states accounts only for the items that can be measured by money. There are lots of items that money cannot measure but still are the most valuable assets for the enterprise, like Human Resources, which the financial statements does not depict. 54

6 The language of accounting has certain practical limitations and, therefore, the financial statements should be interpreted carefully keeping in mind all various factors influencing the true picture. 2.5.Branches of Accounting On the basis of information generated by accounting system, there are three main branches of accounting: Financial Accounting (FA) Financial Accounting (FA) deals with preparation of final accounts/financial statements. Income Statement to get previous year s result of business operation profit/loss. Income statement is also termed as profit & loss account (P & L A/c). Balance Sheet (B/S) to get previous year s financial position picture of assets and liabilities Cost Accounting (CA) Cost accounting deals with present information determining unit cost at different levels (known as cost centers) of ongoing production. Cost accounting process includes accounting and financial management: Cost determination i.e. costing. Cost analysis i.e. studying behavior of profit with respect to cost and volume. Cost control comparison of actual cost with predetermined cost/standard cost. For above-mentioned information, CA system generates: Cost sheet for cost determination. Report on CVP (Cost-Volume-Profit) analysis/be (Break-Even) analysis for analyzing behavior of profits with respect to cost and volume. 55

7 Report on variance analysis for determining variances and to take corrective action whenever needed and hence cost control. Both FA and CA take input data for further processing from book-keeping system. In an organization book-keeping system functions as a part of FA system. In other words, it is not in isolation Management Accounting (MA) Management Accounting (MA) deals with all those information, which helps in decision-making process planning and controlling financial activities. In an organization, MA is common to both FA and CA because all those information, which are generated by FA and CA system are useful in decision-making process and comes under the preview of MA system. CVP analysis and variance analysis of CA system also form part of MA system. Fund Flow Statement (FFS) of FA system also form part of MA system. Because it presents the flow of fund through business organization during financial year and is of great help in assessing fund position. Apart from above information which is common to both FA system and CA system, there are some information exclusively generated by management accountants. Projected statements like: Projected income statement to estimate coming year s target profit. Projected balance sheet to estimate coming year s target financial position. C-Projected FFS/CFS to estimate coming year s target fund/cash position. Developing budget and budgetary control system for the purpose of budgeting. Marginal costing techniques for short-term decision-making purposes (Singh, 2007). 56

8 2.6. Financial Statement Financial statements form part of the process of financial reporting. A complete set of financial statements normally includes a balance sheet, a statement of profit and loss (also known as income statement ), a cash flow statement and those notes and other statements and explanatory material that are an integral part of the financial statements. They may also include supplementary schedules and information based on or derived from, and expected to be read with, such statements. Such schedules and supplementary information may deal, for example, with financial information about business and geographical segments, and disclosures about the effects of changing prices. Financial statements do not, however, include such items as reports by directors, statements by the chairman, discussion and analysis by management and similar items that may be included in a financial or annual report Objectives of Financial Statement The objective of financial statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements prepared for this purpose meet the common needs of most users. However, financial statements do not provide all the information that users may need to make economic decisions since (a) they largely portray the financial effects of past events, and (b) do not necessarily provide non-financial information. A list of the objectives of financial statements proposed by the True Blood Committee (TBC): The basic objective of financial statements is to provide information on which to base economic decisions. 57

9 An objective of financial statements is to serve primarily those users who have limited authority, ability, or resources to obtain information and who rely on financial statements as their principal source of information about enterprise s activity. An objective of financial statements is to provide information useful to investors and creditors for predicting, comparing, and evaluating potential cash flows to them in terms of amount timing and related uncertainly. An objective of financial statements is to provide users with information for predicting, comparing and evaluating enterprise earning power. An objective of financial statements is supply information useful in judging management s ability to utilize enterprise resources effectively in achieving the primarily enterprise goal. An objective of financial statements is to provide factual and interpretive information about transactions and other events that is useful for predicting, comparing and evaluating enterprise earning power. Basic underlying assumptions with respect to matters subject to interpretation, evaluation, prediction or estimation should be disclosed. An objective of financial statements is to provide information useful for the predictive process. Financial forecasts should be provided when they enhance the reliability of users predictions. An objective of a financial statement for governmental and not-for-profit organizations is to provide information useful for evaluating the effectiveness of the management of resources in achieving the organization s goals that are primarily nonmonetary. Performance measures should be expressed in terms of the not-for profit organization s goal. 58

10 An objective of financial statements is to report on those activities of the enterprise affecting society which can be determined and described or measured and which are important to the enterprise in its social environment (Belkaoui, 2004) Financial Reporting Financial reporting may be defined as communication of published financial statements and related information from a business enterprise to third parties (external users) including shareholders, creditors, customers, governmental authorities and the public. It is the reporting of accounting information of an entity (individual, firm, company, government enterprise) to a user or group users. Company financial reporting is a total communication system involving the company as issuer (preparer); the investors and creditors as primary users, other external users; the accounting profession as measures and auditors and the company law regulatory or administrative authorities Objective of Financial Reporting The primary objective of financial reporting is to provide economic information to permit users of the information to make informed decisions. Users include both the management of a company (internal users) and others not involved in the daily operations of the business (external users). The external users usually do not have access to the detailed records of the business and don t have the benefit of daily involvement in the affairs of the company. They make their decisions based on financial statements prepared by management. According to the FASB, financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions (SFAC, 1978). 59

11 The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. Qualitative characteristics are the attributes that make financial information useful. They can be distinguished as fundamental or enhancing characteristics, depending on how they affect the usefulness of the information. Regardless of its classification, each qualitative characteristic contributes to the usefulness of financial reporting information. However, providing useful financial information is limited by two pervasive constraints on financial reporting materiality and cost (IASB, 2008). 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. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit. Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need. Consequently, they are the primary users to whom general purpose financial reports are directed (IFRS, 2011). Financial reporting is not an end in itself but is a means to certain objectives. The objectives of financial reporting and financial statements have been discussed for a long time. While there is no final statement on objectives, to which all parties (of financial reporting) have agreed, some consensus has been developing on the objectives of financial reporting. The following may be described as the primary objectives of financial reporting: investment decision-making and management accountability. 60

12 a) Investment Decision-Making The basic objective of financial reporting is to provide information useful to investors, creditors and other users in making sound investment decisions. The True Blood Committee stated that, the basic objective of financial statements is to provide information useful for making economic decisions recently; the FASB (USA) in its concept No. 1 also concluded that, financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions. It is essential to have an understanding of the investment decision process applied by external users in order to provide useful information to them. The investors seek such investment which will provide the greatest total return with an acceptable range of risk. Investment return is comprised of future interest or dividends and capital appreciation (or loss). The investors while making investment decision aim to determine the amount and certainty of a company s future earning power in order to estimate their future cash return in dividends and capital appreciation. Earning power is the ability of a business firm to produce continuous earnings from the operating assets of the business over a period of years, which may differ from accounting net income. The financial statements and other business data are analyzed in relation to the enterprise s environment to project this future earning power. Investors compare returns on alternative investments relative to risk, which (risk) is the degree of uncertainty of future returns. In this way, investment funds tend to flow toward the most favorably situated companies and industries and away from the weaker and less promising companies. 61

13 b) Management Accountability A second basic objective of financial reporting is to provide information on management accountability to judge management s effectiveness is utilizing the resources and running the enterprise. Management of an enterprise is periodically accountable to the owners not only for the custody and safe-keeping of enterprise resources, but also for their efficient and profitable use and for protecting them to the extent possible from unfavorable economic impacts of factors in the economy such as technological changes, inflation or deflation. Management accountability covers modern performance issues based on efficiency and effectiveness notions. The management accountability concept includes information about future activities, budgets, forecast financial statements, capital expenditures proposal etc. Accountability is beyond the narrow limits of companies. It obviously includes the interest of persons other than existing shareholders. Management accountability is of very great interest not only to existing shareholders and other users but also to potential shareholders, creditors and users. A company generally offers shares, debentures etc. to the respective investing public and therefore it should accept accountability responsibilities to prospective investors also. Certainly annual and other financial statements are intended to play a major role in this regard Development of Financial Reporting Objectives The subject of financial reporting objectives has been generally recognized as very important in accounting area since a long time. Many accounting bodies and professional institutes all over the world have made attempts to define the objectives of financial statements and financial reporting which are vital to the development of financial accounting theory and practice. 62

14 2.9. Benefits of Financial Reporting The financial reporting, if adequate and reliable, would be useful in many respects. Benefits of financial reporting may be listed as follows: Managerial Decision Making The accounting data published in financial reports may have economic effects through its impact on the behavior of the managers of corporate enterprises. The inclusion of accounting numbers in management compensation schemes, or the fear of market misinterpretation of accounting reports may influence a manager s operating and financing decisions Economic Decision Making Financial reporting can provide information important in evaluating the strength and weakness of an enterprise and its ability to meet its commitments. It can supply information about transactions within the business and factors outside the company such as taxation policy, trade restrictions, technological changes, and market potentialities etc., which affect the earning power of a business enterprise Customers Decision Making The data presented in financial statements may affect the decision of company s customers and hence have economic consequences. Customers like employees, may use financial statement data to predict the likelihood and/or timing of a firm going bankrupt or being unable to meet its commitments. This information may be important in estimating the value of a warranty or in predicting the availability of supporting services or continuing supplier of goods over an extended period of time. 63

15 Employee Decisions Employee decisions may be based on perceptions of a company s economic status acquired through financial statements. In particular prospective and present employees may use the financial reports to assess risk and growth potential of a company and therefore, job security and future promotional possibilities. These decisions affect the allocation of human capital in the economy Cost of Capital Adequate disclosure in annual reports is expected, in the long run, to enhance market price of company shares in the investment market. Higher prices of company shares resulting from the full disclosure will have a favorable impact on the company s cost of capital. It also enhances the future marketability of subsequent issue of company s shares Keeping Minimizing Fluctuations in Share Price Adequate disclosure will tend to minimize the fluctuations in company s share prices. Fluctuation is in share prices occur because of the ignorance prevailing in the investment market. Fluctuations show an element of uncertainty in investment decisions. If the securities market is in possession of full information, the ignorance and uncertainty will be reduced and share prices will tend to maintain equilibrium. Besides, increased disclosure would prevent fraud and manipulations and would minimize chances of their occurrences. Additionally, all investors would be treated equally as far as the availability of significant financial information is concerned. Ethics in disclosure demands that no caste system for release of corporate information-telling the sophisticated first and the general public later or not at all-should be followed by corporate managements. 64

16 2.10. Qualitative Characteristics of Financial Information Reporting As stated earlier, the objectives of financial reporting are concerned, in varying degree, with decision-making made by various users. However, there is a need to know that makes financial information useful for decision-making, i.e., what qualities or qualitative characteristics are needed to make the information useful and to help in achieving the purposes of financial reporting. Informational qualities or qualitative characteristics make information reported through financial reporting a desirable commodity and guide the selection of preferred accounting methods and policies from among available alternatives. It is those qualities that distinguish more useful accounting information from less useful information. The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. Qualitative characteristics are the attributes that make financial information useful. They can be distinguished as fundamental or enhancing characteristics, depending on how they affect the usefulness of the information. Regardless of its classification, each qualitative characteristic contributes to the usefulness of financial reporting information. However, providing useful financial information is limited by two pervasive constraints on financial reporting materiality and cost (IASB, 2008). Qualitative characteristics identify the types of information that are likely to be most useful to the existing and potential investors, lenders and other creditors for making decisions about the reporting entity on the basis of information in its financial report (financial information). If financial information is to be useful, it must be relevant (i.e. must have predictive value and confirmatory value, based on the nature 65

17 or magnitude, or both, of the item to which the information relates in the context of an individual entity s financial report) and faithfully represents what it purports to represent (i.e. information must be complete, neutral and free from error). The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable (IFRS, 2011). In this regard, conceptual framework for financial reporting (FRS, 2010) to say that if financial information is to be useful, it must be relevant and faithfully represents what it purports to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable. Chart 2-1 shows the hierarchy of qualitative characteristics of financial reporting. Chart No.2.1 Hierarchy and Components of Qualitative Characteristics of Financial Reporting CAPITAL PROVIDERS (Investors and Creditors) COST MATERIALITY DECISION-USEFULNESS RELEVANCE FAITHFUL REPRESENTATION Predictive Value Confirmatory Value Completeness Neutrality Free from error Comparability Verifiability Timeliness Understandability 66

18 Economic phenomena comprise economic resources, claims on those resources, and the transactions and other events and circumstances that change them. Financial information reporting reflects economic phenomena (that exist or have already occurred) in words and numbers in financial reports. For financial information to be useful, it must possess two fundamental qualitative characteristics relevance and faithful representation (IASB, 2008) Relevance Relevance is one of the two fundamental qualitative characteristics of financial information reporting. Chart 2.2 shows the relevance and related ingredients of this fundamental quality. Chart No.2.2 Components of relevance RELEVANCE Predictive Value Confirmatory Value To be useful in making investment, credit, and similar resource allocation decisions, information must be relevant to those decisions. Relevant information is capable of making a difference in the decisions of users by helping them to evaluate the potential effects of past, present, or future transactions or other events on future cash flows (predictive value) or to confirm or correct their previous evaluations (confirmatory value) (FASB,2006). 67

19 Information is relevant if it is capable of making a difference in the decisions made by users in their capacity as capital providers. Information about an economic phenomenon is capable of making a difference when it has predictive value, confirmatory value or both. Whether information about an economic phenomenon is capable of making a difference is not dependent on whether the information has actually made a difference in the past or will definitely make a difference in the future. Information may be capable of making a difference in a decision and thus be relevant even if some users choose not to take advantage of it or are already aware of it (IASB, 2008). a) Predictive value Conceptual framework for financial reporting (FASB, 2006) says that an item of financial reporting information has predictive value means that it has value as an input to a predictive process. It does not mean that the information itself is a prediction or forecast. Investors, creditors, and others often use information about the past to help in forming their own expectations about the future. Without knowledge of the past, users generally will have no basis for a prediction. For example, information about past or current financial position and performance, generally considered in conjunction with other information, is often used in predicting future financial position and performance and other matters, such as future dividend, interest, or wage payments and the entity s ability to meet its commitments as they become due. Conceptual framework for financial reporting (IASB, 2008) says that Information about an economic phenomenon has predictive value if it has value as an input to predictive processes used by capital providers to form their own expectations about the future. Information itself need not be predictable to have predictive value. Some highly predictable information may not have any predictive value for a particular purpose. For 68

20 example, straight-line depreciation of plant and equipment may be highly predictable from year to year but may not be very helpful in assessing an entity s ability to generate net cash inflows. Also, information about an economic phenomenon need not be in the form of an explicit forecast to have predictive value; it needs only to be a useful input to predictive processes of use to capital providers. In this regard, conceptual framework for financial reporting (FRS, 2010) says that financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes. Financial information need not be a prediction or forecast to have predictive value. Financial information with predictive value is employed by users in making their own predictions. b) Confirmatory value Information that has confirmatory value may serve to confirm the past (or present expectations) based on previous evaluations or it may change (correct) them. Information that confirms past expectations decrease the uncertainty (increases the likelihood) that the results will be as previously expected, If the information changes expectations, it changes the perceived probabilities of the range of possible outcomes or their magnitude. In other words, the information changes the degree of confidence in past expectations. Either way, it is capable of making a difference in users decisions (FASB, 2006). (IASB, 2008) explained that information about an economic phenomenon has confirmatory value if it confirms or changes past (or present) expectations based on previous evaluations. Information that confirms past expectations increases the likelihood that the outcomes or results will be as previously expected. If the information changes expectations, it also changes the perceived probabilities of the range of possible 69

21 outcomes. Although it also, (FRS, 2010) to say that financial information has confirmatory value if it provides feedback about (confirms or changes) previous evaluations. The predictive and confirmatory roles of information are interrelated; information that has predictive value usually also has confirmatory value. For example, information about the current level and structure of assets and liabilities helps users to predict an entity s ability to take advantage of opportunities and to react to adverse situations. The same information helps to confirm or correct users past predictions about that ability (FASB, 2006). (IASB, 2008) says that the predictive and confirmatory roles of information are interrelated; information that has predictive value usually also has confirmatory value. For example, information about the current level and structure of an entity s economic resources and claims helps users to predict an entity s ability to take advantage of opportunities and to react to adverse situations. The same information helps to confirm or correct users past predictions about that ability. (FRS, 2010) explained that the predictive value and confirmatory value of financial information are interrelated. Information that has predictive value often also has confirmatory value. For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with revenue predictions for the current year that was made in past years. The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions. 70

22 Faithful Representation (Reliability) Faithful representation is one of the two fundamental qualitative characteristics of financial information reporting. Chart 2.3 shows the faithful representation (reliability) and related ingredients of this fundamental quality. Financial reports represent economic phenomena in words and numbers. To be useful, financial information must represent not only relevant phenomena, but also faithfully represent the phenomena that it purports to represent. To be a perfectly faithful representation, a depiction would have three characteristics. It would be complete, neutral and free from error. Of course, perfection is seldom, if ever, achievable. The ASC s objective is to maximize those qualities to the extent possible (FRS, 2010). Chart No.2.3 Components of faithful representation (reliability) FAITHFUL REPRESENTATION Completeness Neutrality Free from error A single economic phenomenon may be represented in multiple ways. For example, an estimate of the risk transferred in an insurance contract may be depicted qualitatively (e.g. a narrative description of the nature of possible losses) or quantitatively (e.g. an expected loss). Additionally, a single depiction in financial reports may represent multiple economic phenomena. For example, the presentation of 71

23 the item called plant and equipment in a financial statement may represent an aggregate of all of an entity s plant and equipment (IASB, 2008). Although it also, (IASB, 2008) state that to be useful in financial reporting, information must be a faithful representation of the economic phenomena that it purports to represent. Faithful representation is attained when the depiction of an economic phenomenon is complete, neutral, and free from material error. Financial information that faithfully represents an economic phenomenon depicts the economic substance of the underlying transaction, event or circumstances, which is not always the same as its legal form. a) Completeness Completeness means including in financial reporting all information that is necessary for faithful representation of the economic phenomena that the information purports to represent. Therefore, completeness, within the bounds of what is material and feasible, considering the cost, is an essential component of faithful representation. The importance of completeness is clear in the context of a line item on a financial statement. For example, to omit some revenues during the period from the item revenues on a statement of income (or profit or loss) would faithfully represent neither that item nor subsequent subtotals and totals. Completeness is also important in developing estimates of economic phenomena, such as in estimating fair value using a valuation technique. For example, estimating the fair value of a financial instrument using a pricing model must take into account all of the economic factors that are valid inputs to the model used. Thus, to omit dividends expected to be paid on the underlying shares over the term of a call or put option on those shares would not faithfully represent the fair value of the option (FASB, 2006). 72

24 In this respect, (FRS, 2010) explained that a complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations. For example, a complete depiction of a group of assets would include, at a minimum, a description of the nature of the assets in the group, a numerical depiction of all of the assets in the group, and a description of what the numerical depiction represents (for example, original cost, adjusted cost or fair value). For some items, a complete depiction may also entail explanations of significant facts about the quality and nature of the items, factors and circumstances that might affect their quality and nature, and the process used to determine the numerical depiction. In this regard, conceptual framework for financial reporting (IASB, 2008) to say that a depiction of an economic phenomenon is complete if it includes all information that is necessary for faithful representation of the economic phenomena that it purports to represent. An omission can cause information to be false or misleading and thus not helpful to the users of financial reports. b) Neutral Neutrality refers to absence of bias to attain a predetermined result or to induce a particular behavior. Neutrality is an essential aspect of faithful representation because biased financial information reporting cannot faithfully represent economic phenomena. Neutrality is incompatible with conservatism, which implies a bias in financial information reporting. Neutral information does not color the image it communicates to influence behavior in a particular direction. For example, automobiles might be produced with speedometers that indicate a higher speed than the automobile actually is traveling at to influence drivers to obey the speed limit. But those conservative speedometers would be unacceptable to drivers who expect them to faithfully represent 73

25 the speed of the automobile. Conservative or otherwise biased financial reporting information is equally unacceptable (FASB, 2006). In this respect, (FRS, 2010) explained that a neutral depiction is without bias in the selection or presentation of financial information. A neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise manipulated to increase the probability that financial information will be received favorably or unfavorably by users. Neutral information does not mean information with no purpose or no influence on behavior. On the contrary, relevant financial information is, by definition, capable of making a difference in users decisions. (IASB, 2008) states that the Neutrality is the absence of bias intended to attain a predetermined result or to induce a particular behavior. Neutral information is free from bias so that it faithfully represents the economic phenomena that it purports to represent. Neutral information does not color the image it communicates to influence behavior in a particular direction. Financial reports are not neutral if, by the selection or presentation of financial information, they influence the making of a decision or judgment in order to achieve a predetermined result or outcome. However, to say that financial reporting information should be neutral does not mean that it should be without purpose or that it should not influence behavior. On the contrary, relevant financial reporting information is, by definition, capable of influencing users decisions. c) Freedom from error Faithful representation does not imply total freedom from error in the depiction of an economic phenomenon because the economic phenomena presented in financial reports are generally measured under conditions of uncertainty. Therefore, most financial reporting measures involve estimates of various types that incorporate 74

26 management s judgment. To represent an economic phenomenon faithfully, an estimate must be based on the appropriate inputs, and each input must reflect the best available information. Completeness and neutrality of estimates (and inputs to estimates) are desirable; however, some minimum level of accuracy is also necessary for an estimate to be a faithful representation of an economic phenomenon. For a representation to imply a degree of completeness, neutrality or freedom from error that is impracticable would diminish the extent to which the information faithfully represents the economic phenomena that it purports to represent. Thus, to attain a faithful representation, it may sometimes be necessary to disclose explicitly the degree of uncertainty in the reported financial information (IASB, 2008). Faithful representation does not mean accurate in all respects. Free from error means there are no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process. In this context, free from error does not mean perfectly accurate in all respects. For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate. However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate (FRS, 2010). Enhancing qualitative characteristics are complementary to the fundamental qualitative characteristics. Enhancing qualitative characteristics distinguish more useful information from less useful information. The enhancing qualitative characteristics are comparability, verifiability, timeliness and understandability. These characteristics 75

27 enhance the decision-usefulness of financial reporting information that is relevant and faithfully represented (IASB, 2008). Chart 2.4 shows the enhancing qualitative characteristics and related ingredients of these enhancing characteristics. Chart No.2.4 Components of the enhancing qualitative characteristics RELEVANCE FAITHFUL REPRESENTATI Predictive Value Confirmatory Value Completeness Neutrality Free from error Comparability Verifiability Timeliness Understandability Comparability Comparability refers to the quality of information that enables users to identify similarities in and differences between two sets of economic phenomena. Consistency refers to the use of the same accounting policies and procedures, either from period to period within an entity or in a single period across entities. Comparability is the goal; consistency is a means to an end that helps in achieving that goal. The essence of decision making is choosing between alternatives. Thus, information about an entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for some other period or some other point in time. Comparability is not a quality of an 76

28 individual item of information, but rather a quality of the relationship between two or more items of information. Comparability should not be confused with uniformity. For information to be comparable, like things must look alike and different things must look different. An overemphasis on uniformity may reduce comparability by making unlike things look alike. Comparability of financial reporting information is not enhanced by making unlike things look alike any more than it is by making like things look different. Some degree of comparability should be attained by maximizing the fundamental qualitative characteristics. That is to say, a faithful representation of a relevant economic phenomenon should naturally possess some degree of comparability to a faithful representation of a similar relevant economic phenomenon by another entity. Although a single economic phenomenon can be faithfully represented in multiple ways, permitting alternative accounting methods for the same economic phenomenon diminishes comparability and, therefore, may be undesirable (IASB, 2008). Conceptual framework for financial reporting (FASB, 2006) states that comparability, including consistency, enhances the usefulness of financial reporting information in making investment, credit, and similar resource allocation decisions. Comparability is the quality of information that enables users to identify similarities in and differences between two sets of economic phenomena. Consistency refers to use of the same accounting policies and procedures, either from period to period within an entity or in a single period across entities. Comparability is the goal; consistency is a means to an end that helps in achieving that goal. The essence of investment, credit, and similar resource allocation decisions is choosing between alternatives, such as whether to buy shares in Entity A or in Entity B. 77

29 Thus, information about an entity gains greatly in usefulness if it can be compared with similar information about other entities and with similar information about the same entity for some other period or some other point in time. Comparability is not a quality of an individual item of information, but rather a quality of the relationship between two or more items of information. In this respect, (FRS, 2010) maintains that, users decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one reporting entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date. Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items. Unlike the other qualitative characteristics, comparability does not relate to a single item. A comparison requires at least two items. Consistency, although related to comparability, is not the same as the latter. Consistency refers to the use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities. Comparability is the goal; consistency helps to achieve that goal. Comparability is not uniformity. For information to be comparable, like things must look alike and different things must look different. Comparability of financial information is not enhanced by making unlike things look alike any more than it is enhanced by making like things look different. Some degree of comparability is likely to be attained by satisfying the fundamental qualitative characteristics. A faithful representation of a relevant economic 78

30 phenomenon should naturally possess some degree of comparability with a faithful representation of a similar relevant economic phenomenon by another reporting entity. Although a single economic phenomenon can be faithfully represented in multiple ways, permitting alternative accounting methods for the same economic phenomenon diminishes comparability Verifiability Verifiability is a quality of information that helps assure users that information faithfully represents the economic phenomena that it purports to represent. Verifiability implies that different knowledgeable and independent observers could reach general consensus, although not necessarily complete agreement, that either: (a) the information represents the economic phenomena that it purports to represent without material error or bias; or (b) an appropriate recognition or measurement method has been applied without material error or bias. To be verifiable, information need not be a single point estimate. A range of possible amounts and the related probabilities can also be verified. Verification may be direct or indirect. With direct verification, an amount or other representation itself is verified, such as by counting cash or observing marketable securities and their quoted prices. With indirect verification, the amount or other representation is verified by checking the inputs and recalculating the outputs using the same accounting convention or methodology. An example is verifying the carrying amount of inventory by checking the inputs (quantities and costs) and recalculating the ending inventory using the same cost flow assumption (e.g. average cost or first-in, first-out) (IASB, 2008). 79

31 Timeliness Timeliness means having information available to decision makers before it loses its capacity to influence decisions. Having relevant information available sooner can enhance its capacity to influence decisions, and a lack of timeliness can rob information of its potential usefulness. Some information may continue to be timely long after the end of a reporting period because some users may continue to consider it when making decisions. For example, users may need to assess trends in various items of financial reporting information in making investment or credit decisions (IASB, 2008) Understandability Understandability is the quality of information that enables users who have a reasonable knowledge of business and economic activities and financial reporting, and who study the information with reasonable diligence, to comprehend its meaning. Relevant information should not be excluded solely because it may be too complex or difficult for some users to understand. Understandability is enhanced when information is classified, characterized, and presented clearly and concisely. Comparability also enhances understandability. Information cannot influence a particular user s decision unless it is presented in a manner that the user can understand. However, information may be relevant to a situation even though some people who confront the situation cannot understand it at least not without help. For example, a traveler in a foreign country may have trouble ordering from a menu printed in an unfamiliar language. The listing of items on the menu is relevant to the decision, but the traveler may not be able to use that information unless it is translated into a language that the traveler understands. Thus, information may not be useful to a particular user even though it is relevant to the situation the user faces. 80

32 Similar situations arise frequently in financial reporting. For example, investors or creditors unfamiliar with actions an entity might take to hedge its exposure to financial risks might have difficulty understanding a note to the financial statements that explains its hedging activities and how those activities are reflected in its financial report. That information, however, is relevant to decisions about the entity and should be understandable to users who have a reasonable knowledge of hedging activities and who read and consider the information with reasonable diligence (FASB, 2006). Although it also, (IASB, 2008) states that the understandability is the quality of information that enables users to comprehend its meaning. Understandability is enhanced when information is classified, characterized and presented clearly and concisely. Comparability can also enhance understandability. Although presenting information clearly and concisely helps users to comprehend it, the actual comprehension or understanding of financial information depends largely on the users of the financial report. Users of financial reports are assumed to have a reasonable knowledge of business and economic activities and to be able to read a financial report. In making decisions, users also should review and analyze the information with reasonable diligence. However, when underlying economic phenomena are particularly complex, fewer users may understand the financial information depicting those phenomena. In those cases, some users may need to seek the aid of an adviser. Information that is relevant and faithfully represented should not be excluded from financial reports solely because it may be too complex or difficult for some users to understand without assistance. In this regard, conceptual framework for financial reporting (FRS, 2010) states that classifying, characterizing and presenting information clearly and concisely makes 81

33 it understandable. Some phenomena are inherently complex and cannot be made easy to understand. Excluding information about those phenomena from financial reports might make the information in those financial reports easier to understand. However, those reports would be incomplete and therefore potentially misleading. Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyze the information diligently. At times, even wellinformed and diligent users may need to seek the aid of an adviser to understand information about complex economic phenomena Constraints on Financial Reporting In addition to the qualitative characteristics of relevance, faithful representation, comparability, and understandability, decision-useful financial reporting is subject to two pervasive constraints: materiality and benefits that justify costs. The two constraints are linked because each concerns why some information is included in financial reports and other information, or the same type of information in different circumstances, is not (FASB, 2006). Chart 2.5 shows the constraints on financial reporting and related ingredients of these constraints. Chart No.2.5 Constraints on Financial Reporting Constraints on Financial Reporting Materiality Benefits and Cost 82

34 Constraints on Financial Reporting - Materiality Information is material if its omission or misstatement could influence the decisions that users make on the basis of an entity s financial information. Because materiality depends on the nature and amount of the item judged in the particular circumstances of its omission or misstatement, it is not possible to specify a uniform quantitative threshold at which a particular type of information becomes material. When considering whether financial information is a faithful representation of what it purports to represent, it is important to take into account materiality because material omissions or misstatements will result in information that is incomplete, biased or not free from error (IASB, 2008) Constraints on Financial Reporting Benefits and Cost The conceptual framework for financial reporting (IASB, 2008) says that, financial reporting imposes costs; the benefits of financial reporting should justify those costs. Assessing whether the benefits of providing information justify the related costs will usually be more qualitative than quantitative. In addition, the qualitative assessment of benefits and costs will often be incomplete. The costs of providing information include costs of collecting and processing the information, costs of verifying it, and costs of disseminating it. Users incur the additional costs of analysis and interpretation. Omission of decision-useful information also imposes costs, including the costs that users incur to obtain or attempt to estimate needed information using incomplete data in the financial report or data available elsewhere. Preparers expend the majority of the effort towards providing financial information. However, capital providers ultimately bear the cost of those efforts in the form of reduced returns. Financial reporting information helps capital providers make better decisions, which results in more efficient functioning of capital markets and a 83

35 lower cost of capital for the economy as a whole. Individual entities also enjoy benefits, including improved access to capital markets, favorable effect on public relations, and perhaps lower costs of capital. The benefits may also include better management decisions because financial information used internally is often based at least partly on information prepared for general purpose financial reporting purposes Accounting Standards Accounting Standards are used as one of the main compulsory regulatory mechanisms for preparation of general-purpose financial reports and subsequent audit of the same, in almost all countries of the world. Accounting Standards are concerned with the system of measurement and disclosure rules for preparation and presentation of financial statements. They appear with a set of authoritative statements of how particular types of transactions, events and other costs should be recognized and reported in the financial statements. Accounting Standards are devised to furnish useful information to different users of the financial statements, to such as shareholders, creditors, lenders, management, investors, suppliers, competitors, researchers, regulatory bodies and society at large and so on. In fact, such statements are designed and prescribed so as to improve & benchmark the quality of financial reporting. Thorell and Whittington (1994) describe accounting as an important language of commerce. Like all languages, its effectiveness as a means of communication is aided by precise definition of words and rules as to its structure. Moreover, users costs may be reduced, and the value of the data for comparative purposes enhanced, if all companies use the same definitions and rules their financial reports. 84

36 Efforts to achieve this on a national level, by means of company law or the regulatory activities of professional and other bodies are often referred to as standardization, the rules being referred to as Accounting Standards. Littleton (1953) defines; A standard is an agreed upon criteria of what is proper practice in a given situation; a basis for comparison and judgment; a point of departure when variation is justifiable by the circumstances and reported as such. Standards are not designed to confine practice within rigid limits but rather to serve as guideposts to truth, honesty and fair dealing. They are not accidental but intentional in origin; they are expected to be expressive of the deliberately chosen policies of the highest types of businessmen and the most experienced accountants; they direct a high but attainable level of performance, without precluding justifiable departures and variations in the procedures employed. Bromwich (1985) observes, Accounting Standards are uniform rules for financial reporting applicable either to all or to a certain class of entity promulgated by what is perceived of as predominantly an element of the accounting community specially created for this purpose. Standard setters can be seen as seeking to prescribe a preferred accounting treatment from the available set to method for treating one or more accounting problems. Other policy statement by the profession will be referred to as recommendations. In the similar line, Harvey and Keer (1981) explain that a standard in accounting is a method or an approach to preparing accounts which has been chosen and established by the bodies overseeing the profession. Thus, a standard can be viewed as some form of rule. They further state that the word standard id preferred to principle 85

37 because a standard is pragmatic and it can only do good because it will remove any inhibition about its replacement with a better standard, if this becomes appropriate. The Canadian Institute of Chartered Accounting (CICA) has given a broad definition of Accounting Standards. According to it, Accounting Standards are solid principles for financial accounting and reporting developed through a structured standard setting body (an Accounting Standard Board). Accounting Standards spell out how transactions and other events are to be recognized, measured, presented and disclosed in financial statements. The purpose of such standards is to meet the needs of users of financial statement by providing the information considered necessary to make informed decisions. Van der Tas (1988) define standards as any financial reporting rule published by either the government or a private standard setting body. These rules can refer either to the degree of disclosure or to the accounting method to be applied. Accounting Standards can be described as a vehicle whereby the wisdom and experience of the profession emerges as a consensus in a complex and changing economic and business situation in preference to the views of individual compilers of financial statements. Accounting as a language of business communicates the financial results and health of an enterprise to various interested parties by means of periodical financial statements. Like any other language, accounting should have its grammar (set of rules) and this grammar is said to be encoded in Accounting Standards. In an effort to generate comparable and reliable accounting information to help investors, creditors and others, each country has developed its own national financial Accounting Standards. These standards reflect the culture, history and the 86

38 characteristics of accounting problems facing that country. In some countries, the professional bodies formulate the financial Accounting Standards. Nobes (1987) 16 observes professional accounting standards are also endowed with varying degrees of authority in different countries. A standard can range from one that is legally enforced (e.g., Canada), to one that is usually obeyed and is binding on auditors (e.g., U.K.), to one that is persuasive (e.g., The Netherlands), to one that is unimportant (e.g. domestic pronouncement of the accountancy body in West Germany), to one that is largely unknown to companies or auditors. Accounting Standards are formulated with a view to harmonize different accounting policies in use in a country. The objective of Accounting Standard is, to reduce the accounting alternative in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises with a view to provide meaningful information to various users of financial statements to enable them to make informed economic decisions International Accounting Standards (IAS) The concept of establishing international standards of accounting germinated around the turn of the century when, in 1904, the first international congress of accountants was held in St. Louis. However, the history of International Accounting Standards really began in 1966, with the proposal to establish an international study group comprising the Institute of Chartered Accountants of England and Wales (ICAEW), American Institute of Certified Public Accountants (AICPA) and Canadian Institute of Chartered Accountants (CICA). In February 1967, this resulted in the foundation of the Accountants International Study Group (AISG), which began to publish papers on important topics every few months and created and appetite for change. Many of these papers led the way for the standards that followed. In the 87

39 meantime, international accounting diversity was one of topics discussed in the tenth International Congress of Accountants in Accounting bodies of some countries attending the meeting were concerned in reducing the degree of variation in international accounting practices. As a result, in 1973, the International Accounting Standards Committee (IASC) was formed. The founders of this Committee included ten accounting bodies from Australia, Canada, France, Japan, Mexico, Netherlands, West Germany, the Unites States, United Kingdom and Ireland. The objectives of the IASC are : 1) to formulate and publish in the public interest Accounting Standards to be observed in the presentation of financial statement and to promote their worldwide acceptance and observance; and 2) to work generally for the improvement and harmonization of regulations, Accounting Standards and procedures relating to the presentation of financial statements. Between 1973 and 2001, the IASC promulgated 41standards. With the renaming of IASC as IASB, the objectives of the latter also changed. At present, the IASB: is charged with the following objectives: a) to develop, in the public interest, a single set of high quality, understandable and enforceable global Accounting Standards that require high quality, transparent and comparable information in financial statement and other financial reporting to help participants in the world s capital market and other users make economic decisions; b) to promote the use and rigorous application of those standards; c) to bring about convergence of National Accounting Standards and International Accounting Standards and International Financial Reporting Standards to high quality solutions. To support the effective functioning of the former IASC, the SIC was also constituted in 1997 to assist the former on tackling the contentious accounting issues 88

40 that needed authoritative guidance to stop widespread variations in accounting practices. In tune with a change in nomenclature from IASC to IASB, the SIC was renamed as International Financial Reporting Interpretations Committee (IFRIC). In addition, the Standards Advisory Council (SAC) was also established. The present status of International Accounting Standards are presented under; a) Organization Structure of the IASC Foundation, b) progress of IAS/IFRS, a) Organization Structure of the IASC Foundation The salient features of institutional structure of establishing Financial Reporting Standards are presented under (IASC) Foundation; Standard Advisory Council (SAC); International Financial Reporting Interpretation Committee (IFRIC); International Accounting Standards Board (IASB) and International Financial Reporting Standards (IFRS). From 1973 until 2001 the body in charge was the International Accounting Standards Committee (IASC). IASC was created in 1973 between the professional accountancy bodies in 9 countries and from the year 1982 its membership comprised of all the accountancy bodies who were members of the International Federation of Accountants (IFAC). The principle significance of the IASC was to encourage National Accounting Standard setters around the world to improve and harmonize National Accounting Standards. The members of the IASC who were Professional Accountancy Bodies of the world delegated the responsibility to the IASC Board. The IASC Board was responsible for all activities including standard setting activity. The Standards adopted by the IASC Board were known as the International Accounting Standards (IAS). 89

41 b) IASC Foundation The name of the organization to monitor the promulgation and implementation of IFRS is the International Accounting Standards Committee Foundation (IASC). The IASC was approved in its original form by the erstwhile International Accounting Standards Committee (IASC) in the year 2000 and by the members of the IASC at a meeting on 24th May The erstwhile IASC Board had appointed a nominating committee to appoint the first Trustees. In execution of its duties the first trustees formed the International Accounting Standards Committee Foundation on 6th February There is a key difference between the erstwhile IASC and the present IASC Foundation. The members of the IASC were the accounting bodies of the world who were also the members of the IFAC. The IASC Foundation does not have such a relationship with these global accounting bodies. The IASC Foundation is an independent not for profit private sector organization. Its Governance rests with its 22 Trustees. It receives funding in the form of donations from organizations, accounting firms, central banks and capital market regulators amongst others. The governance structure within IASC foundation comprises its key parts namely: Monitoring Board, Trustees, International Accounting Standards Board (IASB), International Financial Reporting Interpretation Committee (IFRIC) and Standards Advisory Council (SAC). 90

42 Monitoring Board The Monitoring Board plays a pivotal role as the crucial link between the Trustees and the Public Authorities that have generally overseen Accounting Standard setters. This link between the Trustees and the Monitoring Board is established by way of a Memorandum of Understanding (MoU). The monitoring board has the authority to participate in the process and the appointment of Trustees. It has the authority to overlook whether the trustees are discharging their duties in accordance with the constitution. The Trustees make an annual written report to the Monitoring Board. Trustees The Trustees of the IASC foundation are responsible for its Governance including funding. The Trustees are publically accountable to the Monitoring Board of the capital market authorities. The trustees are, in addition to the governance of the foundation, responsible for the appointment of the members of the International Accounting Standards Board (IASB), the International Financial Reporting Interpretation Committee (IFRIC) and the Standards Advisory Council (SAC). They also have the power to terminate non performing members of the above board, committee and council International Financial Reporting Interpretation Committee (IFRIC) The interpretative body of the IASC Foundation is IFRIC. It is responsible for developing guidance on the interpretations of the application of both the IAS and IFRS. Such guidance on interpretation would be on financial reporting issues not specifically dealt with in the IAS and IFRS. It would also be on those issues where there are conflicting or divergent interpretations in the absence of an authoritative guidance. 91

43 IFRIC comprises 14 members appointed by the trustees for a renewable period of three years. No specific geographical allocations have been spelt out in the constitution. Going by the profile of the existing members that comprise the IFRIC it is apparent that the committee does not have representations from India. The constitution provides that the Trustees, as they deem necessary, appoint nonvoting observers and representatives of the regulatory authorities who shall have the right to attend and speak at the meeting. Accordingly, IOSCO (International Organization of Securities Commission) and European Commission are presently the observers International Accounting Standards Board (IASB) International Accounting Standards Committee (IASC) was founded in 1973 through an agreement among independent accounting bodies in Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom, Ireland, and the United States, driven by the need to standardize international accounting practices and terms. Initially, it was composed of volunteer representatives from 13 countries and three international organizations. Members designated two representatives and one technical advisor to serve on different committees. Its board of trustees had additional non-voting observer members from the International Organization of Security Commissions (IOSCO), the Financial Accounting Standards Board (FASB), and the European Commission, among others. IASC had a number of voluntary advisory groups to support its activities, namely the Consultative Group, Standard Interpretations Committee, Advisory Council, and Steering Committee. After 25 years, IASC formed the temporary Strategy Working 92

44 Party in 1997 to review process effectiveness. This committee s major task was to merge national and global accounting standards. The IASC foundation is incorporated and was founded in London England. Incorporated as a not-for-profit, its mission was and is today to provide the world s integrating capital markets with a common language for financial reporting. It became the parent entity of the International Accounting Standards Board (IASB), a subsidiary established as an independent body to set Accounting Standards. This structure continues today, serving more than 100 member countries which abide by its standards. The IASB has two principal aims: 1) develop and issue International Financial Reporting Standards and Exposure Drafts, and 2) approve interpretations developed by International Financial Reporting Interpretations Committee (IFRIC). a) Organizational Structure interact): Currently, IASB has five primary components (the Chart 2-6 shows how they International Accounting Standards Committee (IASC) Foundation (22 trustees, no staff) oversees IASB and its structure and strategy, and is responsible for fundraising. Since 2005, the trustees represent these regions: North America (6), Europe (6), Asia/Oceania (6), and other regions (4). The trustees vote by simple majority and constitutional changes require a three-quarters majority. International Accounting Standards Board, or IASB (12 full-time and 2 part-time staff) has sole responsibility for establishing International Financial Reporting Standards (IFRS). International Financial Reporting Interpretations Committee, or IFRIC (14 members), develops the interpretations for approval by IASB. 93

45 Standards Advisory Council, or SAC (20 members), provides a forum where IASB consults individuals and representatives of organizations affected by its work. It is committed to the development of rigorous International Financial Reporting Standards (IFRS). The council supports IASB by promoting the adoption of IFRS world-wide. This includes publishing articles supportive of IFRS and participating in public meetings. Working Groups serve as expert task forces for individual projects. Chart No.2.6 Primary components of IASB Source: IAS website, IASB s current organizational structure offers numerous advantages: The IASC Foundation s legal structure enables it to raise funds through donations, member fees, and government contributions. Fee-paying members are accounting firms and international corporations. The IASC Foundation focuses on strategic questions and administrative functions as separate responsibilities from setting reporting standards. 94

46 The separate strategic and administrative sections enable it to objectively assess its effectiveness. There is a process to ensure that SAC and IFRIC fulfill their support roles effectively. IASB s status as an independent body, while cooperating with national accounting entities, gives it leverage with the practitioners who are members of these bodies to enforce compliance with the Accounting Standards. Trustees are independent experts in accounting and finance. They only provide information to the industry and are not involved in administration or governance. They are appointed by the IASC, chosen from its members, and operate through subsidiary entities. Through the SAC, IASB can get feedback from the end users of its standards. It believes that, in order to promote its standards and keep them in line with current practices, the community must provide ongoing input Financial Accounting Standards Board (FASB) Historically, the Accounting Standards and procedures in the United States were established by the Accounting Principles Board of the American Institute of Certified Public Accountants. In 1973, the Financial Accounting Foundation (FAF) was launched as an independent, private-sector organization to: Establish and improve financial accounting and reporting standards; Educate constituents about those standards; Administer the standard-setting boards Financial Accounting Standards Board (FASB), Governmental Accounting Standards Board (GASB), and Advisory Councils; Select the members of the standard-setting boards and advisory councils; and Protect the independence and integrity of the standard-setting process. 95

47 FASB is responsible for the development of private sector Accounting Standards. It is granted all power and authority by FAF to set standards for all nongovernmental, public, private, and not-for-profit enterprises. Its standards are officially recognized by the Securities and Exchange Commission4 and the American Institute of Certified Public Accountants. Its mission is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including auditors and users of financial information. FASB works on accounting concepts and standards, through research, to gain new insights and ideas. Activities are open to public participation, and views are actively solicited from membership groups. In 2002, the Sarbanes-Oxley Act amended the U.S. Securities Act of 1933 by broadening the scope of FASB, so that it can, Be organized as a private entity; Have a board of trustees; Be funded, per section 109 of the Sarbanes-Oxley Act, by fees from publicly traded companies, based on market capitalization and sales; Ensure prompt decisions by adopting procedures with a majority vote; and Keep standards current for the protection of investors. These changes effectively made FASB a quasi-governmental agency with the effect of law. a) Organizational Structure The membership of FASB is composed of industry players, including banks, public accounting firms, and certified public accountants. The members of its board of 96

48 trustees are nominated by eight sponsoring organizations: 1) American Accounting Association, 2) American Institute of Certified Public Accountants, 3) Association of Investment Management and Research, 4) Financial Executives International, 5) Government Finance Officers Association, 6) Institute of Management Accountants, 7) National Association of State Auditors, Comptrollers, and Treasures, and 8) Securities Industry Association.FAF is a U.S. non-profit organization. It and all of its subsidiaries are located in Norwalk, Connecticut. Chart 2.7 demonstrates the relationships among the entities. Chart No.2.7 Financial Accounting Foundation and component Financial Accounting Foundation [FAF] Financial Accounting Standard Board [FASB] Financial Accounting Standard Advisory Council Government Accounting Standards Board (GASB) Government Accounting Standards Advisory Council Source: Like IASB, FASB works closely with its end users. It provides a consistent voice from the private sector which informs and advises on standards. As with IASB, FASB was intended to be independent of government control, although its budget is now government mandated. FASB s legal and organizational structures are similar to IASB s. Its original organization was an accounting body, which certified members and promoted high quality, uniform standards. b) Standards Advisory Council (SAC) The members of the SAC are appointed by the Trustees. The objective of the SAC is to advice the IASB on agenda decisions and priorities. The constitution provides that 97

49 the council may comprise of 30 or more members. No geographical allocations have been specified. Members appointed on the council would represent a wide group of organizations and individuals who are affected by or with an interest in international financial reporting (Devarajan, 2009). c) Progress of IAS/IFRS From 1973 until 2001 the International Accounting Standards Committee (IASC) released a series of International Accounting Standards (IAS). Meanwhile, the IASB began a program of reviewing major standards with a view to improve the quality of international standards particularly by removing as many options as possible, by improving disclosure, and providing more implementation guidance so that IASs constituted a rigorous set of standards (Pricewaterhousecoopers, 1998). International Accounting Standards (IAS) initially tended to be too broad, allowing many alternative accounting treatments to accommodate country differences. This was a serious weakness in achieving the objective of comparability. To gain acceptability of its standards, the IASC undertook a project (called the comparability project) aimed at enhancing comparability of financial statements by reducing the alternative treatments in An important part of this effort was its work plan to produce a comprehensive core set of high-quality standards (Core Standards Project). The IASC also persuaded the stock exchange institutions, particularly International Organization of Securities Commissions (IOSCO) and its member the Securities and Exchange Commission (SEC), to accept financial statements prepared in accordance with IASs for multinational registration. This effort became successful in 1993 when IOSCO announced that it would recognize IAS 7 and in the following years announcement, as it would accept 14 IASB standards as they were. Finally, IOSCO 98

50 recommended acceptance of the use of IAS by its members in may In June 2000, the European Commission proposed that all listed companies in the EU should be required to prepare their consolidated financial statements using IAS. Taking into consideration the efforts of IASC and acceptance of 41 IAS by the IASB, it may be construed that the latter has so far issued 47 Exposure Drafts and has come out with 41 IASs. Further, the IASB has issued 13 IFRSs and also guidelines titled Framework for the Preparation and Presentation of Financial Statements. Sometimes a standard is withdrawn and new standard on the same topic is issued if it becomes necessary. The lists of IASs, IFRSs, IFRIC and SIC are shown in Table At present, the IASB has recognized 41 IAS as its own standards with the old nomenclature being International Accounting Standards (IAS) and they are to be considered as IFRS per se and further it has recognized 11 Standing Interpretations (SIC) of IASC as its own interpretations. Since 2011, IASB has promulgated 13 IFRS. Table No.2.1 International Accounting Standards (IAS) IAS TITLE IAS1 Presentation of Financial Statements IAS2 Inventories IAS3 Consolidated Financial Statements Originally issued 1976, effective 1 Jan Superseded in 1989 by IAS 27 and IAS 28 IAS4 Depreciation Accounting Withdrawn in 1999, replaced by IAS 16, 22, and 38, all of which were issued or revised in 1998 IAS5 Information to Be Disclosed in Financial Statements Originally issued October 1976, effective 1 January Superseded by IAS 1 in 1997 IAS6 Accounting Responses to Changing Prices Superseded by IAS 15, which was withdrawn December 2003 IAS7 Statement of Cash Flows IAS8 Accounting Policies, Changes in Accounting Estimates and Errors IAS9 Accounting for Research and Development Activities Superseded by IAS 38 effective IAS10 Events After the Reporting Period IAS11 Construction Contracts IAS12 Income Taxes IAS13 Presentation of Current Assets and Current Liabilities Superseded by IAS 1 IAS14 Segment Reporting IAS15 Information Reflecting the Effects of Changing Prices Withdrawn December 2003 IAS16 Property, Plant and Equipment 99

51 IAS17 Leases IAS18 Revenue IAS19 Employee Benefits IAS20 Accounting for Government Grants and Disclosure of Government Assistance IAS21 The Effects of Changes in Foreign Exchange Rates IAS22 Business Combinations Superseded by IFRS 3 effective 31 March 2004 IAS23 Borrowing Costs IAS24 Related Party Disclosures IAS25 Accounting for Investments Superseded by IAS 39 and IAS 40 effective 2001 IAS26 Accounting and Reporting by Retirement Benefit Plans IAS27 Consolidated and Separate Financial Statements Superseded by IFRS 10, IFRS 12 and IAS 27 (rev. 2011) effective 2013 IAS28 Investments in Associates Superseded by IAS 28 (rev. 2011) and IFRS 12 effective 2013 IAS29 Financial Reporting in Hyperinflationary Economies IAS30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions Superseded by IFRS 7 effective 2007 IAS31 Interests In Joint Ventures Superseded by IFRS 11 and IFRS 12 effective 2013 IAS32 Financial Instruments: Presentation Disclosure provisions superseded by IFRS 7 effective 2007 IAS33 Earnings Per Share IAS34 Interim Financial Reporting IAS35 Discontinuing Operations Superseded by IFRS 5 effective 2005 IAS36 Impairment of Assets IAS37 Provisions, Contingent Liabilities and Contingent Assets IAS38 Intangible Assets IAS39 Financial Instruments: Recognition and Measurement Superseded by IFRS 9 effective 2013 IAS40 Investment Property IAS41 Agriculture Source: Table No.2.2 International Financial Reporting Interpretation Committee (IFRIC) IFRIC TITLE IFRIC1 Changes in Existing Decommissioning, Restoration and Similar Liabilities IFRIC2 Members' Shares in Co-operative Entities and Similar Instruments IFRIC3 Emission Rights Withdrawn June 2005 IFRIC4 Determining Whether an Arrangement Contains a Lease IFRIC5 Rights to Interests Arising from Decommissioning, Restoration and Environmental Rehabilitation Funds IFRIC6 Liabilities Arising from Participating in a Specific Market - Waste Electrical and Electronic Equipment IFRIC7 Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies IFRIC8 Scope of IFRS 2 Withdrawn effective 1 January 2010 IFRIC9 Reassessment of Embedded Derivatives IFRIC10 Interim Financial Reporting and Impairment IFRIC11 IFRS 2: Group and Treasury Share Transactions Withdrawn effective 1 January

52 IFRIC12 IFRIC13 IFRIC14 IFRIC15 IFRIC16 IFRIC17 IFRIC18 IFRIC19 IFRIC20 IFRS IFRS1 IFRS2 IFRS3 IFRS4 IFRS5 IFRS6 IFRS7 IFRS8 IFRS9 IFRS10 IFRS11 IFRS12 IFRS13 SIC SIC 1 SIC 2 SIC 3 SIC 5 SIC 6 SIC 7 SIC 8 SIC 9 SIC 10 SIC 11 SIC 12 SIC 13 Service Concession Arrangements Customer Loyalty Programmers IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction Agreements for the Construction of Real Estate Hedges of a Net Investment in a Foreign Operation Distributions of Non-cash Assets to Owners Transfers of Assets from Customers Extinguishing Financial Liabilities with Equity Instruments Stripping Costs in the Production Phase of a Surface Mine Source: Table No.2.3 International Financial Reporting Standards (IFRS) TITLE First-time Adoption of International Financial Reporting Standards Share-based Payment Business Combinations Insurance Contracts Non-current Assets Held for Sale and Discontinued Operations Exploration for and Evaluation of Mineral Assets Financial Instruments: Disclosures Operating Segments Financial Instruments Consolidated Financial Statements Joint Arrangements Disclosure of Interests in Other Entities Fair Value Measurement Source: Table No.2.4 Standing Interpretations Committee (SIC) TITLE Consistency Different Cost Formulas for Inventories Superseded Consistency Capitalization of Borrowing Costs Superseded Elimination of Unrealized Profits and Losses on Transactions with Associates Superseded Classification of Financial Instruments - Contingent Settlement Provisions Superseded Costs of Modifying Existing Software Superseded Introduction of the Euro First-Time Application of IASs as the Primary Basis of Accounting Superseded Business Combinations Classification either as Acquisitions or Uniting of Interests Superseded Government Assistance No Specific Relation to Operating Activities Foreign Exchange Capitalization of Losses Resulting from Severe Currency Devaluations Superseded Consolidation Special Purpose Entities Jointly Controlled Entities Non-Monetary Contributions by Ventures 101

53 SIC 14 SIC 15 SIC 16 SIC 17 SIC 18 SIC 19 SIC 20 SIC 21 SIC 22 SIC 23 SIC 24 SIC 25 SIC 27 SIC 28 SIC 29 SIC 30 SIC 31 SIC 32 SIC 33 Property, Plant and Equipment Compensation for the Impairment or Loss of Items Superseded Operating Leases Incentives Share Capital Reacquired Own Equity Instruments (Treasury Shares) Superseded Equity Costs of an Equity Transaction Superseded Consistency Alternative Methods Superseded Reporting Currency Measurement and Presentation of Financial Statements under IAS 21 and IAS 29 Superseded Equity Accounting Method Recognition of Losses Superseded Income Taxes Recovery of Revalued Non-Depreciable Assets Business Combinations Subsequent Adjustment of Fair Values and Goodwill Initially Reported Superseded Property, Plant and Equipment Major Inspection or Overhaul Costs Superseded Earnings Per Share Financial Instruments and Other Contracts that May Be Settled in Shares Superseded Income Taxes Changes in the Tax Status of an Enterprise or its Shareholders Evaluating the Substance of Transactions in the Legal Form of a Lease Business Combinations 'Date of Exchange' and Fair Value of Equity Instruments Superseded Disclosure Service Concession Arrangements Reporting Currency Translation from Measurement Currency to Presentation Currency Superseded Revenue Barter Transactions Involving Advertising Services Intangible Assets Web Site Costs Consolidation and Equity Method Potential Voting Rights and Allocation of Ownership Interests Superseded Source: Accounting Standards in India In recent years, there has been an unprecedented increase in the awareness about the need for and importance of Accounting Standards in India. The Accounting Standards which lay down sound and wholesome principles for recognition, measurement, presentation and disclosure of information in the financial statements improve substantially the quality of financial reporting by an enterprise. The Accounting Standards tend to standardize diverse accounting practices with a view to eliminate, to the extent possible, in comparability of information contained in the financial statements of various enterprises. The Accounting Standards also improve the transparency of financial statements by requiring enhanced disclosures. Realizing the significance of Accounting Standards in improving the quality of financial reporting, the Accounting Standards have been granted legal recognition under 102

54 the Companies Act, 1956, which require Accounting Standards to be followed by all companies. Apart from the Companies Act, 1956, various regulatory bodies, e.g., the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI) and the Insurance Regulatory and Development Authority (IRDA) also require compliance with the Accounting Standards issued by the Institute by their respective constituents. This is a clear manifestation of the significance of the Accounting Standards and high quality of Accounting Standards being issued by the Institute of Chartered Accountants of India (ICAI). The Institute of Chartered Accountants of India (ICAI) is a statutory body established under the Chartered Accountants Act, 1949 (Act No XXXVIII of 1949) for the regulation of the profession of chartered accountants in India. During its 61 years of existence, ICAI has achieved recognition as a premier accounting body not only in the country but also globally, for its contribution in the fields of education, professional development, maintenance of high accounting, auditing and ethical standards. ICAI now is the second largest accounting body in the whole world. It is also a founder member of various international professional bodies such as the IFAC, CAPA, and SAFA besides a member of International Accounting Standards Board (IASB). Being a premier accounting body in the country, the ICAI took upon itself the leadership role in standards setting process. The developments in India have been presented under: Accounting Standards in India; and financial reporting regulation in India. As of 2010, the Institute of Chartered Accountants of India has issued 32 Accounting Standards. These are numbered AS-1 to AS-7 and AS-9 to AS-32 (AS-8 is no longer in force since it was merged with AS-26). Compliance with Accounting Standards issued by ICAI has become a statutory requirement with the notification of companies (Accounting Standards) rules, 2006 by the government of India. Before the 103

55 constitution of the National Advisory Committee on Accounting Standards (NACAS), the institute was the sole Accounting Standard setter in India. However NACAS is not an independent body. It can only consider Accounting Standards recommended by ICAI and advise the government of India to notify them under the companies Act, Further the Accounting Standards so notified are applicable only to companies registered under the companies act, For all other entities the Accounting Standards issued the ICAI continue to apply. Table No.2.5 Accounting Standards issued by the (ICAI) As On December 2011 No AS No Title of the Accounting Standards Mandatory date 1 AS 1 Disclosure of Accounting Policies / AS 2 Valuation of Inventories AS 3 Cash Flow Statements AS 4 Contingencies and Events Occurring after the Balance Sheet Date AS 5 Net Profit or Loss for the Period, Prior Period Items and change in Accounting Policies AS 6 Depreciation Accounting AS 7 Construction Contracts(revised 2002) AS 8 Accounting for Research and Development / AS 9 Revenue Recognition / AS 10 Accounting for Fixed Assets / AS 11 Effects of Changes in Foreign Exchange Rates (revised 2003) / AS 12 Accounting for Government Grants AS 13 Accounting for Investments (issued 1993) AS 14 Accounting for Amalgamations Accounting for Retirement Benefits in the Financial Statements AS of Employers 15 AS 15 Employee Benefits (revised 2005) AS 16 Borrowing Costs AS 17 Segment Reporting AS 18 Related Party Disclosures 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

56 30 AS 30 Financial Instruments: Recognition and Measurement AS 31 Financial Instrument: presentation AS 32 Financial Instruments: Disclosures Sources: (1) (2) and (3) ICAI (2006) Compendium of Accounting Standards, New Delhi, p International Financial Reporting Standards (IFRS) The accounting standards board of the Institute of Chartered Accountants of India (ICAI) was constituted on 21 April, 1977, to formulate Accounting Standards applicable to Indian enterprises. Initially, the Accounting Standards were recommendatory in nature and gradually the Accounting Standards were made mandatory. The legal recognition to the Accounting Standards was accorded for the companies in the companies Act, 1956, by introduction of Section 211(3C) through the companies (Amendment) Act, 1999, whereby it is required that the companies shall follow the Accounting Standards notified by the central government on a recommendation made by the National Advisory Committee on Accounting Standards (NACAS) constituted under section 210Aof the said Act. The government of India, ministry of company affairs (now ministry of corporate affairs) notified Accounting Standards in companies (Accounting Standards) rules, 2006 by notification no. G.S.R. 739(E), dated 7 December, 2006, prescribing Accounting Standards 1 to 7 and 9 to 29 as issued by ICAI. It also issued companies (Accounting Standards) amendment rules, 2008 by notification no. G.S.R. no. 212 (E), dated 27 March, 2008 making some modification in existing rules so as to harmonize them with Accounting Standards issued by ICAI. These standards are applicable to preparation of general purpose financial statements for accounting periods commencing on or after 7 December, It may be mentioned that the Accounting Standards notified by the government are virtually identical with the Accounting Standards, read with the Accounting Standards interpretations, issued by ICAI. 105

57 Reserve Bank of India (RBI) in case of banks, the Insurance Regulatory and Development Authority (IRDA) in case of insurance companies and the Securities and Exchange Board of India (SEBI) in case of all listed companies, requires compliance with the Accounting Standards issued by ICAI. ICAI, being a full-fledged member of the International Federation of Accountants (IFAC), while formulating the Accounting Standards (ASs), the ASB gives due consideration to International Accounting Standards (IASs) issued by the International Accounting Standards Committee (IASC) or International Financial Reporting Standards (IFRSs) issued by the IASB, as the case may be, and try to integrate them, to the extent possible. However, where departure from IFRS is warranted keeping in view the Indian conditions, the ASs have been modified to that extent. Further, the endeavor of the ICAI is not only to bridge the gap between ASs and IFRSs by issuance of new AS but also to ensure that the existing ASs are in line with the changes in international thinking on various accounting issues. The National Committee on Accounting Standards (NACAS) constituted by the central government for recommending Accounting Standards to the Government, while reviewing the AS issued by the ICAI, considers the deviations in the AS, if any, from the IFRSs and recommends to the ICAI to revise the AS wherever it considers that the deviations are not appropriate. The term International Financial Reporting Standards (IFRSs) includes IFRSs, IASs and interpretations originated by the IFRIC or its predecessor, the former Standing Interpretations Committee (SIC). IFRS are increasingly being recognized as global reporting standards for financial statements. 'National GAAP' is becoming rare. As global capital markets become increasingly integrated, many countries are moving to 106

58 IFRS. More than 100 countries such as European Union, Australia, New Zealand and Russia currently permit the use of IFRS in their countries. ICAI / MCA has also expressed their view that IFRSs should be adopted in India for the public interest entities such as listed entities, banks and insurance entities and large-sized entities from the accounting periods beginning on or after 1 April, As a consequence the Indian entities will need to start preparing for convergence to IFRS, preferable much earlier. The next few years will be exciting, but challenging at the same time. We at Astute Group are committed to help you converge to IFRS as smoothly as possible, and look forward to teaming with you on this landmark. What is IFRS? IFRS stands for International Financial Reporting Standards and includes International Accounting Standards (IASs) until they are replaced by any IFRS and interpretations originated by the IFRIC or its predecessor, the former Standing Interpretations Committee (SIC). IFRSs are developed and approved by IASB (International Accounting Standard Board).These are standards for reporting financial results and are applicable to general purpose financial statements and other financial reporting of all profit-oriented entities. Profit-oriented entities includes those engaged in commercial, industrial, financial and similar activities, whether organized in corporate or in other forms also includes mutual insurance companies, other mutual co-operative entities, etc. Upon its inception the IASB adopted the body of International Accounting Standards (IASs) issued by its predecessor and as such IFRS includes IAS until they are replaced by any IFRSs. 107

59 One of the basic features of IFRS is that it is a principle-based standard rather than rule based. A separate set of IFRS for Small and Medium-sized Enterprises has been issued by the IASB in July The IFRS for SME represents a simplified set of standards with disclosure requirements reduced, methods for recognition and measurement simplified and topics not relevant to SME's eliminated. Why IFRS? IFRS are increasingly being recognized as Global Reporting Standards for financial statements. National GAAP is becoming rare. As global capital markets become increasingly integrated, many countries are moving to IFRS. More than 100 countries such as European Union, Australia, New Zealand and Russia currently permit the use of IFRS in their countries. The SEC has allowed the use of IFRS without reconciliation to US GAAP in the financial reports filed by foreign private issuers, thereby, giving foreign private issuers a choice between IFRS and US GAAP. SEC is proposing that the US issuers begin reporting under IFRS from 2014 (actually from 2012, if requirements for three year comparable are considered), with full conversion to occur by 2016 depending on size of the entity. This is a milestone proposal that will bring almost the entire world on one single, uniform accounting platform i.e. IFRS ( IFRS in India International Financial Reporting Standards (IFRS) convergence, in recent years, has gained momentum all over the world. As the capital markets become 108

60 increasingly global in nature, more and more investors see the need for a common set of Accounting Standards. India being one of the key global players, migration to IFRS will enable Indian entities to have access to international capital markets without having to go through the cumbersome conversion and filing process. It will lower the cost of raising funds, reduce accountants' fees and enable faster access to all major capital markets. Furthermore, it will facilitate companies to set targets and milestones based on a global business environment, rather than an inward perspective. Furthermore, convergence to IFRS, by various group entities, will enable management to bring all components of the group into a single financial reporting platform. This will eliminate the need for multiple reports and significant adjustment for preparing consolidated financial statements or filing financial statements in different stock exchanges. IFRS is used in many parts of the world, including the European Union, Hong Kong, Australia, Malaysia, Pakistan, and Gulf Cooperation Council (GCC) countries, Russia, South Africa, Singapore and Turkey. As in August, 2008, more than 110 countries around the world, including all of Europe, currently require or permit IFRS reporting. Approximately 85 of those countries require IFRS reporting for all domestic listed companies. In India, there will be two set of Accounting Standards: The existing Indian Accounting Standards (IAS) will be applicable to all companies which are not required to adopt IFRS converged standards. Indian Accounting Standards, as converged with IFRS (Ind-AS) will be applicable to companies operating in India in phased manner beginning from April 1, In the 109

61 first phase companies forming part of stock exchange index and those with net worth of above approx 250 million USD will be required to present their financial statements as per Ind-AS ( There are conceptual differences between IAS and IFRS. Keeping in view the extent of gap between IAS, Ind-AS and the corresponding IFRSs conversion process would need careful handling. By introducing a new company law, the Indian Government has initiated the process to amend the legal and regulatory framework. The conversion would involve, Impact Assessment, Revisiting Accounting Policies and thereafter changing the Accounting & Operational Systems (including ERP) in order to be fully compliant with Ind AS or IFRS. At its 269 meeting the Council of ICAI has decided that public interest entities such as listed companies, banks, insurance companies and large-sized organizations to converge with IFRS for accounting period commencing on or after 1 April, For small and medium size entities i.e. other than public interest entities, ICAI had proposed that a separate standard may be formulated based on the IFRS for Small and Medium-sized Enterprises issued by the IASB after modifications, if necessary. Even MCA had expressed the view that India should converge to IFRS w.e.f 1 April, 2011.With an objective to ensure smooth transition to IFRS from 1 April, 2011, ICAI is taking up the matter of convergence with IFRS with National Advisory Committee on Accounting Standards (NACAS) established by the Ministry of Corporate Affairs, government of India and other regulators including Reserve Bank of India (RBI), Insurance Regulatory and Development Authority (IRDA) and the Securities and Exchange Board of India (SEBI). 110

62 A recent news article highlights that Core Group for IFRS convergence formed by Ministry of Corporate Affairs (MCA) has recommended convergence to IFRS as under: Phase I (opening balance sheet as at 1 April, 2011) Companies which are part of BSE - Sensex 30 and NSE - Nifty 50; Companies whose shares or other securities are listed outside India; Companies whether listed or not, having net worth of more than Rs.1, 000 crores. Phase II (opening balance sheet as at 1 April, 2013) Companies not covered in Phase 1 and having net worth exceeding Rs. 500 crores. Phase III (opening balance sheet as at 1 April, 2014) Listed companies not covered in earlier phases ( Chart No.2.8 Timeline for Convergence IFRS (India) opening balance sheet as at 1 April, 2011 Phase I Phase II opening balance sheet as at 1 April, 2013 opening balance sheet as at 1 April, 2014 Phase III International Financial Reporting Standards (IFRS) Vs. (IGAAP) It is very much true that the Indian Generally Accepted Accounting Principles (IGAAP) is to be promulgated by adopting the International Financial Reporting Standards (IFRS) as far as possible. However, it is observed that this Indian Generally Accepted Accounting Principles (IGAAP) vary from the International Financial 111

63 Reporting Standards (IFRS) with a minimum of difference and wide ranging differences. Comparing the Indian Generally Accepted Accounting Principles (IGAAP) and International Financial Reporting Standards (IFRS), list the major differences between IFRS/ IGAAP are briefly explained below. Table 2.6 & Chart 2.9 summarize these differences. Chart No.2.9 Differences between IFRS Vs IGAAP Differences on the basis of Conceptual Accounting Framework Content of Financial Statements Accounting Differences Table No.2.6 Summary of Major Differences between IFRS Vs IGAAP Subject IFRS IGAAP First time adoption Components of Financial Statements Balance Sheet Income Statement Cash Flow Statements Full retrospective application of IFRS to PL and BS. Reconciliation of PL and BS in respect of last year reported numbers under previous GAAP Comprises of Balance sheet, Profit and Loss A/c. Cash flow statement, changes in equity and accounting policy and notes to Accounts No particular format, a current/ noncurrent presentation of Assets and liabilities is used. No particular format prescribed IAS1 Mandatory for all entities (IAS7) No needs to prepare reconciliation on first time adoption Comprises of Balance sheet, Profit and Loss A/c. Cash flow statement (if applicable), and Notes to Accounts As per Format Prescribed in Schedule VI for Companies, adherence to Banking Regulation for Banks etc. As per Format Prescribed in Schedule VI (AS1) Level 3 entities are exempted (AS 3) 112