BLOG 3 # ACCOUNTING STANDARDS

ACCOUNTING STANDARDS

Introduction

Question:

Can there be a single accounting policy in the world? Like, for inventory valuation only FIFO is allowed. (For your information, as of now there are many ways to calculate the cost of inventory not only FIFO. Various methods accepted are

1. Specific identification method
2. Standard cost method
3. Retail method
4. FIFO
5. Weighted average method

Answer: 

No. There cannot be a single accounting policy which can be implemented across all the companies across all the industries across all the economies.

Conclusion: 

Since every entity operates in a different environment in a different nature of industry with different size of business – a single accounting policy applicable to all the entities is not practical.

Therefore, there are different accounting policies. That means, these different accounting policies, different valuation methods and different disclosures will impact the understandability and comparability of financial statements of two companies. Consider the following profit and loss account.

Profit and Loss A/c of X Ltd and Y Ltd as on 31-3-2018 (Rs. In Crores)

Particulars	X Ltd	Y Ltd	Particulars	X Ltd	Y Ltd
			By Closing Stock	100	110
To Net Profit	50	60

Y Ltd reported a profit of 60 crores which is 10 crores more than that of X Ltd. A reader of these financial statements conclude that Y Ltd is outperforming X Ltd and considering all the other data (assumed to be same) he makes a decision of investing money in Y Ltd.

But What if; the stock in hand of both the companies is an item “A” and the quantity is 10,000 Tons. Both the companies have same stock but because X Ltd followed FIFO and Y Ltd followed Weighted Average Method there is a difference in stock and Y Ltd reported 110 crores of closing stock and X Ltd reported 100 crores. But the fact is that both the companies have same inventory.

Unless the above is clearly disclosed to the reader of financial statements in a manner which he understands, he might make a wrong decision. So as to enable him to make right and informed decision – Accounting Standards are required.

Part 1: What are Accounting Standards?

ž  Accounting Standards (ASs) are written policy documents issued by

—  expert accounting body or

—  by government or

—  other regulatory body

ž  covering the aspects of

—  recognition,

—  measurement,

—  presentation and

—  disclosure of

ž  accounting transactions in the financial statements.

Part 2: What are the issues Accounting Standards deal with?

Accounting Standards deal with the issues of

1. Recognition of events and transactions in the financial statements, (When a Journal Entry for a transaction be passed)
2. Measurement of these transactions and events, (With what amount the above Journal Entry is to be passed)
3. Presentation of these transactions and events in the financial statements in a manner that is meaningful and understandable to the reader, and
4. the Disclosure requirements which should be there to enable the public at large and the stakeholders and the potential investors in particular, to get an insight into what these financial statements are trying to reflect and thereby facilitating them to take prudent and informed business decisions.

Part 3: Why accounting standards are required?

Accounting Standards standardize diverse accounting policies with a view to

1. Eliminate the non-comparability of financial statements and thereby improving the reliability of financial statements, to the maximum possible extent, and
2. Provide a set of standard accounting policies, valuation norms and disclosure requirements.

Part 4: What is the overall objective of Accounting Standards?

ž Accounting standards aim at improving the quality of financial reporting by promoting

—  comparability,

—  consistency and

—  transparency,

in the interests of users of financial statements.

ž  Good financial reporting not only promotes healthy financial markets, it also help to reduce the cost of capital because investors can have faith in financial reports and consequently perceive lesser risks.