Accounting System

UNIT 2 ACCOUNTING CONCEPTS AND

STANDARDS
Structure Page Nos.
2.0 Introduction
2.1 Objectives
2.2 Accounting Structure
2.3 Accounting Concepts
2.3.1 Concepts to be observed at the Recording Stage
2.3.2 Concepts to be observed at the Reporting Stage
2.4 Accounting Standards
2.4.1 Need for Accounting Standards
2.4.2 Benefits of Accounting Standards
2.4.3 Indian Accounting Standards scenario
2.5 The Changing Nature of Generally Accepted Accounting Principles
2.6 Attempts Towards Standardisation
2.7 International Financial Reporting Standards (IFRS)
2.7.1 Need for Convergence of IFRS
2.7.2 Benefits and Challenges of IFRS
2.8 Summary
2.9 Key Words
2.10 Answer to Check Your Progress
2.11 Self-Assessment Questions/Exercises

2.0 INTRODUCTION

All undertaken financial tasks become easy when they are performed with a defined set of
rules or parameters. This framework of rules guides us to perform our activities,
effectively. Now, if these set of rules are widely acceptable, they turn to be standards and
thus becomes valuable to us. To understand this lets us take the example of you, driving
a vehicle on the road. You are supposed to follow ‘the driving rule’ by keeping your
vehicle on the left side of the road. You see all other travellers also follow this rule, while
driving. Let us think what would happen if these vehicle drivers don’t follow this rule;
obviously, this would lead to creation of a chaotic situation on the road. Understandably,
a similar thought process has been the backbone to the discipline of accounting where the
accounting principles which have been evolving over the past several hundred years, have
led to the creation of many rules and conventions which have enabled the accounting
system to become more acceptable, meaningful and trustworthy. Thus it becomes
important for us before making and understanding the accounting reports, to understand
the rationale behind the creation of these reports. The said rationale arises from the
widely familiar and accepted rules and conventions, which require to be familiarised,
first. We all know that the global environments are changing and the accounting
discipline also requires to match the growing business needs. Companies stay in pursuit
to expand their operations internationally. There arises a challenge that different nations
follow different accounting standards and there is a lack of harmony among them. This
underlines the need of standardization and thus this need was met with the framing of a
global set of standards referred as ‘International Financial Reporting Standards (IFRS)’.
These internationally proclaimed standards speak one global business accounting
language not only to remove language barriers but facilitate global trade. It makes the
accounting terms and reports easily understandable and comparable across international
boundaries. So despite the linguistic barriers the rule standardization helps us overcome
this problem through global accounting standardized framework of IFRS.

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 Accounting
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2.1 OBJECTIVES Standards
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After studying this unit, you would be able to:

 Underline the logic for the necessity and creation for a conceptually sound
accounting structure;
 Understand the role of Generally Accepted Accounting Principles (GAAP);
 Appreciate the need and importance for the demand of uniformity in international
accounting practices and;
 Recognise the importance of International Financial Reporting Standards (IFRS).

2.2 ACCOUNTING STRUCTURE

Accounting is a very specified and objectivity laid subject and it works under a defined
set of guidelines, policies, rules, agreements, covenants and conventions. They all
formulate the Accounting’s conceptual framework. This framework is conceptual but
remains flexible to meet to the new challenges arising from the accounting practices
across the world. It serves to be the essence as a knowledge base, with logically and
precisely defined acceptable rules, practices and procedures contribute towards the
creation of a framework for the professionals where they can contribute with their
experiential learning and knowledge in this discipline. This set of standardized rules,
procedures and guiding principles become a guiding light to resolve any ambiguities or
clarifications, which may arise. Thus, it would not be wrong to say that this theoretical
framework would facilitate the accounting profession become globally acceptable.
Hendrickson (1977) holistically, defines it “as logical reasoning in form of a set of broad
principles that (i) provide a general frame of reference by which accounting practice can
be evaluated, and (ii) guide the development of new practices and procedures.” So this
theory mitigates the ambiguities and thus makes it understandable and acceptable. As it is
evolutionary in nature, it has to be governed with a basic set of core principles which
would not only be a standard reference point for appraising, developing and reviewing
but continually evaluate them too.

The American Institute of Certified Public Accountants (AICPA) has also worked on the
varied aspects pertaining to the financial accounting theory and generally accepted
accounting principles, and they say, that the “Financial statements are the product of
process in which a big data pertaining to different perspectives of business actions are
accumulated, analysed, and reported.” These said defined set of activities and processes
are followed with the generally accepted accounting principles (GAAP). The latter,
envisages unanimity of various accounting professionals and firms to define the set of
‘recordable activities’ and they being factored and measured. It also frameworks the
extent of disclosure (or recording) of the accounting information.

GAAP though is principle in nature but it involves a defined and flexible framework of
conventions, rules and procedures which are important to identify the standard or
acceptable account practices.

Since the essence behind these principles is standardization so various terms have been
precisely defined for the ease of understanding. “Principle’ is applied as a “general law or
rule adopted or professed as a guide to action, a settled ground or basis of conduct or
practice”. You will note that this definition describes a “principle as a general law or rule
that is to be used as a guide to action”. This implies that accounting principles do not
prescribe exactly how each detailed event occurring in business should be recorded.
Consequently, there are several matters in accounting practice that may differ from one
company to another.

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Accounting System “Accounting principles are a work of human creation and are accepted for their
usefulness. The general acceptance of an accounting principle (or for that matter, any
principle) usually depends on how well it meets the three criteria of relevance,
objectivity, and feasibility. A principle is relevant to the extent that it results in
meaningful or useful information to those who need to know about a certain business. A
principle is objective to the extent that the information is not influenced by the personal
bias or judgement of those who furnished it. Objectivity connotes reliability or
trustworthiness which also means that the correctness of the information reported can be
verified. A principle is feasible to the extent that it can be implemented without undue
complexity or cost.”

2.3 ACCOUNTING CONCEPTS

You would have understood from the earlier unit 1 that the accounting is the business
language. With widespread acceptability, it showcases various forms as the languages
shows dialects. It means that the accounting also has many terminologies which becomes
a challenge for its global recognition and acceptance. Different combinations of words,
phrases and terms have been used to convey a same or similar meaning, thereby leading
to confusion with the reader. The various terms used for describing the basic ideas, each
term carries its own meaning, the ambiguous use by several accounting professionals
have resulted in the creation of confusion arising from generalization resulting in loose
and overlapping meanings at the readers’ end. Besides, the concept by an author is
proposed as a convention by the other which makes the learner unconvinced and may lose
interest in the subject.
So here would emphasize to put the concepts straight to get out of the terminology puzzle
by acknowledging the generally accepted ideas as ‘concepts’. Going further, the other
such ideas not categorised as concepts are ‘conventions’.
2.3.1 Concepts to be observed at the Recording Stage
i) Business Entity Concept
The Accounting subject distinct business from the owner as it treats them as two separate
entities. So the accounting for the business is from the business viewpoint rather than
from the owner’s perspective. The concept treats a business firm of an enterprising nature
distincting the firm’s owner(s) from the business. So accounting activities of both require
to be recorded separately. While capturing a transaction in the book of records the
accountant must see how the transaction is affecting the business. Say if the business
owner (a separate business entity, already discussed) takes cash out of the business for
meeting his personal expenditure, the entry must be captured for the cash reduction in
business. On the other hand, if the owner brings his cash in to the business he becomes
the creditor to the business and the firm has to capture this cash transaction as the firm’s
liability to pay back to the owner.
This concept of business entity can further be understood with a limited company as in
this case the business/company or firm is a separate legal entity (or personality) as like
any individual despite being involved in many commercial and industrial activities.
Partnership firms are hard to separate the individual nature because of separate persons.
This distinctiveness gets even harder in case of sole proprietorship firm. So you would
have understood that the accounting comes across such challenges to be resolved from
time to time using the set of rules and conventions. We also have understood that
accounting still requires separating business from the owner. It is pertinent mentioning
here that the Law doesn’t accept this distinction between the company and the owner(s)
as distinct activities. So the accountant requires to stay aware while dealing in a legal
matter.
A creditor to the company requires timely information about the firm’s assets as well as
22 the owner(s) personal assets for validating the creditworthiness. The management
appoints employees who carry the responsibilities on them for managing the funds Accounting
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derived from firm owner(s), financial institutions etc. Their efficiencies are reflected in Standards
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various periodic and annual reports and their timely compliance”

Check Your Progress 1

Do you see the application of the Business Entity Concept in any other form, not
explained above?
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Check Your Progress 2

A firm’s owner or proprietor takes an amount of Rs. 75,000 towards mitigating his own
personal expenses. The accountant recorded this as an ‘expense’ entry in the firm’s book
of accounts thereby making a reduction in the profits of the firm. Share your views
whether the accountant has recorded the transaction correct? If not, what else he should
have done?
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Check Your Progress 3

A firm’s owner brings in an amount of INR 25 lakh as capital investment in his business.
Share your understanding whether the firm has a corresponding liability towards the
business owner, from the accounting’s business entity perspective?
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ii) Money Measurement Concept

In accounting, we capture those factual transactions which are monetary in nature. As
monetary transactions have money as medium for exchange and they have a defined
‘value’, it becomes easy to capture them in the books. A firm has a large number of assets
and equities and the money measurement concept uses money as a common denominator.
So the physical count of assets such as 5 tonnes of a certain raw material, 10 different
manufacturing machines, 7 transportation vehicles, or 100 staff count stand no relevant.

So the money (with its denominated value) happens to be the “practical common
denominator” serving a measure of profitability of the business by capturing the monetary
value of the assets and equities. This concept comes with certain limitations also as it
cannot capture the ‘qualitative aspect’ of the said assets which stand important to the
business. Like the efforts done by a manager and his related sacrifices on family and the
health fronts, cannot be captured in the accounting records. On the same lines, any
interpersonal differences or conflicts between two head of the departments may bring in
adverse results on the firm’s performance making the employees become demotivated
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Accounting System and the customer becoming dissatisfied with the product quality. This may lead to the
erosion of the market share to the favour of the competitor. Similarly, due to changes in
the business environment and a new product developed by the R&D team and its
subsequent customer acceptance are of much significance to the business but the Money
measurement concept has its limitations in capturing the above cited examples.

By now, we have understood that Accounting faces its own set of limitations in recording
and showcasing the business activities, of which many of them have underlined
contributions for the company’s projected profitability.

The other limitation of the Money Measurement concept is the ‘time value’. It treats the
present value of rupee money today equal to its value which was say, ten years back or
ten years in the future. That is, the concept assumes the value of the money staying
‘constant’ over the time period as it only records the transaction date. The alterations in
‘purchasing power of money’ arising out of international business environments, forex
rate fluctuations and national reserves, inflation, depreciation etc. are not captured. So
you can recall that rupees’ value when you were young and its value now, have changed
big. Let it be the fuel expenses, rentals or even milk price all have gone up substantially.
The same stands true for the accountants also as they believe that rupee’s purchasing
power modifies, but the issue remains that this acceptance in the changing money values
is not captured in the accounting books. Thus posing to be a major current accounting
hindrance, it aims to resolve this measurement problem or issue to encompass the
qualitative aspect besides identifying and reporting relevant information. It is proposed
that a separate report be provided on the effect of pricing variations on reported financial
position of the firm.”

Check Your Progress 4

Validating the fact that “an organisation is the lengthened shadow of a man”, if a
company’s Director expires in an aeroplane accident. The immediate impact is visible
with the company’s share value eroding significantly at the stock exchanges Will it affect
the firm’s accounts? Justify your stance?
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iii) Objective Evidence Concept

“The term objectivity refers to being free from bias or free from subjectivity. Accounting
measurements are to be unbiased and verifiable independently.” Because of this reason all
accounting transactions requires to be evidenced and be duly endorsed with verifiable
supporting documents like bills, invoices, receipts, cash memos, etc. These substantiate
the accounting transaction be verified later by the auditors. As for the items like
depreciation and the provision for doubtful debts where no documentary evidence is
available, the policy statements made by management are treated as the necessary
evidence.

iv) Dual Aspect Concept

One of the foundational feature of this subject, it emphasizes on the concept that every
business transaction carries a ‘two-fold effect’ as it is traditionally and correctly phrased
that “every receiver is also a giver and every giver is also a receiver”. Let’s recall when
you go for shopping in a mall and you purchase a pair of denim for Rs 1,000. This
involves two transactions; one you pay Rs.1000 and the second you carry the denims.
24 This should explain to you the “two fold effect” i.e., (i) one asset (in form of denims)
increases while (ii) decrease in the cash in hand occurs. On the same lines, if you would Accounting
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have chosen to buy these denims on credit, the assets with you would increase (stock of Standards
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goods) while your liability towards creditors would increase too. So with this, we can
conclude that all business transactions comprises of two parts: (i) the receiving aspect,
and (ii) the giving aspect. To understand this from the first example further, the receiving
aspect is pair of denim while the giving aspect is cash. In the second example the
receiving aspect is goods (denims) and the giving aspect is the creditor. So, we conclude
with this the dual nature of transactions where both the transactions are to be captured in
the account books and this remains as one of the fundamental principle of “double entry
book-keeping” or “the “Double Entry System of Book-keeping” which we would be
deliberating on subsequently. It’s time to move forward to recognize another accounting
effect of this dual aspect concept, we are studying. The owner brings in the required funds
(capital) to start a business. He may generate more funds as required from time to time
from external agencies (creditors). Here, the dual aspect concept says that ‘all receipts
create corresponding obligations for their repayment’. Or, to understand in a better way,
any business contribution, whether in cash or kind, not only increases its resources
(assets), but also its obligations (liabilities/equities) correspondingly. Thus, at any given
point of time, the total assets and the total liabilities must be equal. This equality is called
‘balance sheet equation’ or ‘accounting equation’.
It is stated as under: Liabilities (Equities) = Assets or Capital + Outside Liabilities =
Assets
The term ‘assets’ denotes the resources (property) owned by the business while the term
‘equities’ denotes the claims of various parties against the business assets. Equities are of
two types: (1) owners’ equity, and (ii) outsiders’ equity. Owners’ equity called capital is
the claim of the owners against the assets of the business. Outsiders’ equity called
liabilities is the claim of outside parties like creditors, bank, etc. against the assets of the
business.
Thus, all assets of the business are claimed either by the owners or by the outsiders.
Hence, the total assets of a business will always be equal to its liabilities. When various
business transactions take place, they affect the assets and liabilities in such a way that
this equality is always maintained. We shall understand this with couple of exemplary
transactions to see to this equality maintenance:
1. Mr. XY initiated his business with INR 1,00,000 cash, which formed the asset to the
business. Business entity concept says that the business and the owner are two separate
entities thus Mr. XY contribution of one lakh should be treated as the business liability.
So Capital = Assets
Rs. 1,00,000 = Rs. 1,00,000 (cash)
2. He purchased goods on credit from AB for Rs. 10,000. This increases an asset (stock of
goods) on the one hand and a liability (creditors) on the other. Now the equation will be
Capital + Liabilities = Assets
Rs. 1,00,000 + Rs. 10,000 = Rs. 10,000 + Rs. 1,00,000
Capital + Creditors Stock + Cash
3. He purchased furniture worth Rs. 15,000 and paid cash. This increases one asset
(furniture) and decreases another asset (cash). Now the equation will be:
Capital + Liabilities = Assets
Rs. 1,00,000 + Rs. 10,000 = Rs. 15,000 + Rs. 10,000 + Rs. 85,000
Capital + Creditors Furniture + Stock + Cash
This equation can be presented in the form of a Balance Sheet (a statement of assets and
liabilities) as follows:

XY ‘s Balance Sheet
Capital and Liabilities Rs. Assets Rs.
Capital 1,00,000 Furniture 15,000
(Mr. AB) Creditor 10,000 Stock of Goods 10,000
Cash 85,000
1,15,000 1,15,000
Note that the net sum on both sides of the Balance Sheet remains equal irrespective of the
number of transactions and the items transacted. Also, note that the cash head in the
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assets and liabilities of the business.

v) Cost Concept
Business operations require owing various resources like land, buildings, infrastructure,
machinery, property rights and in accounting terms are called as ‘assets’. It is worth the
price paid for, or cost incurred to acquire it.” This means that as asset purchase
transactions are captured at their original purchase price and this cost is the basis for all
subsequent accounting for the assets. The assets shown on the financial statements do not
necessarily indicate their present market worth (or market values). This is contrary to
what is often believed by an uninformed person reading the statement or report. The term
‘book value’ is used for the amount shown in the accounting records.
A pertinent example is cash, itself. It has also been observed that longer an asset is kept in
a firm, less would be the probability of the accounting value matching the market value of
the asset retained. This remains a problem area for an accounting professional.

The cost concept doesn’t factor the future anticipated cost of a firm’s asset. Any asset is
assumed to have long & limited life. The cost of an asset reduces over a time period and
the account professionals terms this as ‘depreciation process’ which we would be
understanding in coming units. Yes, by that time, we would understand depreciation as
process by virtue of which an asset’s cost gets periodically reduced (or written off) by
factoring it as expense over some accounting period. This means that depreciation as
expenses eats into the firm’s profits. While factoring depreciation, the accountant doesn’t
brings into the account the current market value of the depreciating asset, rather there
exists no correlation in depreciation vis a viz asset’s current market value. It is required to
be clarified here that the logic behind depreciation is to spread and allocate the asset’s
cost for its useful life to the firm and certainly not to appropriate it with its current market
value.
This may exclaim you on the reasons why the assets get marked as ‘costs’, in the
accounting records and there exists a wide difference between their market prices and
book recorded prices. The main argument is that the cost concept meets all the three basic
criteria of relevance, objectivity and feasibility.

Check Your Progress 5

A firm buys a building in 2021 for INR 5 crore. The market was booming at that time and
by the end of the FY 2021-22, the market value of the building quoted Rs.7 crore. The
company went ahead to appreciate the building in their book of records as INR 7 crore for
the Financial year 2021-22. Share your opinion on this, as an accounting professional and
how would you rate this practice?
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Check Your Progress 6

A company buys a transportation vehicle on a good discounted price of INR 4,00,000,
while the prevailing market price is Rs. 6,00,000. Share your views whether the company
should capture the value of the vehicle in their account records as INR 4,00,000 or INR
6,00,000? Please share the reasons to support your stance.

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vi) Accrual Concept

All the accounting concepts studied so far seeks to address various accounting situations
and their solutions. This, accrual concept is another such endeavour which distinct the
receipt of cash, and the right to receive it, and the payment of cash and the legal
obligation to pay it. In the practical business transactions scenarios, the obligation to pay
and the actual movement of cash may not happen at the same time and the “accrual
concept” recognises this distinction. So while recording a “sale of goods” transaction, the
revenue may be received either (i) before the right to receive arises, or (ii) after the right
to receive has been created. The accrual concept provides a guideline to the accountant as
to how s/he should treat the cash receipt and the rights related thereto. In the former case
the receipt will not be recognised as the revenue of the period for the reason that the right
to receive the same has not yet arisen. In the latter case the revenue will be recognised
even though the amount is received in the subsequent period.

The same process be followed pertaining to the expense made by the company.it has been
practically observed that the cash payments towards the expenses made are done either
before or after their due date. So in accounting terms the due amounts which are required
to be paid are categorised as expenses. It also means that the advance payments (i.e., it
does not belong to the accounting period in question) should not be accounted for as
‘expense’, thereby treating the entity receiving such advance payments as ‘debtor’ by the
time his due date of payment arrives. Where an expense has been incurred during the
accounting period, but no payment has been made, the expense must be recorded and the
person to whom the payment should have been made is shown as a creditor.

Check Your Progress 7

The year of a company (from the accounting perspective) gets over on the 31st December
every year. For this company, their premise rent amounts to INR 1,00,000 for the last
quarter is delayed and thus couldn’t be timely paid for any reasons. As an accounts
professional, share your understanding whether this due rental to be paid, should be
factored in the company’s book of accounts for closing purposes?
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Check Your Progress 8

A govt. furniture supplier dispatches various furniture goods to govt. departments. He
finds that few invoices totalling INR 50, 000 were yet to be paid by said departments and
their due date has already surpassed on 31st March i.e the closing date of the yearly book
of accounts. Now share your opinion, explaining whether the supplier consider the
revenue of INR.50, 000 into the closing year account while evaluating the net profit of his
firm?
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2.3.2 Concepts to be observed at the Reporting Stage

i) Continuity Concept or Going Concern Concept

Whereas earlier we have understood that the business person and the firm are two
separate legal entities; now we take it further with the going concern concept. It
says that the ‘Accounting’ understands the business (an accounting entity) will
continue with their business operations perpetually i.e long in the future. Thus a
business entity is factored as “a going concern” that is assumed to sustain its
activities continually or at least, in the foreseeable future. This means it is also
believed that the firms’ owners have no intentions, nor any necessity to close the
firm.

This assumption becomes significant as it makes the business being understood

as a “mechanism for adding value to the resources it consumes”. The business’s
success is evaluated by subtracting output values (sales or revenues) from the
input values (expenses). So, an un-utilized resource becomes ‘cost’ rather than
being recorded at market values. The continuity concept factors such costs be
realized in the future rather than selling them in the markets in present.

This concept serves to enable the assumption that the business remains perpetual and
shall be a going entity in the future or at least in foreseeable future this concept becomes
the foundation for many valuations and allocations in the firm’s accounting task. In case
of depreciation (or amortisation), the process banks on the said concept. It also serves the
investor to stay invested or invest in fresh in a company. It is also true that based on this
accounting concept the accounting process remain transparent for capturing the records
and thereafter reporting the investments, management’s efficiency and reporting the
firm’s position. Also, this concept doesn’t factors the higher current market values or the
liquidation values which stand important in the other concepts studied by now. This
assumption provides a basis for the application of cost in accounting for assets.

Though the accountant stands with this concept theoretically, he has to comprehend that
the firm’s business, partially or wholly may cease to exist or operate, or be sold or exited
(say within a year or two), then the resources could be reported at their current values (or
liquidation values).

ii) Matching Concept

Also widely known as the “Matching of Costs against Revenues Concept”, it
assumes that to ascertain the firm’s accounting results like PnL, Balance sheet
etc. requires collecting all revenues and expenses of that period. Further, you may
also understand the expenses of an accounting year should match with the firm’s
generated revenues of that particular accounting year, which brings forth the
issue of ‘appropriation’ to match the “appropriate costs with appropriate
revenues”. Inflows (revenues) of that accounting period must be identified or
forecasted to appropriate costs spent for getting the said inflow. So costs when
deducted from the revenues results in net resultant for the queried period. So it is
important to understand the importance of recognizing the revenues and costs for
a time period. This requires following set of accounting rules which says “The
Timing of Revenue Recognition Revenue is recognized in the period in which it
is earned or realized”. This is as per the ‘realization principle’ which clearly
states that “while factoring revenues of a defined time period the transactions
happened rather than when cash inflow occurred”. So while accounting for “the
sale of goods (or services)” (i) the revenue is only accepted to be ‘realized’ when
sales transaction happens and not at the time when payment is realized or cash is
accepted for the said debtor. ii) Revenues generated from sources like rentals
28 received, interest earned, or commission charges are time bound so are accounted
 for on defined times. Income generated from them is appropriated in the Profit Accounting
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and Loss statement in the accounting year in which they are earned. For eg, a Standards
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firm invested by buying certain govt. securities or bonds on 1st October’ 2020
amounting to one lakh on which interest earning would be 12%, to be paid on
half-yearly basis i.e on every 1st day of the month of April and October. The first
interest credited amount of INR 6000/- happens on 1st April’ 2021. As per the
obligation the company would be preparing their Profit and Loss for the calendar
year 2020 i.e, from 1st Jan’ 2020 till 31st Dec’ 2020). The abovementioned
interest credited for the period 1st of October to 31st of March. (half yearly) has to
factor INR 3000 for the period 1st October to 31st December - quarter (Three
Month) amounting to INR three thousand should be factored in the header
“Interest Income on investments made” in Profit and Loss A/c for the year 2020.
Noteworthy is that the said amount has not been received during the said year.
The Timing of Costs Recognition: This matching principle says “the expenses
should be recognized in the same period as the associated revenues.” This means,
i) Costs of goods require matching to sales revenue. So, in process of
making the Profit and Loss Account for a said year, one should not factor
in cost of all goods made in that year, rather, factor cost of goods sold
(COGS) in that particular year. COGS is calculated by “subtracting the
cost of closing stock from the cost of goods produced”.
ii) Expenses such as salaries, wages, interest, rent, insurance, etc., are
recognized on time basis. In other words, they are related to the year in
which the service is obtained or the expense is incurred, whether paid
immediately or payable at a later date.
iii) Depreciation on fixed assets is also factored in as a ‘Cost’ since it is
dependent on time. With this, we can summarize with the following
statement, “all revenue earned during an accounting year, whether
received or not, and all costs incurred, whether paid or not have to be
taken into account while preparing the Profit and Loss Account for the
year”. On the same lines, any financial transaction of previous year
having amount involved to be paid in the current year requires not being
factored in the ongoing accounting year’s revenue and costs. It indicates
towards yet another aspect namely the “accrual basis of accounting”
which would be we would be detailing in the forthcoming units. Coming
back to focus on the ‘Matching Concept’; it has consequences for
evaluating the profit and loss for a accounting year.
1. While making annual financial statements it requires to be
adhered that the costs pertaining to a particular financial year
(F.Y) and the same is applicable for revenues also. For example,
when we prepare the Profit and Loss Account for 2017, we shall
take into account all those incomes that were earned during 2017,
and similarly consider only those costs which were incurred in
2017. Any costs or incomes which relate to 2018 shall be
excluded.
2. It requires to be ensured that “all costs incurred during the
accounting period (whether paid or not) and all revenues earned
during that year (whether received or not) are fully taken into
account.”
3. We should consider only those costs which relate to the revenue
taken into account. This is the reason why we consider only the
cost of goods sold, and not the cost of goods produced during
that period.

iii) Full Disclosure Concept

We understand that the various financial statements whether been made monthly,
quarterly, half-yearly or annually serve a basic function of communicating
trustworthy financial information to all the stakeholders in a standard format.
These statements are the sole basis to assess the performance and financial 29
Accounting System position of the firm. These stakeholders can be investors, lenders, suppliers and
internal as well as external customers. So it becomes the responsibility of the
accountant to adhere to the standard norms while publishing such financial
statements as they bring much needed credibility and add to the goodwill of the
firm. Such statements should be elaborative and having foot-notes to disclose all
relevant information of a material nature which relate to the profit and loss and
the financial position of the business. It is therefore, necessary that the disclosure
should be full, fair and adequate.

iv) Accounting Period Concept

On one hand the business is considered perpetual in nature, the results can be
ascertained once the business cease to exist, all its assets sold and all liabilities
paid. Still the accounting statements are required to be made at regular and
defined intervals. There always remains a curiosity with the stakeholders to
remain updated on the financial position of the company and can’t afford any
delay in this. This puts additional pressure on the accountant to report the
changes in the wealth of a firm at varied time intervals depending on established
or prevailing reporting practices or traditions, government and legal compliances.
These annual reports may be adhered and compiled on calendar year or financial
year (as defined by government). Still many firms choose ‘natural’ business year,
known for ending at relatively lower or lowest business activity in the twelve-
month period horizon. It may however, be clarified that the annual reporting is
typically for external reporting while shorter span reporting at the intervals, say
of one month or three months is for internal reporting and compliance purposes.

In an effort of factoring earnings and the cost of those earnings for a specified
accounting period, requires encompassing all the revenues and costs pertaining of
that accounting period requires to be factored irrespective of whether or not they
have been received in cash, or paid in cash. Withstanding all these issues in
allocations and adjustments, the relevance of these short-term reports (i.e., yearly
reports) owe a great deal of importance for business owners, management,
creditors, and stakeholders and they look forward to the accountant for the timely
publication of such reports.

Some other concepts, e.g., the Matching concept, the Realisation concept and the
Dual Aspect concept are discussed in units 4 and 5, and as such, they have not
been taken up here.

After going through the above accounting concepts, you would have concluded
that all the concepts stand important on their own, but they may demonstrate
conflict when they interact. So the knowledge of the accountant comes handy in
such scenarios. For example, in case of business properties’ valuation
perspective, let a company buy a land parcel in 2000 amounting to INR 6,00,000
and it began the construction in the next year i.e 2001 to commence the business
activities, the very next year. The company showcased stellar results meeting to
the stakeholders’ expectations. Now, the Balance Sheet (a statement of assets and
liabilities) for the year 2010 is being prepared and ‘Land’ is required to be
valued. The estimated current market price of this land is Rs. 60, 00,000.

Now, as an accounting professional, would you agree to the proposition of the land be
recorded at INR 60 lakh? The accounting principle makes us accounted in the Balance
sheet at the purchase price only. To begin with, money measurement concept inhibits us
from recognising the price appreciation because of market and inflationary reasons. Then
comes the realisation concept which stops us for unrealised profits being factored in the
book of accounts by the time the said asset (land, here) is not sold for money. Adding to
that, the continuity, or going concern concept, doesn’t recognises the market value of
land thus is not factored in balance sheet as the land remains as the asset and an integral
30
input to pursue business operations. Assuming the contrarian view, if the land be depicted
in balance sheet at the estimated current market value may attract the business owner to Accounting
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abandon/ stop the business by selling land and retire himself. Next, the principle of Standards
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objectivity makes the argument more challenging. As the price of the said land at the
time of acquisition in 2001 is a verifiable document with proofs arising from the sale deed
and other relevant supportive documentary evidences. But in case of the 2010 land
estimation value may be suspected as various valuations would be based on varied
calculations involving time frames, usage, market demand, availability and other
commercial aspects. An accredited valuer may be hired for his valuation methodology be
accepted as verifiable evidence of land’s prevailing market price. Further, the land
requires to be free from all encumbrances, or the cost of already constructed premise in
that land, its quality of construction and compliance to the legal bylaws. Here, the
conservatism concept inhibits accepting the said land market estimation value on
accuracy concerns.

v) Concept of Conservatism
This concept is also called as the concept of prudence, and is known for its statement
“anticipate no profit, provide for all possible losses”. It makes the accountant raise his
guard with abundant caution. This makes him face an interesting proposition of having an
option of capturing values of for assets and revenues on the lesser value while higher
valuations towards liabilities and expenses. The concept states to recognise revenues or
gains only when realized as cash or assets (usually legally enforceable debts). This is
ultimate cash realisation of which can be assessed with reasonable certainty. The concept
says to “factor in for all known liabilities, expenses, and losses whether the amount of
these is known with certainty, or is at best an estimate in the light of the information
available. Probable losses in respect of all contingencies should also be provided for.”
A contingency is defined as “a condition, or a situation, the ultimate outcome of
whichgain or losscannot be determined accurately at present.” It would be ascertained
only post happening of the event. It may be understood that the said event may not even
happened. Say, a client may file a suit in the court of law against the firm and we don’t
know the verdict. So from the accounting point of view, it becomes pertinent to factor or
provision the expected loss in the company’s financial statements. Thus, as a solicitation
of the said concept “net assets and incomes are more likely to be understated than
overstated”. This makes us advocate the practice of valuing inventory (stock of goods left
unsold) at cost or market price, whichever is lower valued. You would observe that this is
an extension of what the cost concept said initially. Though many professionals have a
contrarian view about this concept as it hinders true profit valuation and thereby
distortedly presenting the facts in the firm’s financial statements. So it is correct to state
that a rational use of conservatism is advocated as over-conservatism leads to falsification
of the financial data.

Check Your Progress 9

A company is negotiating to get an order for Rs.5 lakhs from XYZ Company. It is
confident to get an order and as a result, it shows this order as a part of its sales revenue.
Will you approve such an accounting treatment of probable order to be obtained in
coming years?
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vi) Materiality Concept
Business operations involve many activities and many of them may not serve to be
important from the accounting perspective. The role of accountant is again important here
to adjudge whether the vent or happening carries a financial aspect or benefit to the 31
Accounting System company. In any of the cases, observing and recording of such events is costly but is
required for the event be evaluated for relevance later. The discussed concept states for
the items of less importance may not be appropriately treated on accounting theory. Small
petty or stationery items may cost less and have a life of couple of years, but requires
book keeping effort having a larger cost implication than the derived benefit behind this
recording task. As this item is not going to make any impact on the business operations or
the profitability of the firm, the suffered cost actually becomes an expense. Also, some
said stationery item stock may stay unutilized in that accounting year. Thus the book
keeping entry would treat the cumulative amount spent on stationery purchase as
‘expense’ in the very year the stationery items were purchased. The balance of the said
inventory may be treated by the accountant as ‘insignificant’ to be classified as an asset
but as resource for the next accounting year. In other words, the cumulative value of
expenditure on stationery be classified as ‘expense’ for the said period in which this
expense got made.
This classification or differentiation between adjudging an event as “material or
immaterial” rests with the sense of professionalism and situation of the accountant. Also,
there are no guiding directives to help upon. This importance allocation may be adjudged
on the comparative relationship with respect to other alike situations and value based
decisions. However, a set of rules requires to be established for a commonly followed
policy framework for wider acceptance and adherence.

Check Your Progress 10

A firm buys an office table for Rs. 800. Though it is, theoretically speaking, an asset
having a life, of more than one year, the firm shows it as an expense of the year, and
reduces the profit for the year. Is this accounting practice justifiable? Give reasons.
.........................................................................................................................................
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vii) Consistency Concept

Practically, there are various means to capture an accounting event in the firm’s
accounting books. For example, the trade discount received towards buying raw material
can be subtracted from cost of goods, thereby recording the net amount (post trade
discount reduction) or another way could be capturing the trade discount as ‘income’
while the whole cost (without trade discount) be entered. Other activities where the same
differential treatment is administered is while depreciation. “It is a decrease in the value
of assets caused by wear and tear, and passage of time” discussed concept, reiterates to
the accountant to follow and continue with one method or procedure for all similar
forthcoming events. However, the accountant has the prerogative of resorting to other
method on logical grounds.

The appreciable part of the accounting subject and its concepts is the ability of drawing
valid conclusions by utilizing the various reports pertaining to the accounting
information. It facilitates data comparison of data at specific intervals with even of
previous periods. This supports citing of differences and calls for the introspection of the
management for a timely corrective action. “Comparing like with the like” leads to
following of ongoing methods or procedures as any deviation in this regard may affect
the reported financial position of the firm. Also, this discussed inconsistency leads to the
scope of data manipulation and still to corrupt practices.

Check Your Progress 11

Depreciation is being done in a firm and it is being asked to be charged for a machine at
32 the rate of INR 15,000 per annum for the initial 3 yrs. Subsequently, it is to be
depreciated at INR 10,000 for the next two years. Thereafter, the depreciation is Accounting
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provisioned for INR 8,000 for the remaining years. Please share your thoughts on the Standards
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depreciation practice being followed here?
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2.4 ACCOUNTING STANDARDS

By now we have understood that the rules, conventions, concepts in the world of
accounting form the basic structure of accounting. We also have observed overlapping
and co-existence of these concepts. So for a coherent approach involving the best
practices followed internationally, one requires to be facilitated for equated comparison
and evaluation. This requires availability of the desired information at the right time with
the deployment of correct accounting methods. Practicing various accounting practices
leads to difficulty in comparing reports of the firms. Usage of alternative accounting
methods may even led to the non-uniformity of results in the same corporate entity but
separate business units.

2.4.1 Need for Accounting Standards: we all have understood by now that various
stakeholders require the published financial statements for taking the right investment
decisions in the firm. The Indian Companies Act specifies the various types of
information the companies require to disclose, report and publish via their financial
statements. The firm’s accountant or accounts professional owes this responsibility
towards timely and authentic financial information be presented. Since this publication is
in a standard and predefined format, discretion may not be allowed to tamper with the
format, methods and followed procedures. This results in the company’s goodwill
creation and reputation as a transparent, disciplined and consistent in authentic data
reporting. For example, one firm may have reported loss in its annual financial statements
but then also declares a dividend arising out of manipulation of numbers. The firm may
be able to retain its shareholders, lenders, suppliers and investors in short duration and
prevent share capital erosion but in the longer run this decision may prove devastating to
them.

We have understood by now, the importance of these financial reports to the investors,
shareholders and other beneficiaries. We also have agreed to the need of standardized
approach for reporting the financial statements for international coherence. Such financial
reports reveal the management’s competencies in allocating the scares resources in an
effective and efficient way. This calls for the availability and acceptance of widely
acceptable and appropriate standards for the unified benefit of the investor as well as the
nation. We have discussed the financial reporting requires data presentation in a
‘comparative way’ and be followed extensively by the industries. The stakeholder desires
transparency while reporting of financial statements and would certainly wouldn’t expect
any change in accounting methods. He banks on the firm’s management competencies
resulting in better allocation of resources yielding rich dividends. A prerogative to firms
let choose their own reporting stands would be chaotic both for the company but the
national economy too. It may lead to unplanned resource utilization leading to shortages.
So an approach of reporting fictitious profits by the less efficient companies to shift the
resources towards them in the shorter duration, which would result in its scarcity with the
more efficient companies thereby, making a coupling impact on both.

2.4.2 Benefits of Accounting Standards 33

Accounting System There are many benefits of accounting standards. Let us discuss the main benefits of
Accounting Standards one by one.
1) Standardized Accounting: Perhaps the most important advantage of the FASB
standard setting for businesses is the uniform set of accounting principles it promotes.
The FASB clearly states the generally-accepted accounting principles that businesses
must follow to avoid confusion. For example, the FASB prevents businesses from using
one method for calculating inventory at the beginning of a fiscal year and finishing the
year with another method. Without the accounting standards set forth by the FASB,
businesses could use accounting methods that portray financial data inaccurately to
investors.
2) Problem Identification: The FASB standard setting provides a framework upon
which potential accounting problems are identified and corrected. Because all businesses
in the US use the same accounting principles, any problems or inadequacies in the
accounting process are quickly identified and reported to the FASB. The FASB then
investigates the problem and, if needed, modifies or writes a new accounting rule for the
accounting process. For example, if businesses find that reporting a certain type of
liability on their income statement unfairly lowers their net income, they can appeal to the
FASB so that it can identify problems with the standard setting.
3) Private Regulation: The FASB is a private entity with no affiliation to the US
2.4.2government. Despite this, the Securities and Exchange Commission relies on the
FASB to set the accounting rules that all companies in the US must follow. The SEC can
technically create an accounting oversight board or government agency to set accounting
rules. However, using the FASB eases the burden on the US government and lets the
private sector dictate accounting rules
4) International Accounting Standard: The FASB is advantageous because it actively
promotes an internationally recognized set of accounting rules. Globalization has deeply
connected foreign financial markets; a standard set of accounting rules would make
financial reporting more accurate and fair between countries. One of the goals of the
FASB is to make financial reporting more uniform globally with the cooperation of the
International Accounting Standards Board (IASB)
2.4.3 Indian Accounting Standards scenario: Our nation is one of the leading
developing nations of the world and requires to match with the international standard
accounting practices being followed across the world. Another challenge is the wide
National demographic and geographic diaspora which further increases the need for a
harmonised accounting policies and practices across the country. Taking forward this
legacy is the Institute of Chartered Accountants of India (ICAI) formed the Accounting
Standards Board (ASB) in April 1977 with noted representation from the industry as well
as from the government. Its proposals for standards are vetted and circulated to external
agencies, including representative bodies of trade, commerce, and industry.

Since these standards are in recommendatory format in the proposal structure they are
suggested to be implemented by the stock exchange listed firms, corporate bodies,
institutions and other commercial bodies.

It is recommended to you that you study these standards and deliberate it to find out the
qualitative aspect of these accounting standards. More you would gain insights on the
structured rules, policies and procedures of accounting and the need for their
standardization. You may come cross hurdles in understanding few terminologies or
logical aspects of these standards but their understanding to you would open up new
thinking directions in your minds. The more you study the next units, the more you will
increase your inquisitiveness to study more about these accounting standards and the need
of the same in our country.

The implementation of these accounting standards in our country has been a challenge
since they were established without designing the theoretical framework. In the absence
of the latter it has been questioned on these accounting standards and principles proposed
34 to be implemented for lack direction and coherence. Other developed nations like UK and
USA also faced similar situation but they were swift to resolve such issues. The US Accounting
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develop a conceptual framework project through FASB and structurally intended to Standards
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define objectives of financial reporting. This led to suggesting of accounting concepts and
standards commonly known as “Generally Accepted Accounting Principles (GAAP). Any
attempt to develop a conceptual framework regarding the objectives of reporting will
have to take into consideration the answers to the following questions:
i) Who are the users of financial reports?
ii) What decisions do these user groups have to take?
iii) What information can be provided that would assist them to take such decisions?
The objectives, as you have already noted, depend upon the economic, social, legal and
political environment of the country.
Section 133 of Companies Act, 2013 requires the companies to comply with the
prevailing accounting standards. As on 1st April, 2021 there are 32 accounting standards
specified by ICAI, AS from 1-29 are mandatory and AS 30, 31 and 32 are non mandatory
and have been withdrawn.

Check your progress 12

Choose the most appropriate answer from the options given below:

1. The purpose of the International Accounting Standards Board is to:

a. issue enforceable standards which regulate the financial accounting
and reporting of multinational corporations.
b. develop a uniform currency in which the financial transactions of
companies through-out the world would be measured.
c. promote uniform accounting standards among countries of the world.
d. arbitrate accounting disputes between auditors and international
companies.
2. What is not a source of pressure that may influence the accounting
standard setting process?
35
Accounting System a. Congress.
b. Lobbyist.
c. CPA firms.
d. None of the above.
3. What is a possible danger if politics plays too big a role in accounting
standard setting?
a. Accounting standards that are not truly generally accepted.
b. Individuals may influence the standards.
c. User groups become active.
d. The FASB delegates its authority to elected officials.
4. What is not a reason that accounting standards may differ across countries?
a. Governments.
b. Language.
c. Culture.
d. Past Practice.
5. What would be an advantage of having all countries adopt and follow
the same accounting standards?
a. Consistency.
b. Comparability.
c. Lower preparation costs.
d. b and c

2.5 THE CHANGING NATURE OF GENERALLY

ACCEPTED ACCOUNTING PRINCIPLES

Primarily, it is the responsibility of the accounting professional to contribute towards the

development of internationally acclaimed standards. There are professional accounting
bodies like American Institute of Certified Public Accountants (AICPA) and Institute of
Chartered Accountants of India (ICAI) who have immensely contributed in framing the
“Generally Accepted Accounting Principles”. They came across many hindrances in form
of cultural, language and distance barriers, political and polito-socioeconomic
environment’s impact. This noted contribution was not only from the academic
knowledge pooling but in depth evaluation of the legal, regulatory and tax law framework
of the government. This led to the formulation of widely accepted accounting principles
being followed by various stock exchanges and other regulatory agencies like the
Securities and Exchange Board of India (SEBI) who have laid down rules for disclosure
and the extent of accounting information.

We all understand that the Business environment is evolves rapidly and its constituents of
political, economic and financial environments have individual as well as coupling effect
on the business. Thus the business operations require to keep abreast with the rapid
changes and their regular monitoring and evaluation for the continued relevance of
GAAP. So it means that the GAAP are also not standards but evolving standards being
developed with the changing business environments. So the business firms require to
continuously upgrading themselves with modifications in GAAP for developing and
reporting, generally acceptable financial statements with the stakeholders.

2.6 ATTEMPTS TOWARDS STANDARDISATION

Institute of Chartered Accountants in England and Wales had worked since 1942 towards
accounting framework standardization, the visible progress was observed with the
establishment of the Accounting Statements Committee (ASC). There was a non-
confirmatory stance of the public at large towards the applicable financial reporting
36 systems which were prerogatively having dissimilar practices resulting in reporting of
massive financial losses with some large investors. This led to the wealth erosion of Accounting
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large-cap companies leading the dire requirement of standardization in financial reporting Standards
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standards. So ASC started working on identifying the gap areas and narrow down on the
applicable to the standard best practices in the area of accounting and report making. For
this accountants from various companies were brought together to form a standardised
“Exposure Draft” on specific topics discussed. This was shared with the public at large,
seeking reviews and feedback for consideration. This made way for formulating a formal
statement of the accounting methods pertaining to individual accounting issues. These
statements were called “Statement of Standard Accounting Practice (SSAP).” Once
drafted, they were sent for adoption by the accounting profession. Such was the
importance and need of this practice that a notification was sent by Institute itself
signifying for the acceptance by the profession. By now, nineteen statements of standard
accounting practice, in addition to some exposure drafts under consideration, have been
issued by the ASC.

The US identified the need for setting the standards in 1933 when it formed the
“Securities Exchange Commission (SEC)”, a government agency. Its objective was to
regulate and controls the issuance of, and dealings in securities of the companies.
Thereafter, in 1957, a research-based entity, the Accounting Principles Boards (APB) got
established for framing fundamental accounting postulates. And in 1973, the Financial
Accounting Standards Board (FASB) was established with the responsibility of issuance
of statements and articulation of GAAP.it is important to mention here that the role of
SEC towards FASB pronouncements has given considerable credibility to its accounting
policy statement. The FASB has been issuing statements of concepts and financial
accounting standards regularly.

Standards at International Level: the globalization of the world trade across the
geographical borders and to capture new markets and resources, a rapid expansion in
business activities by thee global companies required accounting standardisation at the
international levels. An International Congress of Accountants was organised in 1972 at
Sydney, Australia for deliberating on bringing uniformity in the international accounting
practices, this resulted in the formation of ‘International Accounting Standards
Committee (IASC)’ and was provided with the responsibility of formulating international
standards. IASC’s member nations committed for conformance towards the IASC
standards. They also agreed to provide a critical review on these accounting standards.
This fast convergence for the international standards saw formation of another such
professional body named ‘International Federation of Accountants’ (IFAC) in 1978.

Other efforts towards contribution to the international accounting standards were

witnessed from other countries also. Europe saw foundation of “European Economic
Community (EEC)” while Canada also contributed for standardisation of accounting
practices regarding disclosure and consistency of procedures.

2.7 INTERNATIONAL FINANCIAL REPORTING

STANDARDS

In today’s globalized environment, business does not operate in just one country rather
they operate around the world. However, it must be emphasized that around the globe,
different countries follow different accounting standards. This leads to a need for a global
set of standards commonly referred to as ‘International Financial Reporting Standards
(IFRS)’. IFRS are designed to serve as a common global language of business affairs so
that accounts of various companies are understandable and comparable across
international boundaries. National accounting standards prevailing in different countries
are being replaced by these International Financial Reporting Standards.
37
Accounting System They are a set of standards formulated by International Accounting Standard Board
(IASB) defining the guidelines for the treatment to a financial transaction and reporting of
event in the accounting statements. They are a guiding set of principles and procedures
used to define the foundational parameters for various financial accounting policies and
practices.

The Finance profession is one of the fastest growing in the financial world. The
General Accepted Accounting Principles (GAAP) and International Financial
Reporting Standards (IFRS) are gaining momentum across many countries. Since
they account for much needed transparency of financial reporting across the
world. IFRS carried the responsibility of specifying on the ways various
businesses to follow should be maintaining and reporting their business accounts.
Created to establish a common accounting language, the goal of the international
financial reporting standards is to make financial statements coherent and
consistent across different industries and countries.
IFRS aims to serve as an enabler in the much needed task of comparing the
financial statements across the nations. This is a practically tedious task, as most
countries follow their individually followed set of standards. Say, the US, follows
US GAAP and India, has its version of Indian GAAP. So, it remains a challenge
to bring all such economically empowered nations on the same board.

2.7.1 Need for Convergence of IFRS

The IFRS (International Financial Reporting Standards) convergence has gained

momentum all over the world and India is no exception. As the world is going
global on a massive scale, the need for convergence seems all the way more
important. The needs for common acceptable standards have been felt the world
over and as of date, approximately 100 countries either have adopted fully or
have converged IFRS standards with their own standards. The ultimate goal of
convergence is to have common acceptable standards, which is practiced world
over ensuring transparency & utility of financial information.
Indian Scenario – The Institute of Chartered Accountants of India (ICAI)
develops Accounting Standards. India officially decided in 2007 to converge with
IFRS. The ICAI and IASB (International Accounting Standard Board) then
decided to work together, collaborate and develop quality and comparable
accounting standards instead of fully adopting the IFRS standards completely.
The ICAI decided to adopt IFRS and set the target period as April 2011 but
delayed implementation due to procedural and operational reasons. Finally, the
Ministry of Corporate affairs has announced the implementation of new standards
effective from 1ST April 2016 over a period of four years till 1st April 2019. All
applicable & existing standards would cease after the target date of
implementation. The Ministry of Corporate affairs have notified the
implementation dates as below.
 Listed Companies with more than 500 crores of net worth – 1st April 2016

 Listed Companies with more than 250 crores of net worth – 1stApril, 2017

 Banks, Insurance & Financial Service Companies – 1st April, 2019

The need for IFRS convergence in India is necessary due to the following
reasons:

 To ensure a general understanding of best accounting practices

 To make the financial statements reliable, comparable & transparent
 To standardize financial accounting & reporting across the globe
 To promote foreign Investment & spur Industrial growth
38  To eliminate information barriers for users of financial statements
 Accounting
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Benefits Standards
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1. Easy access to global financial capital markets – Indian companies
would be able to procure investments from abroad on cheaper favourable
terms, which in turn can fund their growth and expansion.
2. Cross Border trade & Investments – Indian firms following IFRS
would be able to do business by listing abroad and this would facilitate more
trade & investment in unrepresented geographies.
3. Eliminate differential reporting – Indian Companies having business
abroad would be able to do away with preparing separate financial
statements, as they would be following IFRS standards. This would reduce
duplicity in financial reporting & eliminate unnecessary reporting.
4. Improved quality & comparability of financial reporting – The
converged IFRS standards are of high quality, easily enforceable and globally
acceptable which in turn increases reliability & comparability. Lenders and
Investors will have more confidence in Indian businesses because of the
commonly followed Accounting standards & procedure thereby improving
trust & confidence.
5. Accounting Profession – Accountants & Finance persons working in
financial reporting domain would also benefit by highlighting their expertise
& talents abroad. They will be more competent to take up challenging global
roles worldwide.

2.7.2 Benefits and Challenges of IFRS

IFRS provides many benefits as far as reporting financial information is concerned.

Let us discuss those benefits in brief:
i) Minimises diversity in accounting practices
ii) Improves the quality and transparency of financial reporting process
iii) Increase the trust and reliance placed by investors, analysts and
stakeholders in a company’s financial statements
iv) Reduces the cost of conversion of financial statements for local
companies which make investments, raising capital and listing abroad
v) Provides a drive to cross border acquisition and partnership, alliance with
foreign entities as well as economic growth expands globally

It also suffers from many challenges. Let us discuss these challenges one by one

1. Training & Awareness – Many do not know the IFRS standards & lack of
knowledge & awareness makes it a difficult task of implementation. Finance
professionals will have to be adequately trained and then the standards can be
implemented consistently and uniformly in right spirit.
2. Changes in Indian regulation – Current regulations governing the financial
regulation would need a complete overhaul to implement the IFRS standards. The
Companies Act 1956, SEBI act 1992, IT Act 1962 etc. will have to be amended
to bring them in line with IFRS regulations. These legal hurdles are a major
constraint in the path of IFRS convergence.
3. Fair Value system of measurement – The IFRS considers the fair value
system of asset measurement and the Indian GAAP recognizes historical system.
This divergence of system would create volatility and subjectivity in financial
statements. This would lead to different results for performance & earnings of the
Company.
4. IT systems – Financial accounting software and tools used for reporting
would have to be completely changed resulting in substantial investment in IT
infrastructure for Indian Companies. Indian companies are habitually reluctant
when any proposal involves cost, time & effort.

39
Accounting System 5. Small & Medium businesses – The SME sector in India is comparatively
larger than other Countries. The cost of convergence far outweighs the
advantages of convergence for these small businesses. The dearth of resource and
skills in financial knowledge adds up to the problem of implementation in this
sector. In addition, SME’s cannot be ignored, considering the role they play in
the Indian economy.

Check Your progress 13

State whether the following statements are True/False:

1. IFRS includes both International Financial Reporting Standards and
International Accounting Standards.
2. International Financial Reporting Standards preceded International
Accounting Standards
3. The standard-setting structure used by the International Accounting
Standards Board is very similar to that used by the Financial Accounting
Standards Board.
4. The rules-based standards of IFRS are more detailed than the
simpler, principles-based standards of U.S. GAAP.
5. The International Accounting Standards Board issues International
Financial Reporting Standards.
6. International Accounting Standards are no longer considered part of
IFRS because they have been replaced by International Financial
Reporting Standards.

2.8 SUMMARY
Accounting is a fast emerging discipline and its development at the international
level also, has generated a lot of interest towards it. This subject has been
instrumental in providing a theoretical framework comprising of principles, rules,
concepts and guidelines from time to time. These guiding rules or principles
require to be widely practiced for bringing the interest from various account
professionals contribute towards its development hence the name, Generally
Accepted Accounting Principles (GAAP). Various initiatives for a coherent
approach across the countries have been endeavoured upon, underlining the need
for the accounting subject to support the international businesses.
These accounting principles are constituted with broad guidelines, wide variety of
methods and practices, making it easy for wider application and adoption.
However, the challenge remains in wide and uniform acceptability amongst the
companies. Since the accounting professionals and investors require comparing
the various financial reports of different companies, and each following their own
set of rules makes the comparison become a tedious task. There is always a risk
of under-reporting and concealing of facts and manipulated earnings, when there
is no standardization in recording and reporting of these accounting statements.
This lames the entire endeavour as the usefulness of the statements to the users.
Globally, the standardization of the accounting practices is well recognised with
many acclaimed institutions and professional entities are engaged in
standardising the accounting practices as a unified movement focussed to bring
international consensus. This requires a fact check of presently practiced ways by
the accountants and then seeks in the refinement of those worked practices by
motivating them to follow the standards (involving ironing their doubts or
resistance, if any) thereby building a sound theory of accounting. Indian context
has demonstrated significant progress in this direction with the adoption of
twenty eight standards for accounting practice. In today’s globalized
environment, business does not operate in just one country rather they operate
40 around the world. However, it must be emphasized that around the globe,
 different countries follow different accounting standards. This leads to a need for Accounting
Accounting
Conceptsand
andits
a global set of standards commonly referred to as ‘International Financial Standards
Functions
Reporting Standards (IFRS)’. IFRS are designed to serve as a common global
language of business affairs so that accounts of various companies are
understandable and comparable across international boundaries. Merits of IFRS
are as follows: i) Completeness, ii) Understandability, iii) Reliability, iv)
Timeliness, v) Neutrality, vi) Verifiability, vii) Consistency, viii) Comparability
and ix) Transparency. The challenges of IFRS are as follows: 1. Training &
Awareness, 2. Changes in Indian regulation 3. Fair Value system of
Measurement 4. IT System 5. Small & Medium businesses

2.9 KEY WORDS

Accounting framework includes generally accepted accounting principles (GAAP) on
the basis of which accounting data is processed, analysed, and reported.

Accounting theory is a set of inter-related principles and propositions, which provide a

general framework for accounting practice, and deal with new developments in the area.

Accrual concept says that an accountant should recognise incomes and expenses when
they have actually accrued, irrespective of whether cash is received or paid.
Consistency concept envisages that accounting information should be prepared on a
consistent basis from period to period, and within periods there should be consistent
treatment of similar items.

Conservatism concept forbids the inclusion of unrealised gains but advocates provision
for possible losses.

Cost Concept states that an asset is to be recorded in books of accounts at a price for, or
at a cost incurred to acquire it.

Entity concept separates the business from owner(s), from the standpoint of accounting.

Going concern concept refers to the expectation that the organisation will have an
indefinite life. This assumption has an important bearing on how the assets are to be
valued.
Materiality concept admonishes that events of relatively small importance need not be
given a detailed or theoretically correct treatment. They may be ignored for recording
purpose.

Money measurement concept states that all transactions are to be recorded only in
monetary terms and record only those transactions, which can be measured in money
terms. It ignores intangibles like employee loyalty and customer satisfaction, as they
cannot be expressed in money terms. It also assumes records on the basis of a stable
monetary unit.

Objectivity principle requires that only the information based on definite and verifiable
facts are to be recorded.

Periodicity concept divides the life of a business into smaller time periods which are
generally one year, and the accountant is supposed to prepare necessary financial
statements for each time period.

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Accounting System IFRS are designed to serve as a common global language of business affairs so that
accounts of various companies are understandable and comparable across international
boundaries.

2.10 ANSWER TO CHECK YOUR PROGRESS

1. Non-conformance or non-observance of ‘separate entity concept’

leads to issues in evaluating firm’s profitability and ascertaining its
financial health. The same problem gets complex when the owner
has many operating businesses firms.

2. Owner withdrawing leads to firm’s capital reduction unless it leads to

anticipated profits. It will not be correct to account such events as
operating expense. They also are not entitled for ‘deductions from
profits’ for tax purposes.

3. Yes, because as per the entity concept the business and the proprietor
are two separate entities. If the proprietor contributes some amount
towards capital, it means that the business has a liability to return it
to the proprietor.

4. No, the given concept doesn’t factors or allows recording such events
as this event’s business effect cannot be objectively evaluated.

5. Revaluation doesn’t matches to postulates of various accounting

concepts like, cost concept, conservatism concept, and continuity
concept. For factoring in the ‘extraordinary gain’ similar to this is
generally not seen ‘justified’. Still, a considerable difference occurs
in historical cost of a fixed asset and its prevailing market value, so it
is concluded that accounting profession be validating these
revaluations to enable the annual statements like the balance sheet
reflect the transparent and authenticated position of firm.

6. As per the cost concept, the company should show the value of
machinery in books of accounts at Rs. 40,000 the price, which is
being actually paid.

7. It should be taken into account, otherwise profit would get

exaggerated.

8. It should be taken into account, otherwise profit be undermined.

9. No. Since the order is not actually obtained, the probable sales
revenue could not be recognized as per the conservatism concept.

10. Though the table has a long-term life and as such can be shown as an
asset, yet the materiality concept requires it to be treated as an expense.

11. It infringes the consistency concept, until there exists a acceptable

and logical cause to shift from the earlier practiced process.
12. 1-c, 2-d, 3-a, 4-b, 5-d
13. i) True, ii) False, iii) True, iv) False, v) True, vi) False

2.11 SELF ASSESSMENT QUESTIONS/EXERCISES

42
1. Share your understanding on the “role of the Entity accounting concepts”Accounting
while Accounting
Conceptsand
andits
drafting the financial statements of a firm? Standards
Functions

2. Logically comment on your views whether accounting information is able to furnish

a transparent presentation about a firm’s financial health??

3. Explain whether you came across any conflicts in any of the accounting concepts?
Cite references to validate your stand?

4. Can the accounting information support in allocation of resources by the

management? Is yes, how?

5. Comment on the need for global standardization of the accounting

practices?

6. Mention your learnings on the contribution from India towards

standardization of the accounting practices especially the GAAP?

7. What do you mean by Accounting Standards? Explain the need for

issuing accounting standards in India.

8. What are the benefits of Accounting Standards and give a list of

mandatory Accounting Standards in India.

9. Briefly explain the following:

i) Conservatism Concept
ii) Full Disclosure Concept
iii) Accounting period Concept
iv) Matching Concept
v) Dual Aspect Concept
vi) Cost Concept
vii) Accrual Concept
viii) Materiality Concept
ix) Consistency Concept
x) Business entity Concept

10. What do you mean by International Financial Reporting Standards (IFRS)? Explain the
benefits and challenges of IFRS.

11. Discuss the need of Convergence of IFRS. Explain its benefits.

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