PUNJAB PATWARI ACCOUNTS NOTES ||Definition, Scope and Accounting Standards: Jaiib /DBF Paper 2 (Module B) Unit 1

Definition, Scope and Accounting Standards: Jaiib /DBF Paper 2 (Module B) Unit 1

 

                       ♦Accounting♦

  • Accounting often is called the language of business. The basic function of any language is to serve as a means of communication. In this, context, the purpose of accounting is to communicate or report the results of business operations and the financial health of the organization.

Features of Accounting

  • Accounting is an art of recording, classifying and summarising business transactions: it not only records the business transaction but also records them in an orderly manner. It also classifies business transactions according to their nature, before recording them in the books of account.
  • Accounting also summarises the data, recorded in books of account, and presents them in a systematic way, in the form of:
  1. Trial Balance
  2. Profit and loss account and
  3. Balance sheet
  • Accounting records the transactions it terms of money: Accounting records business transactions by expressing them in term of money. This makes the recorded data more meaningful. Events that cannot be expressed in money terms, are not recorded in the books of account.
  • Accounting records only the transactions of a financial Character
  • Accounting also interprets the financial data

Purpose and Objectives of Accounting

  • To Keep a systematic record
  • To Ascertain the result of the operations
  • To ascertain the financial position of the business
  • To facilitate rational decision- making
  • To satisfy the requirements of law (Companies Act, Societies Act, Public Trust Act etc and also compulsory under the Sales Tax Act and Income Tax Act)

Types of Accounting

  • Financial Accounting
  •  Cost Accounting
  • Management Accounting
  • Social Responsibility Accounting
  • Human Resource Accounting
  • Inflation Accounting

♦Accounting Standards in India and Its Definition and Scope

The Institute of Chartered Accountants of India (ICAI), recongnising the need to harmonise the diverse accounting policies and practices, constituted an ‘Accounting Standards Borad’ (ASB) on 21st April, 1977. The main function of the ASB is to formulate accounting standards so that the council of ICAI may mandate such standards.

  • ASB shall determine the broad areas in which accounting standards need to be formulated  and the priority about the selection thereof.
  • In the preparation of the accounting standards, the ASB will be assisted by study groups constituted to consider specific subjects. It will also hold a dialogue with the representatives of the government, public and private sector industries and other organisations, for ascertaining their views.
  • Based in the above, an exposure draft of the proposed standard will be prepared and issued to its members for comments and the public at large.
  • After taking into consideration the comments received, the exposure draft will be finalised by the ASB for submission to the council of ICAI.

A mandatory accounting standard, if not followed, requires the auditors, who are members of ICAI, to qualify their audit reports, failing which they will  be guilty of professional misconduct. Both the SEBI and Companies Act 2013 require auditors of qualify the audit reports that do not conform to mandatory accounting standards. Section 134(5) of the Companies Act 2013 also casts a responsibility on the board of directors to comply with mandatory accounting standards.

Under the Section 129(5) of the Companies Act 2013, where the financial statements do not comply with the accounting standards, such companies shall disclose the following:

  • The deviation from the accounting standards
  • The reasons for such a deviation
  • The Financial effects, of any arising out of such a deviation.

♦Accountancy Standards

The Institute of Chartered Accountants of India (ICAI) has so far issued twenty-nine standards:

  • (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 and Extraordinary Items and Changes in less Accounting Policies
  • (AS 6) Depreciation Accounting
  • (AS 7) Accounting for Construction Contracts
  • (AS 8) Accounting for Research and Development (deleted w.e.f. 1/4/2003)
  • (AS 9) Revenue Recognition
  • (AS 10) Accounting for Fixed Assets
  • (AS 11) Accounting for the Effects of Changes in Foreign Exchange Rates
  • (AS 12) Accounting for Government Grants
  • (AS 13) Accounting for Investments
  • (AS 14) Accounting for Amalgamations
  • (AS 15) Accounting for Retirement Benefits in the Financial Statements of Employers
  • (AS 16) Borrowing 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 Interest in Joint Ventures
  • (AS 28) Impairment of Assets
  • (AS 29) Provisions, Contingent Liabilities and Contingent Assets

Apart from these, there are 3 not mandatory Accounting Standards:

  • (AS 30) Financial Instruments; Recognition and Measurement
  • (AS 31) Financial Instruments; Presentation
  • (AS 32) Financial Instruments; Disclosures

♦Generally Accepted Accounting Principles of USA (US GAAP)

Generally accepted accounting principles, or GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.

U.S. law requires businesses that release financial statements to the public and companies that are publicly traded on stock exchanges and indices to follow GAAP guidelines, which incorporate 10 key concepts:

  • Principle of regularity: GAAP-compliant accountants strictly adhere to established rules and regulations.
  • Principle of consistency: Consistent standards are applied throughout the financial reporting process.
  • Principle of sincerity: GAAP-compliant accountants are committed to accuracy and impartiality.
  • Principle of permanence of methods: Consistent procedures are used in the preparation of all financial reports.
  • Principle of non-compensation: All aspects of an organization’s performance, whether positive or negative, are fully reported with no prospect of debt compensation.
  • Principle of prudence: Speculation does not influence the reporting of financial data.
  • Principle of continuity: Asset valuations assume the organization’s operations will continue.
  • Principle of periodicity: Reporting of revenues is divided by standard accounting time periods, such as fiscal quarters or fiscal years.
  • Principle of materiality: Financial reports fully disclose the organization’s monetary situation.
  • Principle of utmost good faith: All involved parties are assumed to be acting honestly.

GAAP compliance makes the financial reporting process transparent and standardizes assumptions, terminology, definitions, and methods. External parties can easily compare financial statements issued by GAAP-compliant entities and safely assume consistency, which allows for quick and accurate cross-company comparisons.

Because GAAP standards deliver transparency and continuity, they enable investors and stakeholders to make sound, evidence-based decisions. The consistency of GAAP compliance also allows companies to more easily evaluate strategic business options.

These three rules are:

  • Basic accounting principles and guidelines: These 10 guidelines separate an organization’s transactions from the personal transactions of its owners, standardize currency units used in reports, and explicitly disclose the time periods covered by specific reports. They also draw on established best practices governing cost, disclosure, going concern, matching, revenue recognition, professional judgment, and conservatism.
  • Rules and standards issued by the FASB and its predecessor, the Accounting Principles Board (APB): The FASB issues an officially endorsed, regularly updated compendium of principles known as the FASB Accounting Standards Codification. The compendium includes standards based on the best practices previously established by the APB. These organizations are rooted in historic regulations governing financial reporting, which were implemented by the federal government following the 1929 stock market crash that triggered the Great Depression.
  • Generally accepted industry practices: There is no universal GAAP model followed by all organizations across every industry. Rather, particular businesses follow industry-specific best practices designed to reflect the nuances and complexities of different areas of business. For example, banks operate using a different set of accounting and financial reporting methods than those used by retail businesses.

♦International Financial Reporting Standard (IFRS)

The International Financial Reporting Standards (IFRS) are accounting standards that are issued by the International Accounting Standards Board (IASB) with the objective of providing a common accounting language to increase transparency in the presentation of financial information.

What is IASB?

The International Accounting Standards Board (IASB), is an independent body formed in 2001 with the sole responsibility of establishing the International Financial Reporting Standards (IFRS). It succeeded the International Accounting Standards Committee (IASC), which was earlier given the responsibility of establishing the international accounting standards. IASB is based in London. It has also provided the ‘Conceptual Framework for Financial Reporting’ issued in September 2010 which provides a conceptual understanding and the basis of the accounting practices under IFRS.

The Principal Objective of the IFRS Foundation are:

  • To Develop a single set of high quality, understandable, enforceable and globally accepted International Financial Reporting Standards (IFRSs)  through its standard-setting body, the International Accounting Standard Board (IASB);
  • To promote the use and rigorous applications of those standard;
  • To take account of the financial reporting needs of emerging economics and small and medium-sized entities (SMEs); and
  • To promote and facilitate adoption of IFRSs, being the standards and interpretations issued by the IASB, through the convergence of national accounting standards and IFRSs.

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List of International Financial Reporting Standards (IFRS)

Standard No.  -Standard Title

  • IFRS 1-  First-time Adoption of International Financial Reporting Standards
  • IFRS 2- Share-based Payment
  • IFRS 3- Business Combinations
  • IFRS 4- Insurance Contracts
  • IFRS 5- Non-current Assets Held for Sale and Discontinue Operations
  • IFRS 6- Exploration and Evaluation of Mineral Resources
  • IFRS 7- Financial Instruments: Disclosures
  • IFRS 8- Operating Segments
  • IFRS 9- Financial Instruments
  • IFRS 10- Consolidated Financial Statements
  • IFRS 11- Joint Arrangements
  • IFRS 12- Disclosure of Interests in Other Entities
  • IFRS 13- Fair Value Measurement
  • IFRS 14- Regulatory Deferral Accounts
  • IFRS 15- Revenue from Contracts with Customers
  • IFRS 16- Leases
  • IFRS 17- Insurance Contracts
  • IAS 1- Presentation of Financial Statements
  • IAS 2- Inventories
  • IAS 7- Statement of Cash Flows
  • IAS 8- Accounting Policies, Changes in Accounting Estimates and Errors
  • IAS 10- Events after the Reporting Period
  • IAS 11- Construction Contracts
  • IAS 12- Income Taxes
  • IAS 16- Property, Plant, and Equipment
  • IAS 17- Leases
  • IAS 18- Revenue
  • IAS 19- Employee Benefits
  • IAS 20- Accounting for Government Grants and Disclosure of Government Assistance
  • IAS 21- The Effects of Changes in Foreign Exchange Rates
  • IAS 23- Borrowing Costs
  • IAS 24- Related Party Disclosures
  • IAS 26- Accounting and Reporting by Retirement Benefit Plans
  • IAS 27- Separate Financial Statements
  • IAS 28- Investments in Associates and Joint Ventures
  • IAS 29- Financial Reporting in Hyperinflationary Economies
  • IAS 32- Financial Instruments: Presentation
  • IAS 33- Earnings per Share
  • IAS 34- Interim Financial Reporting
  • IAS 36- Impairment of Assets
  • IAS 37- Provisions, Contingent Liabilities, and Contingent Assets
  • IAS 38- Intangible Assets
  • IAS 39- Financial Instruments: Recognition and Measurement
  • IAS 40- Investment Property
  • IAS 41- Agriculture

Differences between US GAAP and IFRS

1 j

♦Transfer Pricing

  • Transfer pricing is the method used to sell a product from one subsidiary to another within a company. This approach is used when the subsidiaries of a parent company are measured as separate profit centers. Transfer pricing impacts the purchasing behavior of the subsidiaries, and may have income tax implications for the company as a whole. Here are the key issues:
  • Revenue basis
  • Preferred customers
  • Preferred suppliers

Traditional Methods

  • Market rate transfer price. The simplest and most elegant transfer price is to use the market price. By doing so, the upstream subsidiary can sell either internally or externally and earn the same profit with either option. It can also earn the highest possible profit, rather than being subject to the odd profit vagaries that can occur under mandated pricing schemes.
  • Adjusted market rate transfer price. If it is not possible to use the market pricing technique just noted, then consider using the general concept, but incorporating some adjustments to the price. For example, you can reduce the market price to account for the presumed absence of bad debts, since corporate management will likely intervene and force a payment if there is a risk of non-payment.
  • Negotiated transfer pricing. It may be necessary to negotiate a transfer price between subsidiaries, without using any market price as a baseline. This situation arises when there is no discernible market price because the market is very small or the goods are highly customized. This results in prices that are based on the relative negotiating skills of the parties.
  • Contribution margin transfer pricing. If there is no market price at all from which to derive a transfer price, then an alternative is to create a price based on a component’s contribution margin.
  • Resale Price Methods: The Resale Price (RP) while similar to the Cost plus method, is found by working backwards from the transactions taking place at the next stage in the supply chain and is determined by subtracting an appropriate gross mark-up from the sale price, to an unrelated third party, with the appropriate gross margin being determined by examining the conditions, under which, the goods or services are sold and comparing the said transaction to other third party Transactions.
  • Cost-plus transfer pricing. If there is no market price at all on which to base a transfer price, you could consider using a system that creates a transfer price based on the cost of the components being transferred. The best way to do this is to add a margin onto the cost, where you compile the standard cost of a component, add a standard profit margin, and use the result as the transfer price.
  • Cost-based transfer pricing. Have each subsidiary transfer its products to other subsidiaries at cost, after which successive subsidiaries add their costs to the product. This means that the final subsidiary that sells the completed goods to a third party will recognize the entire profit associated with the product.