The Accounting Standards-setting Process The accounting standard setting, by its very nature, involves reaching an optimal balance of the requirements of financial information for various interest-groups having a stake in financial reporting. With a view to reach consensus, to the extent possible, as to the requirements of the relevant interest-groups and thereby bringing about general acceptance of the Accounting Standards among such groups, considerable research, consultations and discussions with the representatives of the relevant interest-groups at different stages of standard formulation becomes necessary. The standard-setting procedure of the ASB, as briefly outlined below, is designed in such a way so as to ensure such consultation and discussions: Identification of the broad areas by the ASB for formulating the Accounting Standards. Constitution of the study groups by the ASB for preparing the preliminary drafts of the proposed Accounting Standards. Consideration of the preliminary draft prepared by the study group by the ASB and revision, if any, of the draft on the basis of deliberations at the ASB. Circulation of the draft, so revised, among the Council members of the ICAI and 12 specified outside bodies such as Standing Conference of Public Enterprises (SCOPE), Indian Banks’ Association, Confederation of Indian Industry (CII), Securities and Exchange Board of India (SEBI), Comptroller and Auditor General of India (C& AG), and Department of Company Affairs, for comments. Meeting with the representatives of specified outside bodies to ascertain their views on the draft of the proposed Accounting Standard. Finalisation of the Exposure Draft of the proposed Accounting Standard on the basis of comments received and discussion with the representatives of specified outside bodies. Issuance of the Exposure Draft inviting public comments. Consideration of the comments received on the Exposure Draft and finalisation of the draft Accounting Standard by the ASB for submission to the Council of the ICAI for its consideration and approval for issuance. Consideration of the draft Accounting Standard by the Council of the Institute, and if found necessary, modification of the draft in consultation with the ASB. The Accounting Standard, so finalised, is issued under the authority of the Council Indian Accounting Standards on the following subjects have been issued: AS 1 Disclosure of Accounting Policies AS 2 Valuation of Inventories AS 3 Cash Flow Statements AS 4 Contingencies and Events Occurring after the Balance Sheet Date AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies AS 6 Depreciation Accounting AS 7 Construction Contracts AS 8 Accounting for Research and Development (Withdrawn pursuant to becoming mandatory) AS 9 Revenue Recognition AS 10 Accounting for Fixed Assets AS 11 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 Employee Benefits AS 16 Borrowing Costs AS 17 Segment Reporting AS 18 Related Party Disclosures AS 19 Leases AS 20 Earnings per Share AS 21 Consolidated Financial Statements AS 22 Accounting for Taxes on Income AS 23 Accounting for Investments in Associates in Consolidated Financial Statements AS 24 Discontinuing Operations AS 25 Interim Financial Reporting AS 26 Intangible Assets AS 27 Financial Reporting of Interests in Joint Ventures AS 28 Impairment of Assets AS 29 Provisions, Contingent Liabilities and Contingent Assets AS 30 Financial Instruments: Recognition and Measurement AS 31 Financial Instruments: Presentation Accounting Standard 1: Disclosure of Accounting Policies Significant Accounting Policies followed in preparation and presentation of financial statements should form part thereof and be disclosed at one place in the financial statements. Any change in the accounting policies having a material effect in the current period or future periods should be disclosed. The amount by which any item in financial statements is affected by such change should be disclosed to the extent ascertainable. If the amount is not ascertainable the fact should be indicated. If fundamental assumptions (going concern, consistency and accrual) are not followed, fact to be disclosed. Major considerations governing selection and application of accounting policies are i) Prudence, ii) Substance over form and iii) Materiality. The ICAI has made an announcement that till the issuance of Accounting Standards on (i) Financial Instruments : Presentation, (ii) Financial Instruments : Disclosures and (iii) Financial Instruments : Recognition and Measurement, an enterprise should provide information regarding the extent of risks to which an enterprise is exposed and as a minimum, make following disclosures in its financial statements: a. category-wise quantitative data about derivative instruments that are outstanding at the balance sheet date, b. the purpose, viz. hedging or speculation, for which such derivative instruments have been acquired, and c. the foreign currency exposures that are not hedged by a derivative instrument or otherwise. This announcement is applicable in respect of financial statements for the accounting period(s) ending on or after March 31, 2006. Accounting Standard 6: Depreciation Accounting Standard does not apply to depreciation in respect of forests, plantations and similar regenerative natural resources, wasting assets including expenditure on exploration and extraction of minerals, oils, natural gas and similar non-regenerative resources, expenditure on research and development, goodwill and livestock. Special considerations apply to these assets. Allocate depreciable amount of a depreciable asset on systematic basis to each accounting year over useful life of asset. Useful life may be reviewed periodically after taking into consideration the expected physical wear and tear, obsolescence and legal or other limits on the use of the asset. Basis for providing depreciation must be consistently followed and disclosed. Any change to be quantified and disclosed. A change in method of depreciation be made only if required by statute, for compliance with an accounting standard or for appropriate presentation of the financial statements. Revision in method of depreciation be made from date of use. Change in method of charging depreciation is a change in accounting policy and be quantified and disclosed. In cases of addition or extension which becomes integral part of the existing asset depreciation to be provided on adjusted figure prospectively over the residual useful life of the asset or at the rate applicable to the asset. Where the historical cost undergoes a change due to fluctuation in exchange rate, price adjustment etc. depreciation on the revised unamortised amount should be provided over the balance useful life of the asset. On revaluation of asset depreciation should be based on revalued amount over balance useful life. Material impact on depreciation should be disclosed. Deficiency or surplus in case of disposal, destruction, demolition etc. be disclosed separately, if material. Historical cost, amount substituted for historical cost, depreciation for the year and accumulated depreciation should be disclosed. Depreciation method used should be disclosed. If rates applied are different from the rates specified in the governing statute then the rates and the useful life be also disclosed. Accounting Standard 9: Revenue Recognition Standard does not deal with revenue recognition aspects of revenue arising from construction contracts, hire-purchase and lease agreements, government grants and other similar subsidies and revenue of insurance companies from insurance contracts. Special considerations apply to these cases. Revenue from sales and services should be recognised at the time of sale of goods or rendering of services if collection is reasonably certain; i.e., when risks and rewards of ownership are transferred to the buyer and when effective control of the seller as the owner is lost. In case of rendering of services, revenue must be recognised either on completed service method or proportionate completion method by relating the revenue with work accomplished and certainty of consideration receivable. Interest is recognised on time basis, royalties on accrual and dividend when owner’s right to receive payment is established. Disclose circumstances in which revenue recognition has been postponed pending significant uncertainties. Accounting Standard 10: Accounting for Fixed Assets Fixed asset is an asset held for producing or providing goods and/or services and is not held for sale in the normal course of the business. Cost to include purchase price and attributable costs of bringing asset to its working condition for the intended use. It includes financing cost for period up to the date of readiness for use. Self-constructed assets are to be capitalised at costs that are specifically related to the asset and those which are allocable to the specific asset. Fixed asset acquired in exchange or part exchange should be recorded at fair market value or net book value of asset given up adjusted for balancing payment, cash receipt etc. Fair market value is determined with reference to asset given up or asset acquired. Revaluation, if any, should be of class of assets and not an individual asset. Basis of revaluation should be disclosed. Increase in value on revaluation be credited to Revaluation Reserve while the decrease should be charged to P & L A/c. Goodwill should be accounted only when paid for. Assets acquired on hire purchase be recorded at cash value to be shown with appropriate note about ownership of the same. (Not applicable for assets acquired after 1st April, 2001 in view of AS 19 – Leases becoming effective). Gross and net book values at beginning and end of year showing additions, deletions and other movements, expenditure incurred in course of construction and revalued amount if any be disclosed. Assets should be eliminated from books on disposal/when of no utility value. Profit/Loss on disposal be recognised on disposal to P & L statement. Amounts of earnings used as numerator for computing basic and diluted EPS and their reconciliation with Profit and Loss statement are disclosed. Also, the weighted average number of equity shares used in calculating the basic EPS and diluted EPS and the reconciliation between the two EPS is to be disclosed. Nominal value of shares is disclosed along with EPS. It has been clarified that if an enterprise discloses EPS for complying with requirements of any source or otherwise, should calculate and disclose EPS as per AS 20. Disclosure under Part IV of Schedule VI to the Companies Act, 1956 should be in accordance with AS 20 (ASI- 12). Note: Earnings Per Share apply to the enterprise whose equity shares and potential equity shares are listed on a recognised stock exchange. If the enterprise is not so covered but chooses to present EPS, then it should calculate EPS in accordance with the standard. Ethics in Accounting Ethics in accounting is of utmost importance to accounting professionals and those who rely on their services. Certified Public Accountants (CPAs) and other accounting professionals know that people who use their services, especially decision makers using financial statements, expect them to be highly competent, reliable, and objective. Those who work in the field of accounting must not only be well qualified but must also possess a high degree of professional integrity. A professional's good reputation is one of his or her most important possessions. The general ethical standards of society apply to people in professions such as medicine and accounting just as much as to anyone else. However, society places even higher expectations on professionals. People need to have confidence in the quality of the complex services provided by professionals. Because of these high expectations, professions have adopted codes of ethics, also known as codes of professional conduct. These ethical codes call for their members to maintain a level of self-discipline that goes beyond the requirements of laws and regulations. CODES OF ETHICS By joining their professional organizations, people who work in the field of accounting agree to uphold the high ethical standards of their profession. Each of the major professional associations for accountants has a code of ethics. The Code of Professional Conduct of the American Institute of CPAs (AICPA), the national professional association for CPAs, sets forth ethical principles and rules of conduct for its members. The principles are positively stated and provide general guidelines that CPAs (or any professionals, for that matter) should strive to follow. The rules of conduct are much more explicit as to specific actions that should or should not be taken. The Institute of Management Accountants (IMA) Standards of Ethical Conduct applies to practitioners of management accounting and financial management, and the Institute of Internal Auditors (IIA) Code of Ethics applies to its members and to Certified Internal Auditors (CIAs). ETHICAL RESPONSIBILITIES A distinguishing mark of professions such as medicine and accounting is acceptance of their responsibilities to the public. The AICPA Code of Professional Conduct describes the accounting profession's public as consisting of "clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of CPAs to maintain the orderly functioning of commerce." Many, but not all, CPAs work in firms that provide accounting, auditing, and other services to the general public; these CPAs are said to be in public practice. Regardless of where CPAs work, the AICPA Code applies to their professional conduct, although there are some special provisions for those in public practice. Internal auditors, management accountants, and financial managers most commonly are employees of the organizations to which they provide these services; but, as professionals, they, too, must also be mindful of their obligations to the public. The responsibilities placed on accounting professionals by the three ethics codes and the related professional standards have many similarities. All three require professional competence, confidentiality, integrity, and objectivity. Accounting professionals should only undertake tasks that they can complete with professional competence, and they must carry out their responsibilities with sufficient care and diligence, usually referred to as due professional care or due care. The codes of ethics of the AICPA, IMA, and IIA all require that confidential information known to accounting professionals not be disclosed to outsiders. The most significant exception to the confidentiality rules is that accounting professionals' work papers are subject to subpoena by a court; nothing analogous to attorney-client privilege exists. INDEPENDENCE Maintaining integrity and objectivity calls for avoiding both actual and apparent conflicts of interest. This notion is termed independence. Being independent in fact and in appearance means that one not only is unbiased, impartial, and objective but also is perceived to be that way by others. While applicable to all accounting professionals, independence is especially important for CPAs in public practice. The AICPA's rules pertaining to independence for CPAs who perform audits are detailed and technical. For instance, a CPA lacks independence and thus may not audit a company if he or she (or the spouse or dependents) owns stock in that company and/or has certain other financial or employment relationships with the client. ETHICS ENFORCEMENT To a large extent, the accounting profession is self-regulated through various professional associations rather than being regulated by the government. The AICPA, the IMA, and the IIA have internal means to enforce the codes of ethics. Furthermore, the professional organizations for CPAs in each state, known as state societies of CPAs, have mechanisms for enforcing their codes of ethics, which are usually very similar to the AICPA Code. Violations of ethical standards can lead to a person's being publicly expelled from the professional organization. Because of the extreme importance of a professional accountant's reputation, expulsion is a strong disciplinary measure. However, ethical violations can lead to even more adverse consequences for CPAs because of state and federal laws. The state government issues a CPA's license to practice, usually through an organization known as the state board of accountancy. Since state laws governing the practice of accountancy typically include important parts of the AICPA Code, the Code thus gains legal enforceability. Consequently, ethical violations can result in the state's revoking a CPA's license to practice on a temporary or even permanent basis. Because a licensed CPA is also likely to belong to the AICPA and the state society of CPAs, investigations of ethics violations may be carried out jointly by the AICPA, the state society, and the state board of accountancy. CPAs in public practice who audit the financial statements of public corporations are subject to federal securities laws and regulations, including the Securities Exchange Act of 1934. The Securities and Exchange Commission (SEC), which administers these laws, has broad powers to regulate corporations that sell their stock to the public. One important SEC requirement is that these corporations' financial statements be audited by an independent CPA. The SEC has the authority to establish and enforce auditing standards and procedures, including what constitute independence for a CPA. The SEC has largely delegated standard setting to the private sector but retains oversight and enforcement responsibilities. In 1998 the SEC and the AICPA jointly announced the creation of the Independence Standards Board (ISB), a private-sector body whose mission is to improve auditor independence standards.