AS 1 refers to the disclosure of accounting policies. It states that an enterprise needs to disclose significant accounting policies followed by it to prepare and present its financial statements.
This is because a business entity’s state of affairs gets significantly impacted by the accounting policies used in preparing its financial statements.
Typically, every enterprise follows accounting policies appropriate to its own business as well as industry. Thus, an enterprise mandatorily needs to disclose its significant accounting policies in order to present a true and fair view of its state of affairs.
Current Practices Followed in Disclosing the Accounting Policies
Disclosure Required by Law
Sometimes, law requires a business entity to disclose certain accounting policies followed by it in order to prepare and present financial statements. In such cases, the entity needs to necessarily disclose these accounting policies.
Disclosure Required by ICAI
Institute of Chartered Accountants of India (ICAI)) has been issuing notifications over a period of time recommending disclosure of certain accounting policies.
Thus, an enterprise following such accounting policies while preparing its financial statements needs to disclose these policies necessarily.
For example, translation policies in respect of foreign currency items.
Disclosure in Annual Reports to Shareholders
Few enterprises in India include a separate statement showcasing their accounting policies used to prepare their financial statements.
Thus, an enterprise can even include a separate statement reflecting its accounting policies. However, such a statement must be included in the annual reports to the shareholders of the enterprise.
Disclosure of Accounting Policies not Fully Disclosed
It has been witnessed that the accounting policies at present are not disclosed in the financial statements regularly and fully. Many enterprises prefer inserting descriptions pertaining to the important accounting policies in the notes to their financial statements.
The enterprises can follow such a practice. However, the nature and degree of such a disclosure varies immensely. It varies between corporate and non – corporate sectors as well as the units in the same sector.
Disclosure in case of Enterprises including a Separate Statement of Accounts
A wide variation pertaining to the nature and degree of disclosure also exists. The variation exists especially among those enterprises that include a separate statement of accounting policies in their annual reports presently.
In such cases, there are few firms that include such a separate statement of accounting policies in their books of accounts. While others give such details in the form of supplementary information.
Purpose of Disclosure of Accounting Policies
The very purpose behind giving a statement of accounting policies is to encourage better understanding of the financial statements. Further, it also helps in facilitating more meaningful comparison between financial statements of various companies.
Thus, a separate accounting standard on Disclosure has been established to achieve these objectives. This accounting standard promotes the disclosure of accounting policies. Further, it also describes the manner in which such accounting policies need to be disclosed in the financial statements.
Is there a Need to Disclose Fundamental Accounting Assumptions?
Usually, an enterprise need not specifically state or disclose the fundamental accounting assumptions followed in preparing its financial statements.
However, it needs to disclose such assumptions only if it fails to follow them while preparing its financial statements.
Following are the generally accepted fundamental accounting assumptions followed while preparing financial statements:
1. Going Concern
Generally, an enterprise is assumed to be a going concern. This means the enterprise continues to operate for the foreseeable future.
In other words, it is assumed that an enterprise neither intends nor is necessarily required to liquidate or cut down its scale of operations significantly.
According to this assumption, the accounting policies followed by an enterprise to prepare its financial statements are consistent across different periods.
As per this assumption, the revenues and costs are recognized as they are earned or incurred rather than when money is received or paid. Such accrued revenues or costs recorded in the financial statements concern to the periods to which they relate.
Nature of Accounting Policies
Meaning of Accounting Policies
The term ‘accounting policies’ in AS 1 refer to the following while preparing financial statements an enterprise:
- specific accounting principles
- methods to apply those accounting principles
No Standardized List of Accounting Policies
There is no standardized list of accounting principles applicable to varied circumstances experienced by different enterprises.
Thus, varied accounting principles and methods to apply to those principles are followed by different enterprises. These enterprises operate in a diverse and complex environment of economic activity.
So, the management of each enterprise has to make considerable amount of judgement at its own level. This is done in order to choose an appropriate set of accounting principles and methods to apply those principles in specific circumstances faced by each of them.
Number of Alternative Accounting Policies Reduced
ICAI as well as other regulatory bodies have made efforts to reduce the number of alternative accounting policies to be followed in preparing financial statements. These efforts have been made, particularly in the case of corporate enterprises.
However, the possibility to completely eliminate the availability of the alternative accounting principles and the methods to apply those principles is not likely. This is because each enterprise has to encounter different circumstances under different conditions.
Areas in which Different Accounting Policies are Encountered
Following are the areas where different accounting policies may be adopted by different enterprises:
- Methods of depreciation, depletion and amortization
- Treatment of expenditure during construction
- Conversion or translation of foreign currency items
- Valuation of inventories
- Treatment of goodwill
- Valuation of investment
- Treatment of retirement benefits
- Recognition of profit on long-term contracts
- Valuation of fixed assets
- Treatment of contingent liabilities
However, the above list is not an exhaustive list.
What are the Considerations to Keep in mind While Selecting Accounting Policies?
The basic consideration while selecting accounting policies to prepare financial statements is that such policies should represent a true and fair view the company’s affairs. This also includes presenting true and fair view of the profit or loss earned by a business enterprise at the closing date.
Besides this primary consideration, there are a few major considerations to be kept in mind while selecting accounting policies. These include:
An enterprise cannot forecast its profits keeping in mind the uncertainty related to the future events. Instead, it can only recognize the profits when they are realized.
Further, such recognized profits are not necessarily realized in cash. In addition to this, an enterprise also creates a provision for all known liabilities and losses.
This is despite the fact that the amount of such liabilities and losses cannot be determined with certainty. Thus, it means that such a provision represents only a best estimate of such liabilities and losses according to the information available.
2. Substance over Form
As per this consideration, the accounting treatment and presentation of transactions and events in the financial statements must be governed by their substance.
This means merely the legal form of accounting treatment and presentation of such events in the financial statements should not be considered.
The financial statements should disclose all the material items. The material items are the ones that influence the decisions of the financial statement users once they become aware of such items.
Disclosure of Accounting Policies
- It is necessary to disclose all the significant accounting policies adopted while presenting & preparing financial statements. This is done to ensure proper understanding of financial statements.
- The disclosure of significant accounting policies should form part of the financial statements.
- Disclosure of accounting policies must be made in one place as it helps the financial statement users in reading such statements. Such a disclosure should not be made in a way that it is scattered over several statements, schedules and notes.
- An enterprise should disclose any change in an accounting policy that has a material effect. Further, the enterprise should also disclose the amount by which any item in the financial statements is affected by such a material change. Such an amount needs to be disclosed to the extent ascertainable. However, only the fact of such a material change needs to be indicated where such amount is not ascertainable wholly or partly. On the other hand, there might be cases where a change in the accounting policies does not have a material impact on the current period’s financial statements. But are reasonably expected to have a material impact in later periods. In such cases, an enterprise needs to disclose the fact of such a change in the period in which the change is adopted.
- A business entity needs to keep in mind that a disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item in the accounts.