ACCOUNTING STANDARDS

The Institute of Chartered Accountants of India (ICAI) being the premier accounting body in the country had set up the Accounting Standards Board (ASB) on 21st April, 1977, with key objective of formulating Accounting Standards to harmonise varied accounting policies. ICAI being the associate member of the International Accounting Standards Committee and full-fledged member of the International Federation of Accountants decided to consider the International Accounting Standards while formulating Accounting Standards and try to integrate them to the extent possible in the light of the local laws and regulations. Apart from playing sheet anchor role in standard-setting in the country, the ASB plays an active role in international standard-setting by participating in various international accounting forums.

Accounting Standards are defined as written statements of accounting rules or guidelines or practices for preparing the uniform or consistent financial statements and for other disclosures affecting the users of accounting information.

Accounting Standards are therefore written policy documents issued by expert accounting body or by Government of its regulatory body (e.g. Securities and Exchange Board of India) covering such aspects as recognition (Meaning) Measurement, Presentation and disclosure of accounting transaction in financial statements. Accounting Standards are therefore the codified accounting principles.

Accounting Standards consist of detailed rules to be adopted for treatment of various items in accounting before the financial reports are presented to the internal or external users. The purpose or focus of accounting standards is to convey the same meaning of any accounting concept to all people in the same sense so that uniformity and compatibility in financial reporting is achieved.

AS 1,  Disclosure of Accounting Policies

Disclosure of Accounting Policies

To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Such disclosure should form part of the financial statements. 

Accounting Policies refer to the specific accounting principles and methods of applying those principles adopted by the enterprise in the preparation and presentation of financial statements.

Disclosure of accounting policies or of changes therein cannot remedy wrong or inappropriate treatment of the item in the books of accounts.

Consideration in Selection of Accounting Policies

Primary Consideration-Financial statements should represent true and fair view

Major considerations in achieving the primary consideration

1. Prudence
2. Substance over form
3. Materiality

1. Fundamental Accounting

                Assumptions - Disclose  if not followed

1. Going Concern
2. Consistency
3. Accrual

Change in an Accounting Policy 

Disclose change which has material effect in the current period or is reasonably expected to have material impact in later periods. 

In case of change which has material effect in the current period, disclose, to the extent ascertainable, the amount by which any item in the financial statements is affected by such change.

 If not ascertainable, wholly or in part, indicate the fact.

AS  - 2  Valuation of Inventories

This Standard deals with the determination of value at which inventories are carried in the financial statements, including the ascertainment of cost of inventories and any write-down thereof to net realisable value.

INVENTORIES-

Inventories are assets: 

1. held for sale in the ordinary course of business; 
2. in the process of production for such sale; or
3. in the form of materials or supplies to be consumed in the production process or in the rendering of services classified-

• goods purchased and held for resale e.g. merchandise, computer software or land and other property held for resale;
•  finished goods produced or
•  work-in-progress being produced by the enterprise and include materials, maintenance supplies, consumables and loose tools to be used in the production process.

 

But does not include –

1. spare parts
2. servicing equipment
3. standby equipment

As these are covered in the definition of PPE as per AS 10.

VALUATION RULE-

COST

OR

NET REALIZABLE VALUE

Whichever is less

• Meaning of NET REALIZABLE VALUE-

 Estimated selling price - the estimated costs of completion and the estimated costs necessary to make the sale 

Assessment to be made at each balance sheet date

Other terms & terminologies-

Cost of Inventories

Cost of inventories include cost of conversion of raw material to finished goods , other direct costs related to the production of finished goods.

Costs of purchase

• Purchase price excluding trade discounts, rebates, etc.
• Duties and indirect taxes other than refundable duties and taxes 
• Freight inwards, carriage inwards
• Other expenditure directly attributable to the acquisition

Costs of conversion

 Allocation of fixed production overheads based on normal capacity 

Variable production overheads assigned to each unit of production on the basis of the actual use of production facilities

Exclusions

• Abnormal wastage 
• Storage costs unless necessary in the production process prior to a further production stage
• Selling and Distribution costs
• Administrative overheads that do not contribute to bringing the inventories to their present location and condition
• Unallocated overheads
• Interest and other borrowing costs are usually not related to bringing the inventories to their present location and condition and hence usually not included in the cost of inventories

Exception-

Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost.

Cost formulas: AS -2 (Revised) then mentions various formulas for determining the historical cost such as

1. Specific identification of cost,
2.  First-in-First-out (FIFO) and
3.  Weighted average cost.

Cost Formulas:

The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs.

For other inventories, cost can be assigned by using the first-in, first-out (FIFO), or weighted average cost formula, whichever reflects the fairest possible approximation to the cost incurred in bringing the inventories to their present location and condition.

Nature of the standard:

AS-2 (Revised) is mandatory in nature.

 It implies that it is the duty of the auditor to examine whether this accounting standard is complied with in the presentation of financial statements covered by their audit. In the event of any deviation from this accounting standard, it will be their duty to make adequate disclosures in their audit reports so that the users of financial statements may be aware of such deviations.

Excluded inventories (not dealt with by AS 2)

1. work in progress arising under construction contracts
2. work in progress arising in the ordinary course of business of service providers
3. shares, debentures and other financial instruments held as stock-in-trade
4. producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realisable value in accordance with well-established practices in those industries

AS 9 - Revenue Recognition

This Standard deals with the bases for recognition of revenue in the Statement of Profit and Loss of an enterprise. The Standard is concerned with the recognition of revenue arising in the course of the ordinary activities of the enterprise from:

a) Sale of goods

 b) Rendering of services

c) Interest, royalties and dividends

Meaning of Revenue-

Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends.

Measurement

• Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. 
• In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.

 This standard, therefore does not apply to:

1. Revenue arising from construction contracts
2.  Revenue arising from hire-purchase, lease agreements
3.  Revenue arising from government grants and other similar subsidies
4. Revenue of insurance companies arising from insurance contracts.

 

Recognition criteria

  i) Sale of goods

a) Property in goods or significant risks and rewards of ownership have been transferred

 b) No effective control is retained in the goods transferred by the seller to a degree usually associated with ownership

 c) No significant uncertainty exists regarding the amount of the consideration

At the time of performance it should not be unreasonable to expect ultimate collection.

      ii) Rendering of services

a) Performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished.

b) No significant uncertainty exists regarding the amount of the consideration

 

At the time of performance it should not be unreasonable to expect ultimate collection.

FOR RENDERING OF SERVICES

 

AS - 9 provides that revenue from service transactions is usually recognised as the service is performed e.g. when the railways move the goods to the given destination, the service is performed. The performance of service is measured by two methods, namely:

 

• Completed service contract

Completed service contract method is a method of accounting which recognises revenue in the Statement of Profit and Loss only when the rendering of services under a contract is completed or substantially completed.

• Proportionate completion method

Proportionate completion method is a method of accounting which recognises revenue in the Statement of Profit and Loss proportionately with the degree of completion of services under a contract.

 

Revenue arising from the use by others of enterprise resources yielding:

• Interest - Time proportionate basis

• Royalty - Accrual basis (consider terms of agreement)

• Dividend - When right to receive dividend is established

Recognise revenue when no significant uncertainty as to measurability or collectability exists.

EXCLUSION FROM AS- 9

The following items are not included within the definition of "revenue" for the purpose AS-9:

1. Realised gains resulting from the disposal of, and unrealised gains resulting from the holding of, non-current assets e.g. appreciation in the value of fixed assets;
2.  Unrealised holding gains resulting from the change in value of current assets, and the natural increases in herds and agricultural and forest products;
3.  Realised or unrealised gains resulting from changes in foreign exchange rates and adjustments arising on the translation of foreign currency financial statements;
4.  Realised gains resulting from the discharge of an obligation at less than its carrying amount;
5. Unrealised gains resulting from the restatement of the carrying amount of an obligation

 

Examples

1. Recognition of revenue when delivery is delayed at buyer's request:

          When the delivery of goods is delayed at the specific request of the buyer but the buyer takes title and accepts billing, the revenue should be recognised                     immediately. However, the goods must be on hand, identified and ready for delivery to the buyer at the time of revenue recognition.

2.  Revenue recognition when goods are delivered subject to conditions:

a) Installation and inspection:

   In this case revenue should be recognised. When goods are installed at customer's place to his satisfaction and the goods are inspected and accepted by the              customer.

b) Sale on approval:

Revenue should be recognised only when the buyer formally confirms the acceptance of the goods or when the time period for rejection has elapsed or where no time has been fixed, a reasonable time has elapsed.

c) Guaranteed sales (money back sales):

In guaranteed sales, delivery is made giving the buyer an unlimited right of return. In such cases, revenue recognition would depend on the substance of the agreement. In retail sales offering a guarantee of "money back if not completely satisfied", sale should be recognised immediately, and a suitable provision for returns should be made on the basis previous experience.

d) Consignment sales:

Revenue should be recognised only when the goods are sold to a third party

e)  Cash on delivery sales:

Revenue should be recognised only when the cash in received by the seller or his agent. Examples are: Value Payable Post (V. P. P.) sales, documents through bank sales.

f) Warranty sales:

Revenue should be recognised immediately but provision should be made to cover unexpired warranty.

g)  Where the purchaser makes a series of instalment payments to the seller and the seller delivers the goods only when the final payment is received:

Revenue should not be recognised until goods are delivered. However, when experience indicates that most such sales have been consummated (completed), revenue may be recognised when a significant deposit is received. It is clarified that entire revenue should be recognised on receipt of significant deposit. and not merely revenue proportionate to deposit.

h) Special order and shipments:

Where payment is received for goods not presently held in stock, e.g., the goods are to be manufactured or are to be delivered directly to the consumer from a third party. Revenue from such sales should be recognised only when the goods are manufactured, identified and ready for delivery to the buyer by the third party.

i) Sales to intermediate parties:

It means the goods sold to distributors, dealers or others for sale. Revenue from such sale can generally be recognised if significant risks of ownership have passed; however if the buyer is, in substance, an agent, in such cases the sale should be treated as a consignments sale.

j) Subscriptions for publications:

Revenue received or billed should be deferred and recognised either on a straight line basis over time or, where the items delivered vary in value from period to period, revenue should be based on the sales value of the item delivered in relation to the total sales value of all items covered by the subscription.

k)  Instalment sales:

When the consideration is receivable in instalments, revenue attributable to the sales price exclusive of interest should be recognised at the date of sale. The interest element should be recognised asrevenue, proportionately to the unpaid balance due to the seller.

l) Trade discounts and volume rebates:

Trade discounts and volume rebates received are not included within the definition of revenue, since they represent a reduction of cost. Trade discounts and volume rebates given should be deducted in determining revenue.

Some examples are given below:

1. Installation fees:

      Revenue should be recognised when the equipment is installed and accepted by the customer.

2. Advertising and insurance agency commission:

Revenue should be recognised when the service is complete Advertising or media commission will be recognised only when the advertisement or commercial appears before the public. Insurance-commission should be recognised '. on the effective corrfrnencernent or renewal dates of the related policies.

3. Financial service commission:

A financial service may be rendered as a single act or may be provided over a period of time. Similarly, charges for such services may be made as a single amount or in stages over the period of the service or the life of the transaction to which it relates: Such charges may be settled in full when made, or added to a loan or other account and settled in stages. The recognition of such revenue should therefore have regard to:

(a) whether the service has been provided "once and for all" or is on a "continuing" basis;

(b) the incidence of the costs relating to the service;

(c) when the payment for the service will be received.

In general, commissions charged for arranging or granting loan or other facilities should be recognised when a binding obligation has been sanctioned and accepted by the borrower. Commitment, facility or loan management fees which relate to continuing obligations or services should normally be recognised over the life of the loan or facility having regard to the amount of the obligation outstanding, the nature of the services provided and the timing of the costs relating there to.

4. Admission fees: .

Revenue from artistic performances, banquets and other special events should be recognised when the event takes place. When a subscription relates to a number of events, the fee should be allocated to each event on a systematic and rational basis.

5. Tuition fees:

Revenue should be recognised over the period of instruction.

6. Entrance and membership fees:

Revenue recognition from these sources will depend on the nature of the services being provided. Entrance fee received is generally capitalised. If the membership fee permits only membership and all other services or products are paid for separately, or if there is a separate annual subscription, the fee should be recognised when received. If the membership fee entitles the member to services or publications to be provided during the year, it should be recognised on a systematic and rational basis having regard to the timing and nature of all services provided.