Month: April 2020

In order to ensure transparency consistency, comparability, adequacy and reliability of financial reporting, it is essential to standardize the accounting principles and policies, Accounting Standards provide framework and standard accounting polices so that the financial statements of different enterprises become comparable.

Accounting Standards are selected set of accounting policies or broad guidelines regarding the principles and methods to be chosen out of several alternatives. The Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI) formulas Accounting Standards to be established by the Council of the ICAI.

Objective of Accounting Standards:

Objective of Accounting Standards is to standarize the diverse accounting policies and practices with a view to eliminate to the extent possible the non-comparability of financial statements and the reliability to the financial statements.

The institute of Chartered Accountants of India, recognizing the need to harmonize the diverse accounting policies and practices, constituted at Accounting Standard Board (ASB) on 21st April, 1977.

IFRS:

IFRS is a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements.

IFRS are generally principles-based standards and seek to avoid a rule-book mentality. Application of IFRS requires exercise of judgment by the preparer and the auditor in applying principles of accounting on the basis of the economic substance of transactions.

IFRS are issued by the International Accounting Standards Board (IASB).

The term IFRS comprises IFRS issued by IASB; IAS issued by IASC; and Interpretations issued by the Standing Interpretations Committee (SIC) and the International Financial Reporting Interpretations Committee (IFRIC) of the IASB.

“FOR THE EFFECTIVE STUDY OF ACCOUNTING STANDARDS AND IFRS THERE IS A STRONG NEED TO STUDY THE LINKAGE BETWEEN THESE TWO TERMS THAT MEANS CONVERGENCE.”

The convergence of accounting standards refers to the goal of establishing a single set of accounting standards that will be used internationally, and in particular the effort to reduce the differences between the US generally accepted accounting principles (USGAAP) and the International financial reporting standards (IFRS)

Convergence of Indian accounting standards with International financial reporting standards (IFRS):

Convergence means to achieve harmony with IFRSs; in precise terms convergence can be considered “to design and maintain national accounting standards in a way that financial statements prepared in accordance with national accounting standards draw unreserved statement of compliance with IFRSs”, i.e., when the national accounting standards will comply with all the requirements of IFRS.

But convergence doesn’t mean that IFRS should be adopted word by word, e.g., replacing the term ‘true & fair’ for ‘present fairly’, in IAS 1, ‘Presentation of Financial Statements’. Such changes do not lead to non-convergence with IFRS.

The reason behind convergence is:

As, Availability of essential financial information about a company to its shareholders and other stakeholders in accordance with internationally accepted financial norms is considered as an integral and important part of good corporate governance. To ensure this and to implement the G-20 commitment to achieve a single set of high quality global accounting standards, the Government has taken decision to achieve convergence of Indian accounting standards with International financial reporting standards (IFRS) in a phased manner in accordance with the roadmap suggested by the Government.

Convergence in Indian Scenario:

With regard to India, the Ministry of Corporate Affairs (MCA) has committed to converge the Indian Accounting Standards with the IFRS effective 1st April 2011. The convergence process is picking up momentum with the credit going to the Ministry of Corporate Affairs. The Ministry has extended its unstinted support and guidance to the various regulatory and legal bodies that are spearheading a smooth transition process. Laudably, the highest authorities of the Indian Government have concluded that convergence of Indian Accounting Standards with IFRS is very vital for the country to take a lead role in the global foray.

Entities covered under convergence

Keeping in view the complex nature of IFRSs and the extent of differences between the existing ASs and the corresponding IFRSs and the reasons therefore, the ICAI is of the view that IFRSs should be adopted for the public interest entities from the accounting periods beginning on or after 1st April, 2011.

Public interest entities:

With a view to determine which entities should be considered as public interest entities for the purpose of application of IFRSs, the criteria for Level I enterprises as laid down by the Institute of Chartered Accountants of India and the definition of ‘small and mediumsized company’ as per Clause 2(f) of the Companies (Accounting Standards) Rules, 2006, as notified by the Ministry of Company Affairs (now Ministry of Corporate Affairs) in the Official Gazette dated December 7, 2006, were considered. The ICAI is of the view that in view of the complexity of recognition and measurement principles and the extent of disclosures required in various IFRSs, and the fact that about four years have elapsed since the ICAI laid down the criteria for Level I enterprises, as far as the size is concerned, it needs a revision. Accordingly, the ICAI is of the view that a public interest entity should be an entity:

(i) Whose equity or debt securities are listed or are in the process of listing on any stock exchange, whether in India or outside India; or

(ii) Which is a bank (including a cooperative bank), financial institution, a mutual fund, or an insurance entity; or

(iii) Whose turnover (excluding other income) exceeds rupees one hundred crore in the immediately preceding accounting year; or

(iv) Which has public deposits and/or borrowings from banks and financial institutions in excess of rupees twenty five crore at any time during the immediately preceding accounting year; or

(v) which is a holding or a subsidiary of an entity which is covered in (i) to (iv) above.

Scope of Accounting Standards:

Efforts will be made to issue Accounting Standards which are in conformity with the provisions of the applicable laws, customs, usages and business environment of our country.

However, if due to subsequent amendments in the’ law, a particular Accounting Standard is found to be not in conformity with such law, the provisions of the said law will prevail and the financial statements should be prepared in conformity with such law.

The Accounting Standards by their very nature cannot and do not override the local regulations which govern the preparation and presentation of financial statements in our country. However, the Institute will determine the extent of disclosure to be made in financial statements and the related Auditor’s reports.

Such disclosure may be by way of appropriate notes explaining the treatment of particular items. Such explanatory notes will be only in the nature of clarification and therefore, need not be treated as adverse comments on the related financial statements.

The Accounting Standards are intended to apply only to items which are material. Any ‘imitations with regard to the applicability of a specific Standard will be made clear by the Institute from time to time.

The date from which a particular Standard will come into effect, as well as the class of enterprises to which it will apply, will also be specified by the Institute. However, no standard will have retroactive application, unless otherwise stated.

The institute will use its best endeavors to persuade the Government appropriate authorities industrial and business community to adopt these standards in order to achieve uniformity in the presentation of financial statements.

In carrying out the task of formulation of Accounting Standards, the intention is to concentrate on basic matters. The endeavor would be to confine Accounting Standards to essent.als and not to make them so complex that they cannot be applied effectively and on a nationwide basis. In the years to come, it is to be expected that Accounting Standards will undergo revision and a greater degree of sophistication may then be appropriate.

Objectives of Accounting Standards

Accounting standards are a set of principles, rules, and guidelines established by accounting authorities to guide the preparation and presentation of financial statements. These standards serve various objectives, aiming to enhance transparency, comparability, and reliability of financial reporting.

1. Consistency and Comparability:

Objective: Ensure consistency in financial reporting methods and promote comparability of financial statements across different entities and periods.

Rationale: Consistent application of accounting standards facilitates meaningful comparisons of financial information, both within the same entity over time and between different entities.

• Transparency:

Objective: Enhance the transparency of financial reporting by providing a clear and accurate representation of an entity’s financial position, performance, and cash flows.

Rationale: Transparency helps users of financial statements, including investors, creditors, and other stakeholders, make informed decisions based on a reliable understanding of an entity’s financial health.

• Reliability and Faithful Representation:

Objective: Promote the reliability of financial information by requiring faithful representation of economic transactions and events in financial statements.

Rationale: Reliable financial statements contribute to the credibility of financial reporting, instilling confidence in users that the information accurately reflects the entity’s financial position and performance.

• Relevance:

Objective: Ensure that financial statements are relevant to the needs of users, providing information that is timely and can influence their economic decisions.

Rationale: Relevant financial information assists users in making predictions about an entity’s future performance and helps them evaluate past decisions.

• Understandability:

Objective: Facilitate the understanding of financial statements by users who may not have an in-depth knowledge of accounting.

Rationale: Financial statements should be presented in a clear and concise manner, making it easier for a diverse range of users to comprehend and interpret the information.

• Accounting Policy Consistency:

Objective: Encourage entities to consistently apply accounting policies to similar transactions and events.

Rationale: Consistency in the application of accounting policies over time ensures that financial statements reflect the entity’s economic activities in a uniform and reliable manner.

• Reliability and Materiality:

Objective: Emphasize the importance of materiality in financial reporting decisions, ensuring that financial statements are free from material misstatements.

Rationale: Materiality helps in focusing on information that is significant to users, allowing them to distinguish between material and immaterial information in financial statements.

• Disclosure of Accounting Policies:

Objective: Require entities to disclose their significant accounting policies, providing transparency about the methods used in preparing financial statements.

Rationale: Disclosure of accounting policies enables users to understand the basis of accounting and the principles applied by the entity, promoting transparency and accountability.

• Enhancement of Credibility and Accountability:

Objective: Enhance the credibility of financial reporting and hold entities accountable for the accuracy and fairness of their financial statements.

Rationale: Accounting standards contribute to the reliability and integrity of financial reporting, fostering trust among stakeholders and promoting accountability.

• Global Comparisons:

Objective: Facilitate global comparisons of financial statements by promoting the convergence of accounting standards.

Rationale: Standardized accounting practices allow for easier comparisons between entities operate.

Procedure for Issuing Accounting Standards:

Broadly, the following procedure will be adopted for formulating Accounting Standards:

ASB shall determine the broad areas in which Accounting Standards need to be formulated and ‘priority in regard to the selection thereof.

In the preparation of Accounting Standards, ASB will be assisted by Study Groups constituted to consider specific subjects. In the formation of Study Groups, provision will be made for wide participation by the members of the institute and others.

ASB will also hold a dialogue with the representatives of the Government, Public Sector Undertakings. Industry and other Organisations for ascertaining their views.

On the basis of the work of the Study Groups and the dialogue with the organisation, an exposure draft of the proposed standard will be prepared and issued for comments by members of the Institute and the public at large.

The draft of the proposed standard will include the following basic points:

A Statement of concepts and fundamental accounting principles relating to the Standard.

Definitions of the terms used in the Standard.

The manner in which the accounting principles have been applied for.

The presentation and disclosure requirements in complying with the Standard.

Class of enterprises to which the Standard will apply.

Date from which the Standard will be effective.

After taking into consideration the comments received, the draft of the proposed Standard will be finalized by ASB and submitted to the Council of the Institute.

The Council of the Institute will consider the final draft of the proposed Standard, and it found necessary, modify the same in consultation with ASB. The Accounting Standard on the relevant subject will then be issued under the authority of the Council.

Compliance with the Accounting Standards:

While discharging their attest functions, it will be duty of the members of the Institute to ensure that the Accounting Standards are implemented in the presentation of financial statements covered by their audit reports.

In the event of any deviation from the Standards, it will also be their duty to make adequate disclosures in their reports so that the users of such statements may be aware of such deviations.

In the initial years, the Standards will be recommendatory in character and the Institute will give wide publicity among the users and educate members about the utility of Accounting Standards and the need for compliance with the above disclosure requirements. Once an awareness about these requirements Is ensured, steps will be taken, in course of time, to enforce compliance with the accounting standards.

The adoption of Accounting Standards in our country and disclosure of the extent to which they have not been observed will, over the years, have an important effect, with consequential improvement in the quality of presentation of financial statements.

Accounting Standards Importance

• Improves Reliability of Financial Statements

There are many stakeholders of a company and they rely on the financial statements for their information. Many of these stakeholders base their decisions on the data provided by these financial statements. Then there are also potential investors who make their investment decisions based on such financial statements.

So, it is essential these statements present a true and fair picture of the financial situation of the company. The Accounting Standards (AS) ensure this. They make sure the statements are reliable and trustworthy.

• Attains Uniformity in Accounting

Accounting Standards provides rules for standard treatment and recording of transactions. They even have a standard format for financial statements. These are steps in achieving uniformity in accounting methods.

• Prevents Frauds and Accounting Manipulations

Accounting Standards (AS) lay down the accounting principles and methodologies that all entities must follow. One outcome of this is that the management of an entity cannot manipulate with financial data. Following these standards is not optional, it is compulsory.

So, these standards make it difficult for the management to misrepresent any financial information. It even makes it harder for them to commit any frauds.

• Comparability

This is another major objective of accounting standard. Since all entities of the country follow the same set of standards their financial accounts become comparable to some extent. The users of the financial statements can analyze and compare the financial performances of various companies before taking any decisions.

Also, two statements of the same company from different years can be compared. This will show the growth curve of the company to the users.

• Assists Auditors

Now the accounting standards lay down all the accounting policies, rules, regulations, etc in a written format. These policies have to be followed. So if an auditor checks that the policies have been correctly followed he can be assured that the financial statements are true and fair.

• Determining Managerial Accountability

The accounting standards help measure the performance of the management of an entity. It can help measure the management’s ability to increase profitability, maintain the solvency of the firm, and other such important financial duties of the management.

Management also must wisely choose their accounting policies. Constant changes in the accounting policies lead to confusion for the user of these financial statements. Also, the principle of consistency and comparability are lost.

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.

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, passage of time or obsolescence through technology and market changes.
Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined.

• The depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset.

Depreciable assets are assets which
[1] are expected to be used during more than one accounting period; and
[2] have a limited useful life; and
[3] are held by an enterprise for use in the production or supply or for administrative purposes.

Depreciable amount of a depreciable asset is its historical cost, or other amount substituted for historical cost less the estimated residual value.

Useful life is the period over which a depreciable asset is expected to be used by the enterprise.
The useful life of a depreciable asset is shorter than its physical life.

There are two method of depreciation:

1] Straight Line Method (SLM)

2] Written Down Value Method (WDVM)

Note: A combination of more than one method may be used.

The depreciation method selected should be applied consistently from period to period. The change in method of depreciation should be made only if;

• The adoption of the new method is required by statute; or

• For compliance with an accounting standard; or

• If it is considered that change would result in a more appropriate preparation of financial statement; or

• When there is change in method of depreciation, depreciation should be recalculated in accordance with the new method from the date of the assets coming into use. (i.e RETROSPECTIVELY)

The deficiency or surplus arising from such recomputation should be adjusted in the year of change through profit and loss account.

Such change should be treated as a change in accounting policy and its effect should be quantified and disclosed.

The useful lives of major depreciable assets may be reviewed periodically. Where there is a revision of the estimated useful life, the unamortised depreciable amount should be charged over the revised remaining useful life. (i.e. PROSPECTIVELY)

Any addition or extension which becomes an integral part of the existing asset should be depreciated over the remaining useful life of that asset.

The depreciation on such addition may also be applied at the rate applied to the existing asset.
Where an addition or extension retains a separate identity and is capable of being used after the existing asset is disposed of, depreciation should be provided independently on the basis of estimate of its own useful life.

Where the historical cost of a depreciable asset has undergone a change due to increase or decrease in the long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors, the depreciation on the revised unamortised depreciable amount should be provided prospectively over the residual useful life of the asset.

This accounting standard is not applied on the following items.
• Forests and plantations
• Wasting assets
• Research and development expenditure
• Goodwill
• Live stock

Disclosure requirements

1] the historical cost
2] total depreciation for each class charged during the period
3] the related accumulated depreciation
4] depreciation method used ( Accounting policy)
5] depreciation rates if they are different from those prescribed by the statute governing the enterprise.

• Revenue includes: Proceeds from sale of goods
  Proceeds from rendering of services
  Interest, royalty and dividends.
  Sale of goods
  Revenue from sales should be recognized when
•  All significant risks and rewards of ownership have been transferred to the buyer from the seller.

• Ultimate realisability of receipt is reasonably certain.

Rendering of Services

Revenue from service transactions is usually recognized as the service is performed, either by proportionate completion method or by the completed service contract method.
1) Proportionate Completion method: This is a method of accounting, which recognises revenue in the statement of profit and loss proportionately with degree of completion of services under a contract.
Revenue is recognised by reference to the performance of each act. The revenue recognised under this method would be determined on the basis of contract value, associated costs, number of acts or other suitable basis.
2) Completed service contract method: This 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.
Revenue under this method is recognised on completion or substantial completion of the job.
Revenue from Interest: Recognised on time proportion basis
Revenue from Royalties: Recognised on accrual basis in accordance with the terms of the relevant agreement.
Revenue from Dividends: Recognised when right to receive is established
Subsequent uncertainty in collection: When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of services, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded.
Disclosure: An enterprise should disclose the circumstances in which revenue recognition has
been postponed pending the resolution of significant uncertainties.
examples
1] On sale, buyer takes title and accepts billing but delivery is delayed at buyer’s request
Revenue should be recognised notwithstanding that physical delivery has not been
completed.
2] Delivery subject to installations and inspections
Revenue should not be recognised until the customer accepts delivery and
installation and inspection are complete. However, when installation process is very
simple, revenue should be recognised. For example. Television sale subject to
installation.
3] Sale on approval
Revenue should not be recognised until the goods have been formally accepted or time
for rejection has elapsed or where no time has been fixed, a reasonable time has elapsed.
4] Sales with the condition of ‘money back if not completely satisfied’
It may be appropriate to recognize the sale but to make suitable provision for
returns based on previous experience.
5] Consignment sales
Revenue should not be recognised until the goods are sold to a third party.
6] Installment sales
Revenue of sale price excluding interest should be recognised on the date of sale.
7] Special order and shipments
Revenue from such sales should be recognized when the goods are identified and ready  for delivery.
8] Where seller concurrently agrees to repurchase the same goods at a later date
The sale should not be recognised, as this is a financial arrangement.
9] Subscriptions received 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.
10] Advertisement commission received
It is recognised when the advertisement appears before public.
11] Tution fees received
Should be recognised over the period of instruction.
12] Entrance and membership fees
Entrance fee is generally capitalized
If the membership fee permits only membership and all other services or products are paid for separately, 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.
13] Sale of show tickets
Revenue should be recognised when the event takes place.
14] Guaranteed sales of agricultural crops
When sale is assured under forward contract or government guarantee, the crops can be  recognised at net realizable value although it does not satisfy the criteria of revenue  recognition.
The above accounting standard is not applicable for:

•  Revenue arising from construction contracts
•  Revenue arising from hire purchase, lease agreements
•  Revenue arising from Government grants and subsidies
•  Revenue of Insurance companies arising from insurance contracts
•  Profit or loss on sale of fixed assets
•  Realized or unrealized gains resulting from changes in foreign exchange rates

IAS 1 Presentation of Financial Statements sets out the overall requirements for financial statements, including how they should be structured, the minimum requirements for their content and overriding concepts such as going concern, the accrual basis of accounting and the current/non-current distinction. The standard requires a complete set of financial statements to comprise a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of changes in equity and a statement of cash flows.

IAS 1 was reissued in September 2007 and applies to annual periods beginning on or after 1 January 2009.

Objective of IAS 1

The objective of IAS 1 (2007) is to prescribe the basis for presentation of general purpose financial statements, to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities. IAS 1 sets out the overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content. [IAS 1.1] Standards for recognising, measuring, and disclosing specific transactions are addressed in other Standards and Interpretations. [IAS 1.3]

Scope

IAS 1 applies to all general purpose financial statements that are prepared and presented in accordance with International Financial Reporting Standards (IFRSs). [IAS 1.2]

General purpose financial statements are those intended to serve users who are not in a position to require financial reports tailored to their particular information needs. [IAS 1.7]

Objective of financial statements

The objective of general purpose financial statements is to provide information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users in making economic decisions. To meet that objective, financial statements provide information about an entity’s: [IAS 1.9]

Assets liabilities equity income and expenses, including gains and losses contributions by and distributions to owners (in their capacity as owners) cash flows.

That information, along with other information in the notes, assists users of financial statements in predicting the entity’s future cash flows and, in particular, their timing and certainty.

Components of financial statements

• A complete set of financial statements includes: [IAS 1.10]
• A statement of financial position (balance sheet) at the end of the period
• A statement of profit or loss and other comprehensive income for the period (presented as a single statement, or by presenting the profit or loss section in a separate statement of profit or loss, immediately followed by a statement presenting comprehensive income beginning with profit or loss)
• A statement of changes in equity for the period
• A statement of cash flows for the period
• Notes, comprising a summary of significant accounting policies and other explanatory notes
• Comparative information prescribed by the standard.

An entity may use titles for the statements other than those stated above.  All financial statements are required to be presented with equal prominence. [IAS 1.10]

When an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements, it must also present a statement of financial position (balance sheet) as at the beginning of the earliest comparative period.

Reports that are presented outside of the financial statements including financial reviews by management, environmental reports, and value added statements are outside the scope of IFRSs. [IAS 1.14]

Fair presentation and compliance with IFRSs

The financial statements must “present fairly” the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events, and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation. [IAS 1.15]

IAS 1 requires an entity whose financial statements comply with IFRSs to make an explicit and unreserved statement of such compliance in the notes. Financial statements cannot be described as complying with IFRSs unless they comply with all the requirements of IFRSs (which includes International Financial Reporting Standards, International Accounting Standards, IFRIC Interpretations and SIC Interpretations). [IAS 1.16]

Inappropriate accounting policies are not rectified either by disclosure of the accounting policies used or by notes or explanatory material. [IAS 1.18]

IAS 1 acknowledges that, in extremely rare circumstances, management may conclude that compliance with an IFRS requirement would be so misleading that it would conflict with the objective of financial statements set out in the Framework. In such a case, the entity is required to depart from the IFRS requirement, with detailed disclosure of the nature, reasons, and impact of the departure. [IAS 1.19-21]

Going concern

The Conceptual Framework notes that financial statements are normally prepared assuming the entity is a going concern and will continue in operation for the foreseeable future. [Conceptual Framework, paragraph 4.1]

IAS 1 requires management to make an assessment of an entity’s ability to continue as a going concern.  If management has significant concerns about the entity’s ability to continue as a going concern, the uncertainties must be disclosed. If management concludes that the entity is not a going concern, the financial statements should not be prepared on a going concern basis, in which case IAS 1 requires a series of disclosures. [IAS 1.25]

Accrual basis of accounting

IAS 1 requires that an entity prepare its financial statements, except for cash flow information, using the accrual basis of accounting. [IAS 1.27]

Consistency of presentation

The presentation and classification of items in the financial statements shall be retained from one period to the next unless a change is justified either by a change in circumstances or a requirement of a new IFRS. [IAS 1.45]

Materiality and aggregation

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity. [IAS 1.7]*

Each material class of similar items must be presented separately in the financial statements. Dissimilar items may be aggregated only if they are individually immaterial. [IAS 1.29]

However, information should not be obscured by aggregating or by providing immaterial information, materiality considerations apply to the all parts of the financial statements, and even when a standard requires a specific disclosure, materiality considerations do apply. [IAS 1.30A-31]

* Clarified by Definition of Material (Amendments to IAS 1 and IAS 8), effective 1 January 2020.

Offsetting

Assets and liabilities, and income and expenses, may not be offset unless required or permitted by an IFRS. [IAS 1.32]

Comparative information

IAS 1 requires that comparative information to be disclosed in respect of the previous period for all amounts reported in the financial statements, both on the face of the financial statements and in the notes, unless another Standard requires otherwise. Comparative information is provided for narrative and descriptive where it is relevant to understanding the financial statements of the current period. [IAS 1.38]

An entity is required to present at least two of each of the following primary financial statements: [IAS 1.38A]

• Statement of financial position
• Statement of profit or loss and other comprehensive income
• Separate statements of profit or loss (where presented)
• Statement of cash flows
• Statement of changes in equity
• Related notes for each of the above items.

* A third statement of financial position is required to be presented if the entity retrospectively applies an accounting policy, restates items, or reclassifies items, and those adjustments had a material effect on the information in the statement of financial position at the beginning of the comparative period. [IAS 1.40A]

Where comparative amounts are changed or reclassified, various disclosures are required. [IAS 1.41]

IAS 2 is an international financial reporting standard produced and disseminated by the International Accounting Standards Board (IASB) to provide guidance on the valuation and classification of inventories.

IAS 2 defines inventories as assets which are:

(a) held for sale in the ordinary course of business,

(b) in the process of production for such sale,

(c) in the form of materials or supplies to be consumed in the production process or rendering of services.

IAS 2 requires that those assets that are considered inventory should be recorded at the lower of cost or net realisable value. Cost not only includes the purchase cost but also the conversion costs, which are the costs involved in bringing inventory to its present condition and location, such as direct labour. IAS 2 also allows for the capitalisation of variable overheads and fixed overheads so long as the fixed overheads are allocated on a systematic and consistent basis and in respect to usual output levels. Where output is lower than expected the resultant excessive overhead should be considered an expense and not capitalised but when output is abnormally high the fixed overhead allocated to each unit must be decreased so as not to overvalue the inventory.

In the event of there being multiple products produced from one process, such as a main product and a by-product, where the costs are not clearly separated, the costs should be allocated “on a rational and consistent basis”,[1] such as based on the market value of each unit once the two products become separate.

IAS 2 does not allow for the capitalisation of:

    (a) the cost of abnormal levels of waste

    (b) storage costs where the storage is not part of the production process

    (c) administrative costs

    (d) selling costs

The valuation of work in progress on construction and service contracts falls outside IAS 2 (IFRS 15 applies instead); similarly for financial instruments, IAS 32 and IFRS 9 apply and for biological assets arising from agricultural activity, IAS 41 applies instead of IAS 2.[2] For the capitalisation of borrowing costs in inventories, consult “IAS 23 Borrowing Costs”.

IAS 2 allows for two methods of costing, the standard technique and the retail technique. The standard technique requires that inventory be valued at the standard cost of each unit; that is, the usual cost per unit at the normal level of output and efficiency. The retail technique values the inventory by taking its sales value and then reducing it by the relevant gross profit margin. Where items of inventory are not ordinarily interchangeable or where certain items are earmarked for specific projects, these items are required to have their specific costs identified and assigned to them individually.

IAS 2 also requires the use of the First-in, First-out (FIFO) principle whereby those items which have been in stock the longest are considered to be the items that are being used first, ensuring that those items which are held in inventory at the reporting date are valued at the most recent price. As an alternative, costs of inventories may be assigned by using the weighted average cost formula.

The value of inventories must be recorded at the lower of cost or net realisable value. Where net realisable value drops to below the cost of inventory the loss is to be recognised as an expense in the period in which the drop of value occurs.