4

1.1
CHAPTER a

PRESENTATION &
DISCLOSURES BASED
ACCOUNTING
STANDARDS
UNIT 1: ACCOUNTING STANDARD 1
DISCLOSURE OF ACCOUNTING POLICIES

LEARNING OUTCOMES
After studying this chapter, you would be able to Comprehend the-
 Fundamental Accounting Assumptions
 Nature of Accounting Policies
 Areas in Which Different Accounting Policies are Encountered.
 Considerations in the Selection of Accounting Policies.

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 4.2 ADVANCED ACCOUNTING

1.1 INTRODUCTION
Irrespective of extent of standardization, diversity in accounting policies is
unavoidable for two reasons. First, accounting standards cannot and do not cover
all possible areas of accounting and enterprises have the freedom of adopting any
reasonable accounting policy in areas not covered by a standard.
Second, since enterprises operate in diverse situations, it is impossible to develop
a single set of policies applicable to all enterprises for all time.
The accounting standards, therefore, permit more than one policy even in areas
covered by it. Differences in accounting policies lead to differences in reported
information even if underlying transactions are same. The qualitative characteristic
of comparability of financial statements, therefore, suffers due to diversity of
accounting policies. Since uniformity is impossible, and accounting standards
permit more than one alternative in many cases, it is not enough to say that all
standards have been complied with. For these reasons, Accounting Standard 1
requires enterprises to disclose significant accounting policies actually adopted by
them in preparation of their financial statements. Such disclosures allow the users
of financial statements to take the differences in accounting policies into
consideration and to make necessary adjustments in their analysis of such financial
statements.
The purpose of Accounting Standard 1, Disclosure of Accounting Policies, is to
promote better understanding of financial statements by requiring disclosure of
significant accounting policies in an orderly manner. As explained in the preceding
paragraph, such disclosures facilitate more meaningful comparison between
financial statements of different enterprises for same accounting period. The
standard also requires disclosure of changes in accounting policies such that the
users can compare financial statements of same enterprise for different accounting
periods.

This Accounting Standard applies to all enterprises.

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 PRESENTATION & DISCLOSURES BASED 4.3
ACCOUNTING STANDARDS v
v v
v
1.2 FUNDAMENTAL ACCOUNTING ASSUMPTIONS
v

Fundamental Accounting
Assumptions

Going concern Consistency Accrual

Fundamental Accounting
Assumptions

If followed If not followed

Disclosure required in financial

Not required to be disclosed
statements

Going Concern: The financial statements are normally prepared on the assumption
that an enterprise will continue its operations in the foreseeable future and neither
there is intention, nor there is need to materially curtail the scale of operations.
Financial statements prepared on going concern basis recognise among other
things the need for sufficient retention of profit to replace assets consumed in
operation and for making adequate provision for settlement of its liabilities.

Consistency: The principle of consistency refers to the practice of using same

accounting policies for similar transactions in all accounting periods. The
consistency improves comparability of financial statements through time. An
accounting policy can be changed if the change is required (i) by a statute (ii) by
an accounting standard (iii) for more appropriate presentation of financial
statements.

Accrual basis of accounting: Under this basis of accounting, transactions are

recognised as soon as they occur, whether or not cash or cash equivalent is actually
received or paid. Accrual basis ensures better matching between revenue and cost

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 4.4 ADVANCED ACCOUNTING

and profit/loss obtained on this basis reflects activities of the enterprise during an
accounting period, rather than cash flows generated by it.
While accrual basis is a more logical approach to profit determination than the cash
basis of accounting, it exposes an enterprise to the risk of recognising an income
before actual receipt. The accrual basis can, therefore, overstate the divisible profits
and dividend decisions based on such overstated profit lead to erosion of capital.
For this reason, accounting standards require that no revenue should be recognised
unless the amount of consideration and actual realisation of the consideration is
reasonably certain.
Despite the possibility of distribution of profit not actually earned, accrual basis of
accounting is generally followed because of its logical superiority over cash basis
of accounting. Section 128(1) of the Companies Act, 2013 makes it mandatory for
companies to maintain accounts on accrual basis only. It is not necessary to
expressly state that accrual basis of accounting has been followed in preparation
of a financial statement. In case, any income/expense is recognised on cash basis,
the fact should be stated.

1.3 ACCOUNTING POLICIES

The accounting policies refer to the specific accounting principles and the methods
of applying those principles adopted by the enterprise in the preparation and
presentation of financial statements.
Accountant has to make decisions from various options for recording or disclosing
items in the books of accounts e.g.

Items to be disclosed Method of disclosure or valuation

Inventories FIFO, Weighted Average etc.

Cash Flow Statement Direct Method, Indirect Method

This list is not exhaustive i.e. endless. For every item right from valuation of assets
and liabilities to recognition of revenue, providing for expected losses, for each
event, accountant need to form principles and evolve a method to adopt those
principles. This method of forming and applying accounting principles is known as
accounting policies.

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 PRESENTATION & DISCLOSURES BASED 4.5
ACCOUNTING STANDARDS v
v v
v some
As we say that accounts is both science and art, it’s a science because we have
v
tested accounting principles, which are applicable universally, but simultaneously
the application of these principles depends on the personal ability of each
accountant. Since different accountants may have different approach, we generally
find that in different enterprises under same industry, different accounting policies
are followed. Though ICAI along with Government is trying to reduce the number
of accounting policies followed in India but still it cannot be reduced to one.
Accounting policy adopted will have considerable effect on the financial results
disclosed by the financial statements; it makes it almost difficult to compare two
financial statements.

1.4 SELECTION OF ACCOUNTING POLICY

Financial Statements are prepared to portray a true and fair view of the
performance and state of affairs of an enterprise. In selecting a policy, alternative
accounting policies should be evaluated in that light. In particular, major
considerations that govern selection of a particular policy are:
Prudence: In view of uncertainty associated with future events, profits are not
anticipated, but losses are provided for as a matter of conservatism. Provision
should be created for all known liabilities and losses even though the amount
cannot be determined with certainty and represents only a best estimate in the
light of available information. The exercise of prudence in selection of accounting
policies ensure that (i) profits are not overstated (ii) losses are not understated (iii)
assets are not overstated and (iv) liabilities are not understated.
Example 1

The most common example of exercise of prudence in selection of accounting policy

is the policy of valuing inventory at lower of cost and net realisable value.
Suppose a trader has purchased 500 units of certain article @ ` 10 per unit. He sold
400 articles @ ` 15 per unit. If the net realisable value per unit of the unsold article
is ` 15, the trader should value his stock at ` 10 per unit and thus ignoring the profit
` 500 that he may earn in next accounting period by selling 100 units of unsold
articles. If the net realisable value per unit of the unsold article is ` 8, the trader
should value his stock at `8 per unit and thus recognising possible loss ` 200 that he

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 4.6 ADVANCED ACCOUNTING

may incur in next accounting period by selling 100 units of unsold articles.
Profit of the trader if net realisable value of unsold article is ` 15
= Sale – Cost of goods sold = (400 x ` 15) – (500 x ` 10 – 100 x ` 10) = ` 2,000

Profit of the trader if net realisable value of unsold article is ` 8

= Sale – Cost of goods sold = (400 x ` 15) – (500 x `10 – 100 x ` 8) = ` 1,800
Example 2

Exercise of prudence does not permit creation of hidden reserve by understating

profits and assets or by overstating liabilities and losses. Suppose a company is facing
a damage suit. No provision for damages should be recognised by a charge against
profit, unless the probability of losing the suit is more than the probability of not
losing it.
Substance over form: Transactions and other events should be accounted for and
presented in accordance with their substance and financial reality and not merely
by their legal form.

Materiality: Financial statements should disclose all ‘material items, i.e. the items
the knowledge of which might influence the decisions of the user of the financial
statement. Materiality is not always a matter of relative size. For example a small
amount lost by fraudulent practices of certain employees can indicate a serious
flaw in the enterprise’s internal control system requiring immediate attention to
avoid greater losses in future. In certain cases quantitative limits of materiality is
specified. A few of such cases are given below:
(a) A company should disclose by way of notes additional information regarding
any item of income or expenditure which exceeds 1% of the revenue from
operations or `1,00,000 whichever is higher (Refer general Instructions for
preparation of Statement of Profit and Loss in Schedule III to the Companies
Act, 2013).

(b) A company should disclose in Notes to Accounts, shares in the company held
by each shareholder holding more than 5 per cent shares specifying the
number of shares held. (Refer general Instructions for Balance Sheet in
Schedule III to the Companies Act, 2013).

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 PRESENTATION & DISCLOSURES BASED 4.7
ACCOUNTING STANDARDS v
v v
Manner of disclosure: All significant accounting policies adopted vin the
preparation and presentation of financial statements should be disclosed v

The disclosure of the significant accounting policies as such should form part of
the financial statements and the significant accounting policies should normally be
disclosed in one place.

1.5 DISCLOSURE OF CHANGES IN ACCOUNTING

POLICIES
Any change in the accounting policies which has a material effect in the current
period or which is reasonably expected to have a material effect in a later period
should be disclosed. In the case of a change in accounting policies, which has a
material effect in the current period, the amount by which any item in the financial
statements is affected by such change should also be disclosed to the extent
ascertainable. Where such amount is not ascertainable, wholly or in part, the fact
should be indicated.

Change in Accounting
Policy

Not material in current period but

Material in current period
ascertainable in later periods

Fact of such change in later

Amount Amount not
period to be disclosed in
ascertained ascertained
current period.

Amount to be
Fact to be disclosed
disclosed

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 4.8 ADVANCED ACCOUNTING

Example 3
A simple disclosure that an accounting policy has been changed is not of much use
for a reader of a financial statement. The effect of change should , therefore, be
disclosed wherever ascertainable. Suppose a company has switched over to weighted
average formula for ascertaining cost of inventory, from the earlier practice of using
FIFO. If the closing inventory using FIFO method is `2 lakhs and that by weighted
average method is `1.8 lakhs, the change in accounting policy pulls down profit and
value of inventory by `20,000. The company may disclose the change in accounting
policy in the following manner:

‘The company values its inventory at lower of cost or net realisable value. Since net
realisable value of all items of inventory in the current year was greater than
respective costs, the company valued its inventory at cost. In the present year , the
company has changed to weighted average method, which better reflects the
consumption pattern of inventory, for ascertaining inventory costs from the earlier
practice of using FIFO method for the purpose. The change in policy has reduced
profit for the year and value of inventory as at the year end by `20,000.
A change in accounting policy is to be disclosed if the change is reasonably expected
to have material effect in future accounting periods, even if the change has no
material effect in the current accounting period.
The above requirement ensures that all important changes in accounting policies are
actually disclosed.

1.6 DISCLOSURE OF DEVIATIONS FROM FUNDA-

MENTAL ACCOUNTING ASSUMPTIONS
If the fundamental accounting assumptions, viz. Going concern, Consistency and
Accrual are followed in financial statements, specific disclosure is not required. If a
fundamental accounting assumption is not followed, the fact should be disclosed.
The principle of consistency refers to the practice of using same accounting policies
for similar transactions in all accounting periods.

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 PRESENTATION & DISCLOSURES BASED 4.9
ACCOUNTING STANDARDS v
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Illustration 1 v
v
In the books of M/s Prashant Ltd., closing inventory as at 31.03.20X2 amounts to
` 1,63,000 (on the basis of FIFO method).
The company decides to change from FIFO method to weighted average method for
ascertaining the cost of inventory from the year 20X1-X2. On the basis of weighted
average method, closing inventory as on 31.03.20X2 amounts to ` 1,47,000.
Realisable value of the inventory as on 31.03.20X2 amounts to ` 1,95,000.
Discuss disclosure requirement of change in accounting policy as per AS-1.

Solution
As per AS 1“Disclosure of Accounting Policies”, any change in an accounting policy
which has a material effect should be disclosed in the financial statements. The
amount by which any item in the financial statements is affected by such change
should also be disclosed to the extent ascertainable. Where such amount is not
ascertainable, wholly or in part, the fact should be indicated. Thus Prashant Ltd.
should disclose the change in valuation method of inventory and its effect on
financial statements. The company may disclose the change in accounting policy in
the following manner:

‘The company values its inventory at lower of cost and net realizable value. Since
net realizable value of all items of inventory in the current year was greater than
respective costs, the company valued its inventory at cost. In the present year i.e.
20X1-X2, the company has changed to weighted average method, which better
reflects the consumption pattern of inventory, for ascertaining inventory costs from
the earlier practice of using FIFO for the purpose. The change in policy has reduced
current profit and value of inventory by ` 16,000.
Illustration 2
Jagannath Ltd. had made a rights issue of shares in 20X2. In the offer document to
its members, it had projected a surplus of `40 crores during the accounting year to
end on 31st March, 20X2. The draft results for the year, prepared on the hitherto
followed accounting policies and presented for perusal of the board of directors
showed a deficit of `10 crores. The board in consultation with the managing director,
decided on the following:

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 4.10 ADVANCED ACCOUNTING

(i) Value year-end inventory at works cost ( ` 50 crores) instead of the hitherto
method of valuation of inventory at prime cost ( ` 30 crores).
(ii) Provide for permanent diminution in the value of investments, which had taken
place over the past five years, the amount of provision being `10 crores.
As chief accountant of the company, you are asked by the managing director to draft
the notes on accounts for inclusion in the annual report for 20X1-20X2.

Solution
As per AS 1, any change in the accounting policies which has a material effect in
the current period or which is reasonably expected to have a material effect in later
periods should be disclosed. In the case of a change in accounting policies which
has a material effect in the current period, the amount by which any item in the
financial statements is affected by such change should also be disclosed to the
extent ascertainable. Where such amount is not ascertainable, wholly or in part, the
fact should be indicated. Accordingly, the notes on accounts should properly
disclose the change and its effect.
Notes on Accounts:
(i) During the year inventory has been valued at factory cost, against the practice
of valuing it at prime cost as was the practice till last year. This has been done
to take cognizance of the more capital intensive method of production on
account of heavy capital expenditure during the year. As a result of this
change, the year-end inventory has been valued at ` 50 crores and the profit
for the year has increased by ` 20 crores.(ii) The company has decided to
provide `10 crores for the permanent diminution in the value of investments
which has taken place over the period of past five years. The provision so
made has reduced the profit disclosed in the accounts by `10 crores.
Illustration 3
XYZ Company is engaged in the business of financial services and is undergoing tight
liquidity position, since most of the assets of the company are blocked in various
claims/petitions in a Special Court. XYZ has accepted Inter-Corporate Deposits (ICDs)
and it is making its best efforts to settle the dues. There were claims at varied rates
of interest, from lenders, from the due date of ICDs to the date of repayment. The
company has provided interest, as per the terms of the contract till the due date and

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 PRESENTATION & DISCLOSURES BASED 4.11
ACCOUNTING STANDARDS v
v v
a note for non-provision of interest on the due date to date of repayment was vaffected
in the financial statements. On account of uncertainties existing regarding v the
determination of the amount and in the absence of any specific legal obligation at
present as per the terms of contracts, the company considers that these claims are in
the nature of "claims against the company not acknowledged as debt”, and the same
has been disclosed by way of a note in the accounts instead of making a provision in
the statement of profit and loss. State whether the treatment done by the Company
is correct or not.
Solution

AS 1 ‘Disclosure of Accounting Policies’ recognises 'prudence' as one of the major

considerations governing the selection and application of accounting policies. In
view of the uncertainty attached to future events, profits are not anticipated but
recognised only when realised though not necessarily in cash. Provision is made for
all known liabilities and losses even though the amount cannot be determined with
certainty and represents only a best estimate in the light of available information.

Also as per AS 1, ‘accrual’ is one of the fundamental accounting assumptions.

Irrespective of the terms of the contract, so long as the principal amount of a loan
is not repaid, the lender cannot be replaced in a disadvantageous position for non-
payment of interest in respect of overdue amount. From the aforesaid, it is apparent
that the company has an obligation on account of the overdue interest. In this
situation, the company should provide for the liability (since it is not waived by the
lenders) at an amount estimated or on reasonable basis based on facts and
circumstances of each case. However, in respect of the overdue interest amounts,
which are settled, the liability should be accrued to the extent of amounts settled.
Non-provision of the overdue interest liability amounts to violation of accrual basis
of accounting. Therefore, the treatment, done by the company, of not providing
the interest amount from due date to the date of repayment is not correct.

Reference: The students are advised to refer the full text of AS 1 “Disclosure of
Accounting Policies”.

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 4.12 ADVANCED ACCOUNTING

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. Which of the following is NOT a major consideration in selection and
application of accounting policies?

(a) Prudence

(b) Comparability

(c) Materiality

(d) Substance over form

2. Adoption of different accounting policies by different companies operating in
the same industry affects which of the qualitative characteristics the most?

(a) Comparability

(b) Relevance

(c) Faithful representation

(d) Reliability
3. Which of the following statement would not be correct in relation to disclosures
to be made in the financial statements after making any change in an
accounting policy?

(a) Any change in an accounting policy which has a material effect should
be disclosed.

(b) The amount by which any item in the financial statements is affected by
such change should be disclosed to the extent ascertainable. Where such
amount is not ascertainable, wholly or in part, the fact should be
indicated.

(c) If a change is made in the accounting policies which has no material effect
on the financial statements for the current period but which is reasonably
expected to have a material effect in later periods, the fact of such change

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 PRESENTATION & DISCLOSURES BASED 4.13
ACCOUNTING STANDARDS v
v v
v
should be appropriately disclosed in the period in which the change is
adopted. v

(d) If a change is made in an accounting policy which has material effect on

the financial statements for the current period and is reasonably expected
to have a material effect in later periods, the fact of such change should
be appropriately disclosed only in the later periods i.e. year(s) next to the
year in which the change is adopted.

Theoretical Questions
4. What are the three fundamental accounting assumptions recognised by
Accounting Standard (AS) 1? Briefly describe each one of them.

5. Has Accounting Standard 1 prescribed the manner in which the accounting

policies followed by the entity should be disclosed?

Scenario based Questions

6. State whether the following statements are 'True' or 'False'. Also give reason
for your answer.

(i) Certain fundamental accounting assumptions underline the preparation

and presentation of financial statements. They are usually specifically
stated because their acceptance and use are not assumed.

(ii) If fundamental accounting assumptions are not followed in presentation

and preparation of financial statements, a specific disclosure is not
required.

(iii) All significant accounting policies adopted in the preparation and

presentation of financial statements should form part of the financial
statements.

(iv) Any change in an accounting policy, which has a material effect should
be disclosed. Where the amount by which any item in the financial
statements is affected by such change is not ascertainable, wholly or in
part, the fact need not to be indicated.

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 4.14 ADVANCED ACCOUNTING

7. Give examples of areas where accounting policies adopted could be different

for different enterprises. Would there be any adverse impact due to the
adoption of different policies, and if yes, how does Accounting Standard 1 seek
to address such issue?
8. ABC Ltd. was making provision for non-moving inventories based on issues for
the last 12 months up to 31.3.20X1.
The company wants to provide during the year ending 31.3.20X2 based on
technical evaluation:

Total value of Inventory ` 100 lakhs

Provision required based on 12 months issue `3.5 lakhs
Provision required based on technical ` 2.5 lakhs
evaluation

Does this amount to change in Accounting Policy?

Can the company change the method of provision?

ANSWERS/HINTS
Answers to the Multiple Choice Questions
1 (b) 2 (a) 3 (d)

Answers to the Theoretical Questions

4. Accounting Standard (AS) 1 recognises three fundamental accounting
assumptions. These are: (i) Going Concern; (ii) Consistency; and (iii) Accrual
basis of accounting.

5. Paras 18-20 of Accounting Standard 1, Disclosure of Accounting Policies, lay

down the manner in which accounting policies have to be disclosed, which is
stated as under:

▪ 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.

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 PRESENTATION & DISCLOSURES BASED 4.15
ACCOUNTING STANDARDS v
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▪ v
Such disclosure should form part of the financial statements.
v
▪ All the disclosures should be made at one place instead of being
scattered over several statements, schedules and notes.

Answers to the Scenario based Question

6. (i) False; As per AS 1 “Disclosure of Accounting Policies”, certain
fundamental accounting assumptions underlie the preparation and
presentation of financial statements. They are usually not specifically
stated because their acceptance and use are assumed. Disclosure is
necessary if they are not followed.
(ii) False; As per AS 1, if the fundamental accounting assumptions, viz.
Going Concern, Consistency and Accrual are followed in financial
statements, specific disclosure is not required. If a fundamental
accounting assumption is not followed, the fact should be disclosed.
(iii) True; 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. The disclosure of the significant accounting policies as such
should form part of the financial statements and they should be
disclosed in one place.
(iv) False; Any change in the accounting policies which has a material effect
in the current period or which is reasonably expected to have a material
effect in later periods should be disclosed. Where such amount is not
ascertainable, wholly or in part, the fact should be indicated.
7. There are various areas where different accounting policies could be adopted
by different entities within the same industry. An entity may choose to value
its inventories using FIFO method, whereas another entity may choose to
value the same using Weighted Average method.
While an entity is free to choose its accounting policy as long as in the
financial statements reflect a true and fair view of the state of affairs of the
enterprise as at the balance sheet date and of the profit or loss for the period
ended, the application of different accounting policies by different entities
affects the comparability of the financial statements of such different entities

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by stakeholders, analysts, investors etc. To mitigate the loss of comparability,

Accounting Standard 1, Disclosure of Accounting Policies requires disclosure
of significant accounting policies as a part of the financial statements. This
would help users of the financial statements to understand the policies
followed by different entities, particularly if they belong to the same industry,
and make a correct analysis of each entity resulting in more informed
decision-making.
8. Accounting policy of a company may require that provision for non-moving
inventories should be made. The method of estimating the amount of
provision may be changed in case a more prudent estimate can be made.
The decision of making provision for non-moving inventories on the basis of
technical evaluation does not amount to change in accounting policy.
In the above case, considering the total value of inventory, the change in the
amount of required provision of non-moving inventory from ` 3.5 lakhs to
` 2.5 lakhs is also not material.
The disclosure can be made for such change in the following lines by way of
notes to the accounts in the annual accounts of ABC Ltd. for the
year 20X1-X2:
"The company has provided for non-moving inventories on the basis of
technical evaluation unlike preceding years. Had the same method been
followed as in the previous year, the profit for the year and the corresponding
effect on the year-end net assets would have been lower by ` 1 lakh."

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