FRRB Corner: Issues discussed in regard to Compliance with Accounting Standard 1 Disclosure of Accounting Policies.

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. Accounting Principles followed cannot be same for all entities or all types of business and therefore, it is for the wisdom of the Management to determine the most suitable accounting policy and accordingly comply with it.

Considering the above, and that the users (and auditors) have to be familiar with the judgment of the management on various decisions taken in relation to the preparation of financial statements, the disclosure of accounting policies is important. The Financial Reporting Review Board has reviewed the financial statements and has offered its comments on the Quality of Disclosure of Accounting Policies. On review of the comments, it may be useful to keep the following aspects, before forming an accounting policy or amending the existing one (which would again require disclosure appropriately if it results in a change in accounting policy from presently followed policy. A mere change or amendment in language or nomenclature of the terminologies used would not amount to change in accounting policy.

1. Has the Company ensured that all the Accounting Policies required to be disclosed are disclosed?

To ensure that all the Significant Accounting Policies have been disclosed or not, it is better that every major element in the financial statement (especially when there are alternative methods of accounting, as permitted by the standards) be analyzed from the perspective of the requirements of the Accounting Standards, Guidance Notes, Industry practice, Entity / business specific disclosure requirements, etc., is referred to in the Accounting Policy Statement. The factors that may be considered in making the choice of accounting policy are discussed (not exhaustive) in the following paragraphs.

2. Whether the fact of compliance with Accounting Standard is enough disclosure in the Accounting Policy Statement?

There is no doubt that Accounting Standard needs to be complied with when choosing accounting policy. However, considering that how the business itself adopts to the accounting standard needs to be conveyed to the readers of the financial statements. A detailed note on how the standard is adopted needs to be disclosed, since the readers may not be well versed with accounting standards and its requirements.

For example:

In one of the Annual Reports, as reviewed by the FRRB, it is mentioned in the Accounting Policy is as stipulated under AS 9. FRRB is of the view, rightly so; that the policy regarding timing of recognition of revenue arising from sales, interest, royalty and dividend needs to be disclosed for better understanding of the financials.

3. Whether the terminologies used in Accounting Policies should be aligned to the terminologies used in Accounting Standards?

Some of the terminologies / words would have been assigned a specific meaning in the Accounting Standard, and hence its important to use them.

For example:

In one of the Annual Reports, as reviewed by the FRRB, it is mentioned in the Accounting Policy that Finished goods have been valued at cost or market value, whichever is lower, Finished stocks are valued at cost or realizable value whichever is lower. In the case of item A stocks, to the extent these are considered saleable, valuation is done at Raw Materials cost plus Packing Charges or realizable value whichever is lower. The underlined words should have been Net Realizable Value which is the terminology used and conveys a meaning that it is not only the market value or realizable value; it also considers the estimated cost to sell the product. Similarly, in the above two cases the mode of valuation is not described like whether it is on FIFO Basis, Weighted Average basis or Specific Identification method, etc., Further, the Accounting policy should also define how the cost is arrived at or what it includes viz., the Cost includes the purchase price, freight, net of taxes, etc.,

Therefore the Accounting Policy would be incomplete in absence of full details. In absence of the right terminologies being used, the reader may get an impression of non-compliance with Accounting Standard; though in fact it may not be so.

4. Whether the impact on the financial statements is an essential factor to be considered for disclosing any accounting, which is not in line with mandatory provisions of financial reporting standards, guidance notes, framework for preparation of financial statements, etc.,? FRRB has given an example, one of the Annual Reports mentioned Guidance Note on Accounting Treatment for Excise Duty issued by the ICAI requires that the closing stock of

finished goods should also include excise duty element and a provision for the liability to be made as the duty liability accrued on manufacture. However, inventory is valued at net of excise duty and provision for excise duty liability is, thereby, not considered necessary, as there is no impact on profit and loss account. No impact on financials is not a reason to be cited for non-compliance with accounting standard or guidance note.

In fact, as rightly pointed by FRRB; the non-provision of excise duty would be violation of Section 209(3)(b) of Companies Act 1956, which mandates that all the Companies have to be maintain accounts on accrual basis. This is also not in line with AS 2, which requires auditors to qualify in the audit report about non-compliance with AS 2. 5. How does one determine what is significant accounting policy to be disclosed? The word significant is very subjective. What is significant in ones judgment may not be so in anothers judgment. Therefore, it is very important for the Auditor / Accountant to determine what is significant considering that in the absence of which, the financial statements would be materially vitiated, incorrect (or perceived to be incorrect) and incomplete. The concept of materiality is very important in this regard. Any accounting policy that may be relevant for the readers of the financial statements should be disclosed.

For example an entity having loans and other borrowings would also have borrowing costs, which may be significant. These either could be written off or may have been capitalized as required by AS 16. Therefore, the disclosure on Borrowing Costs would then be significant.

Where Accounting Standard gives alternative methods of arriving the amount to be accounted, for example: determining the depreciation (straight line or written down value); could one of the factors to determine whether any accounting policy needs to be disclosed.

6. Whether the basic accounting assumptions needs to be questioned or looked into when accounting policies are framed / disclosed?

One of the assumptions on which the financial statements are prepared is the Going Concern. The FRRB has observed that an entity has disclosed the factors affecting their operations and indicates that assumption of going concern may not be appropriate in preparing the financials. However, the entity has failed to disclose the fact that the going concern assumption is no longer tenable and therefore misguiding the readers of the financial statements. Apart from the Management s responsibility to ensure that there is adequate disclosure of the fact that Going Concern is no longer valid, the Auditor should also consider the requirements of SA 570 and its impact on the Audit Report.

Conclusion:

Ensure all the elements of the financial statements are referred to in Accounting Policy to the extent it is possible and significant.

The Accounting Policy should reflect the entitys accounting principles rather than a quote from the Accounting Standard.

Accounting Policy cannot be a departure from Accounting Standard, Guidance Note or other requirements of Company Law.

To make a prudent judgment on what is significant to be disclosed.