Accounting Standard 1: DISCLOSURE OF ACCOUNTING POLICIES

1. Which Accounting Standard deals with Disclosure of Accounting Policies

Accounting Standard (AS) 1 “Disclosure of Accounting Policies”, issued by ICAI deals with the disclosure of significant policies followed in preparing and presenting final accounts.

2. Is Disclosure of Accounting Policies Mandatory

Yes, disclosure of accounting policies is mandatory (compulsory). It must be followed by all concerns (whether a company, firm or proprietorship).

3. Why is Disclosure of Accounting Policies Important

The disclosure of accounting policies followed helps to properly study, compare and judge the figures in the final accounts. The accounting policies followed may not be same for all concerns. Due to such importance, even the Companies Act and the Income tax Act make it compulsory to adopt AS 1 and make a disclosure of accounting policies.

4. What is the Purpose of AS – 1

To state which accounting policies should be disclosed in the final accounts and in what manner.

5. Which are the Fundamental Accounting Assumptions

a. Going Concern: The concern is normally viewed as a going concern, that is, as continuing in operation in future. It is assumed that the concern has neither the intention nor the necessity of winding up or of reducing the level of its operations.

b. Consistency: It is assumed that accounting policies are consistent from one accounting year to another.

c. Accrual: Revenues and costs are recorded in the final accounts of the period to which they relate as they are earned or incurred (and not as money is received or paid)

6. Is it necessary to disclose Fundamental Accounting Assumptions

No, The fundamental accounting assumptions are usually not specifically disclosed because their acceptance and use are assumed. Disclosure is necessary only if these assumptions are not followed. Thus, if a concern is changes method of depreciation from WDV to FIM, the fundamental assumption of ‘Consistency’ is no longer valid and a disclosure is necessary.

7. Meaning of Accounting Policy

Accounting policies refer to the specific accounting principles and the methods of applying those principles adopted by the concern in the preparation and presentation of final accounts.

8. Areas in which different Accounting Policies may be adopted

1. Methods of depreciation
2. Valuation of stock
3. Treatment of goodwill
4. Valuation of investments
5. Treatment of expenditure during construction
6. Conversion of foreign currency items
7. Recognition of profit on long – term contracts
8. Valuation of fixed assets
9. Treatment of contingent liabilities.

The above list of examples is illustrative and not exhaustive.

9. Basic rule followed in Selection of an Accounting Policy

A concern should select such accounting policies as enable it to present a true and fair view of its state of affairs.

10. Major factors influencing selection of Accounting Policy

1. Prudence: Since future events are uncertain (may or may not happen), profit are not anticipated but recorded only when realized. Provision is made for all known liabilities and losses even though the amount can only be an estimate and not an exact figure.
2. Substance over form: It is the substance (essence) of transactions and not their legal form that should be considered while recording them in final accounts. (For example, based on this factor, AS-9 on Revenue Recognition states that revenue from sale should be recorded when the risks & rewards of ownership have passed, rather than when the legal title has passed).
3. Materiality: Final accounts should disclose all “material” items, i.e. items whose knowledge might influence the decisions of the user of the final accounts.

11. Rules followed in Disclosure of Accounting Policies

a. All significant accounting policies adopted in the preparation and presentation of final accounts should be disclosed.

b. Such disclosure should form part of the final accounts.

c. All policies should be disclosed in one place instead of being scattered at many places in several schedules and notes to the accounts.

12. Rules followed in Disclosure of Change in Accounting Policies

a. Any important change in an accounting policy should be disclosed.

b. The effect of such change on the value of any item in the final accounts should also be disclosed. If such amount cannot be ascertained, wholly or in part, such fact should be disclosed.

c. A change likely to have an effect not in current but in later years should also be disclosed in the year in which the change is made.

13. Can Disclosure of a Policy be a Remedy for Wrong Entry

No, disclosure of accounting policies or of changes therein cannot remedy (rectify) a wrong entry in the accounts (e.g. a concern cannot write off capital expenditure as revenue expenses by disclosing in the notes to accounts that it is the accounting policy of the concern to do so.)

14. Main features or requirements of AS - 1

1. All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed.

2. If the fundamental accounting assumption, viz. Going Concern, Consistency and Accrual are followed in financial statements, specific disclosure is not required. But if a fundamental accounting assumption is not followed, the fact should be disclosed.

3. Any change in the accounting policies which has a material effect in the current period or which is 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. If such amount is not ascertainable, wholly or in part, the fact should be indicated.

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

EXAMPLES ON AS1

Q. 1. Which different accounting policies may be adopted in the areas of method of depreciation.

Ans. The method of depreciation may be (i) at cost; or (ii) at cost or market value whichever is lower. Cost of Stock may be calculated (i) under First in First Out (FIFO) Method; or (ii) under Weighted Average Method.

[See Accounting Standard 6 below].

Q. 2. Which different accounting policies may be adopted in the areas of valuation of stock.

Ans. Stock may be valued (i) at cost; or (ii) at cost or market value whichever is lower. Cost of Stock may be calculated (i) under First Out (FIFO) Method; or (ii) under Weighted Average Method.

Market Value of Stock may be calculated as

1. Net Realisable Value; or

(ii) Net Replacement Value. [See Accounting Standard 2].

Q. 3. M/S Gupta & Co. has changed the method of valuation of stock from FIFO to Weighted Average with effect of the current year. However, this change has no effect on the accounts for the current year though it may have a big effect in future. Therefore M/S Gupta & Co. has not made any disclosure about this change in the accounts of the current year.

Ans. According to AS 1, a change likely to have an effect not in current but in later year should also be disclosed in the year in which the change is made. Hence, the action of Gupta & Co. is not in accordance with AS 1.

Q. 4. JW Ltd. sent a copy of final accounts to all its members. The Managing director sent a separate letter to each member containing the note on the accounting policies followed for preparing the final accounts.

Ans. Accounting policies of the JW Ltd. should have been disclosed as a note forming part of the accounts.

Q. 5. The accounting policies for recording income and expenses were given below the income and Expenditure Account and the accounting policies for recording assets and liabilities were given below the Balance Sheet by the Company.

Ans. All policies should be disclosed in one place. Thus, instead of separate notes below the income and Expenditure A/c and the Balance Sheet, the accounting policies should have been disclosed in one place as a note forming part of the accounts.

Q. 6. Hilary & Co. prepares its accounts on cash basis.

Ans. According to AS 1, accrual is a fundamental accounting assumption. If such fundamental accounting assumption is not followed, it must be disclosed in the notes to accounts.

Q. 7. YP & Co. having sales of Rs.100 crores shows an item of expenditure under a separate head of account only if it exceeds Rs.5,000. All such items below Rs.5,000 each are combined together and shown as ‘General Expenses’ in the profit and loss account.

Ans. AS 1 state that ‘materiality’ is an important factor in selecting and applying an accounting policy. The amount of Rs.5,000 is not material (important) since the sales are Rs.100 crores. The accounts would not show a wrong picture if such accounting policy is followed. In fact such policy is legally allowed under the Companies Act. Hence, this accounting policy can be followed but a disclosure should be made in the notes to accounts.