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A Note on Financial Reporting Standard (14
Questions & Answers)
1. What is the distinction betweenStandard setting bodies and regulatory
authorities?
There is a distinction between the standard
setting bodies and regulatory authorities.
Standard Setting bodies such as International
Accounting Standards Board (ISAB), USA,
Financial Accounting Standards Board (FASB),
USA, Institute of chartered Accountants of
India (ICAI) are typically professional bodies
governed by the principle of self regulation.
Whereas, Securities Board of India (SEBI),
India and Companies Act/Income Tax act
(India) are government authorities and havelegal authority to enforce financial reporting
requirements.
2. What is IFRS?IFRS is International Financial Reporting
Standards and it is attempt to have one global
standard for financial reporting. At the centerof financial IFRS framework is (a) fair
representation of financial position; (b)
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financial performance and; (c) cash flows of a
company.
3. What are the qualitativecharacteristics of Financial Statements
under IFRS framework?
(a) Understandability (information should bereadily understandable; (b) Relevance
(Information should be timely rather than
dated (c) Reliability (Reliable information is
free from bias and materiality). Materiality
means that omission & misstatement of
information.
4. What elements provide information onfinancial position and Financial
performance?
Financial position is measured by relativecomposition of Assets, Liabilities and Equity in
the balance sheet. The financial performance is
measured by Revenue, Expenses and Capital
account adjustments such as depreciation.
5. What are the underlying assumptionsunder IFRS framework?Accrual basis of accounting and going concern
are the two key underlying assumptions of
IFRS.
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6. What is GAAP?GAAP is Generally Accepted Accounting
Practice and it is a standard prescribed
primarily in USA. GAAP is the standards and
prescriptions prescribed by various bodies but
primarily issued by American Institute of
Certified Public Accountants (AICPA). There are
hierarchy in GAAP. The top level hierarchy is
standards issued by Financial Accounting
Standards board (FASB). Prescriptions from
other bodies come into play only when there is
no relevant explicit prescription by FASB.
7. What are main difference betweenGAAP and IFRS?
The principle difference between GAP and IFRS
lies in that GAAP provides separate objectivesfor business and non-business entities where
as IFRS makes no such distinction.
3What are disclosures and where they are
presented in the annual report?
Under both GAAP and IFRS, companies can
choose alternative accounting policies such asthat in depreciation accounting and inventory
accounting. These policies have to be disclosed
either as footnotes to the financial statements
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or discuss their accounting policies in
Managerial discussion & analysis (MD&A)
8. What are the Accounting Standards(AS) in India?
Some of the important accounting standards in
India are AS#1 (Deals with discloser
requirements); As#2 (deals with valuation of
inventories); AS#3 (Cash Flow statement);
AS#5 (Net profit or loss for current period and
previous period & significant changes in
accounting polices thereof); AS#9 (Revenue
Recognition); AS#17 (Segment Reporting);
AS#22 (taxes on income).
9. What is AS#1?AS#1 deals with disclosure polices of the
company. It facilitates better understanding offinancial statements as well as meaningful
comparison between financial statements of
different enterprises. Accounting policies are
specific accounting principles and their
application in preparation of financial
statements. These policies pertain to thefollowing:
Treatment ofGoodwill
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Valuation of InventoriesValuation of Investments
Valuation of Fixed Assets
Methods of Depreciation
Treatment of retirement benefits
Treatment of Contingent Liabilities
PRIMARY CONSIDERATION of the accounting
policy is to provide the financial statements
that represent a true and fair view of the state
of affairs of the enterprise. The SECONDARY
CONSIDERATIONs are Prudence, Substance &
Materiality. The fundamental assumptions in
accounting are (a) going concern; (b)
Consistency and; (c) accrual. These are
not explicitly stated in the annual reportbut are assumed.
The disclosure requirements are as
follows:
All significant accounting policiesadopted should be disclosed.
The disclosure should form part of the
financialstatements.
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Any change in the accounting policieswhich has a material effect in the
current period should be disclosed along
with amount of effect.
If the fundamental accounting
assumptionsare not followed, the fact
should be disclosed.
10. What is AS#2?Scope: Specifies the principals for valuing the
inventory & Disclosure of the specific policies
adopted by the management for the valuation
of inventory.
This statement should be applied in accounting
for inventories other than:
a.Work in progress arising underconstruction contracts, including directly
related service contracts.
b.Work in progress arising in the ordinarycourse of business of service providers.
c.Shares, debentures and other financialinstruments held as stock-in-trade; And.
d.Producers inventories of livestock,agricultural and forest products, and
mineral oils, ores and gases to that extent
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that they are measured at net realisable
value in accordance with well established
practices in those industries.
Definition of Inventories: they are assets,
held for sale in the ordinary course of business
in the process of production for such sale and
in the form of materials or supplies to be
consumed in the production process or in the
rendering of services.
Definition of Net Realizable Value is the
estimated selling price in the ordinary course
of business less the estimated costs of
completion and the estimated cost necessary
to make the sale. Inventories are written down
to net realizable value on an item-by-itembasis except where it is appropriate to group
similar or related items;An assessment of net
realizable value is made as at each balance
sheet date.The valuation takes into
consideration cost and selling price fluctuations
directly relating to events occurring after thebalance sheet date to the extent that such
events confirm the conditions existing at the
balance sheet date.
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Prescription on valuation: Inventoriesshould be valued at the lower ofCostand Net
Realizable Value. The Practice of writing
down inventories below cost to Net Realizable
Value is consistent with the view that assets
should not be carried in excess of amounts
expected to be realized from their sale or use.
The cost of inventories should comprise:
(a) Cost of purchase ( including Duties and
taxes (other than those subsequently
recoverable by the enterprise from the taxing
authorities like MODVAT); Freight inwards and
other expenditure directly attributable to the
acquisition; (b) Cost of conversion: (Labor
Costs directly related to the production of
finished goods; Fixed and variable production
overheads that are incurred in converting
materials into finished goods and; Other
costs: included only to the extent they are
incurred in bringing the inventories to their
present location and condition. The cost should
exclude (a) Abnormal wastages of materials,
labour or other production costs; (b0 Storage
costs, unless they are necessary in the
production process; (c) Administrative
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overheads which do not contribute to bringing
the inventories to their present location and
condition and; (d) Selling and distribution
overheads.
Methods of Valuation of Inventory: FIFO,
LIFO, Weighted average.
Disclosure Requirements: Accounting
policies adopted in measuring
inventories, Cost formula used, Total carryingamount of inventories, methods of
Classification of the inventory into raw
materials and components, work in progress,
finished goods, stores and spares, and loose
tools.
11. What is AS#5?AS#5 deals with NET PROFIT OR LOSS FOR
THE PERIOD, PRIOR PERIOD ITEMS AND
CHANGES IN ACCOUNTING POLICIES. Some
relevant definitions under AS#5 are:
Ordinary activities are any activities and
other incidental activities which are undertaken
by an enterprise as part of its business.
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Extraordinary items are income or expensesthat arise from non recurring events and
transactions.
Prior period items are income or expenses,
which arise, in the current period as a result of
errors or omissions in the preparation of the
financial statements of one or more prior
periods.
Accounting policies are the specificaccounting principles and the methods of
applying those principles in the preparation
and presentation of financial statements.
Disclosure requirements under AS#5 are as
follows:
Extraordinary items: The nature and the
amount ofeach extraordinary item should be
separately disclosed in the statement of profit
and loss in a manner that its impact on
current profit or loss can be perceived.
Ordinary items: When items of income andexpense from ordinary activities are of such
size, nature or incidence that their
disclosure is relevant to explain the
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performance of the enterprise for the period,
the nature and amount of such items should
be disclosed separately.
Prior period items: The nature and amount
of prior period items should be separately
disclosed in the profit and loss statement in
such a way that their impact on the current
profit or loss can be perceived.
Accounting estimates: The nature andamount of a change in an accounting estimate
which has a material effect in the current
period or which is expected to have a material
effect in subsequent periods, should be
disclosed. If the effect cannot be quantified,
this fact should be disclosed.
Accounting policies: The effect of any
change in an accounting policy, if material,
should be disclosed in thefinancial statements
of the period quantifying the impact. Where
the effect cannot be quantified, wholly or in
part, the fact should be disclosed.
12. What is AS#9?AS#9 deals with recognizing revenue arising in
the course of the ordinary activities of the
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enterprise. It includes sale of goods, rendering
of services and use by others of enterprise
resources yielding interest, royalties and
dividends. This statement does not deal with
the Revenue arising from construction
contracts; Revenue arising from hire-purchase,
lease agreements, Revenue arising from
government grants and other similar subsidies
and the Revenue of insurance companies
arising from insurance contracts.
Revenue Recognition under of sale ofgoods should be based on the following
CONDITIONS:
a.The property in goods in transferred for aprice.
b.All significant risks and rewards have beentransferred and no effective control is
retained.
c.No significant uncertainty exists regardingthe amount of consideration.
d.It is reasonable to expect ultimatecollection of consideration.
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REVENUE RECOGNITION underRENDERING service should be based on
the following conditions:
a.Service is recognised either on completedservice or proportionate completion
method.
b.No, 1significant uncertainty existsregarding amount of consideration.
c. It is reasonable to expect ultimatecollection of consideration
d.Completed service method recognisesrevenue only when service complete or
substantially complete. In such cases
there are more than one act involved
and revenue is recognised on' execution of
all those acts.e.Proportionate completed method
recognises revenue proportionate with the
degree of completion of services. In such
cases there are more than one act involved
and revenue is recognised on execution of
certain acts.REVENUE RECOGNITION IN USE OFENTERPRISE RESOURCESBY OTHERS
under the following conditions:
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a.Interest: Revenue is recognized on thetime basis determined by the amount
outstanding and the rate applicable.
b.Royalty: Revenue is recognized inaccordance with the terms of the relevant
agreement.
c.Dividends: Revenue is recognized onlywhen a right to receive payment is
established.
DISCLOSURE REQUIREMENTS under AS#9When recognition of revenue is postponed due to
the effect of uncertainties, an enterprise should
disclose the circumstances in which revenue
recognition has been postponed.
13. What is AS#17?AS#17 deals with reporting financial
information about different types of products
and services an enterprise produces, and the
different geographical areas in which it
operates. Segment reporting benefits users in
terms of (a) Better understanding of the
performance of the enterprise; (b) Assess the
risks and returns of the enterprise and; (c)
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Make more informed judgments about the
enterprise as a whole.
Definitions under AS#17BUSINESS SEGMENT is a Distinguishable
component of an enterprise engaged in
providing an individual product or service
subject to risks and returns different from
other business segments.
GEOGRAPHICAL SEGMENT is a
Distinguishable component of an enterprise
Engaged in providing products or services
within a particular economic environment that
is subject to risks and returns that are differentfrom those of components operating in other
economic environments
Identification of Segment for Reporting: A
segment should be identified for reporting ifIts
revenue from sales to external customers is 10per cent more of the total revenue, or Its
segment result, whether profit or loss, is 10
per cent or more of the combined result of all
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segments in profit or loss, or Its segment
assets are 10 per cent or more of the total
assets of all segments. The location of
production or service facilities and other assets
of an enterprise or the location of its
customers. If total revenue attributable to all
reportable segment is less than 75% of the
total enterprises revenue, additional segments
should be identified as reportable segments,
even if they do not meet the 10% thresholds,
until at least 75% of total enterprises revenue
is included in reportable segments.
If a segment is identified as a reportable
segment in the current period, preceding
period segment data is presented for
comparative purpose, even if that segment did
not satisfy the 10% threshold in the preceding
period. A segment identified as a reportable
segment in the immediately preceding period
should continue to be a reportable segment for
the current period even if it does not meet the
10% threshold.
A segment should be reported as Business
Segment If RISKS AND RETURNS associated
with products and services are affected by
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Differences in the business segment. A
segment is reported as Geographic segment if
Operation are different countries or
geographical locations.
Companies can go for matrix presentation If
the risk & return of an enterprise are equally
effected by differences in the products and
services it produces and by differences in the
geographical areas in which it operates, then
the enterprise should use BUSINESS
SEGMENTS as its PRIMARY SEGMENT
reporting format and GEOGRAPHICAL
SEGMENTS as its SECONDARY REPORTING
format & full segment disclosures is given on
each basis
DISCLOSURE REQUIREMENTS underAS#17
a.Segment revenue from sales to externalcustomers
b.Segment revenue from transactions with othersegments
c.Segment resultd.Total carrying amount of segment assets;e.Total amount of segment liabilities;
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f.Additions to tangible and intangible fixedassets;
g.Depreciation and amortization for the periodh.Significant other non-cash expenses
14. What is AS#22?AS#22 deals with taxes on income. It deals
with ACCOUNTING INCOME (LOSS) which is
Net profit or loss for a period as per profit and
loss statement and TAXABLE INCOME (TAX
LOSS) which isIncome (loss) for a period
determined in accordance with the tax laws.
Accounting income and taxable income for a
period are seldom the same. Differences
between the two are on account of permanent
Differences & Timing Differences
Permanent differences are those which arise in
one period and do not reverse subsequently.
For e.g., an income exempt from tax or an
expense that is not allowable as a deduction
for tax purposes. Timing differences are thosewhich arise in one period and are capable of
reversal in one or more subsequent periods.
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For e.g., Depreciation, Sales Tax, Bonus etc.,
U/s 43B
CURRENTTAX is the amount that is expected
to be paid to the taxation authorities.
DEFERREDTAX ASSETS ANDLIABILITIES
are the tax amounts at the tax rates and tax
laws that have been enacted at the balance
sheet date. Excess tax paid as on balance
sheet date will be deferred tax assets and
taxes paid in short as on balance sheet are
deferred tax liabilities.
DISCLOSURE REQUIREMENTS underAS#22
a.Disclose major components of deferred taxassets and liabilities.
b.Deferred tax assets and liabilities should bedistinguished from assets and liabilities
representing current tax for the period
c.Disclose nature of evidence supportingrecognition of deferred tax assets in the
event of there being unabsorbed
depreciation or carried forward losses.
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d.On first implementation of the standard,the net deferred tax balance accumulated
prior to adoption of the standard should be
adjusted against revenue reserves.
HUL Annual Report - Instruction for study:
1.You may be asked to give the reported amount
of a particular asset or liability, revenue,
expenses, gains or losses. You have to
thoroughly read the Annual report and
familiarise yourself as to where the information
is available. For instance the amount of
revenue & expense, deferred tax assets,
deferred liability, Accounts payable, accounts
receivable, cost of goods sold etc
2.You have to familiarise yourself with where you
will find significant accounting policies. You
may be asked to explain a given accounting
policy.
3.You have to familiarise with the accounting
standards and should be able to relate a given
accounting policy with the accounting standard
4.You have to familiarize with segments wise
information reported in the annual report. You
may be asked to relate segment wise
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information with corresponding accounting
standard.
5.You have to familiarize with disclosures? In
addition you have to understand why they
important?
6.You have to familiarise with interest in Joint
ventures as reported in the annual report.
7.You have to familiarise with Operating
activities, investment activities and financing
activities reported in page 117? You should be
in a position to Define each type of activity
8.Familiarise with related party disclosure & its
significance in reporting
9.You have to familiarise with the kinds of
disclosures are presented in Management
Discussion and Analysis (MD&A) section of theannual report