Disclosure of Accounting Policies FAQs and their answers are given below:
1. How does an entity select an accounting policy which is appropriate in respect of a transaction or event which is not at all covered by Accounting Standards?
The methodology for the selection of accounting policy for any transaction or event not covered by Accounting Standards has not been spelt out in AS 1. In the absence of a Standard, the entity has to identify if there is any Guidance Note (of ICAI), and failing this, has to identify the existence or absence of pronouncements of other international bodies. This is done by analogising the transaction in hand to similar transactions or events dealt with in other Standards or in IFRS.
In such a selection, the major consideration is to ensure True and Fair View. In addition, Prudence, Materiality and Substance over Form have to be taken into account. The entity should also take cognizance of the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses laid out in the Conceptual Framework.
Situations like this do arise, for example, if an entity has to account for Carbon Credits. Carbon Credits, also known as carbon offsets, are permits that allow the owner to emit a certain amount of carbon dioxide or other greenhouse gases.
One unit of credit permits the emission of one ton of carbon dioxide or the equivalent of other greenhouse gases. It is a certification or licensing mechanism, and Carbon Credit units are at times bought and sold to meet regulatory requirements of carbon emissions. There is no Standard that deals with accounting for carbon credits. ICAI has brought out a GN on this topic.
2. An entity is a subsidiary. In presenting consolidated financial statements, the Parent has to maintain uniform accounting policies for all the entities covered by CFS. How does the subsidiary choose its accounting policy for its own stand-alone financial statements?
In practice, most subsidiaries will choose to select and adopt accounting policies that are adopted by the Parent. This process, if adopted, will simplify the consolidation process. When the Group selects and adopts the most appropriate accounting policy for the consolidation, it is unlikely that such a policy, when adopted by the Subsidiary, will vitiate the true and fair view of the information presented by the Subsidiary.
In certain rare cases, the Subsidiary may have some transactions or events of unique nature, which the Parent may not have. In such a case, and in the absence of a similar transaction in the books of Parent, the appropriate accounting policy adopted by the Subsidiary will be carried over to CFS.
3. An entity has determined that the going concern assumption is not valid and hence, prepares its statements on a liquidation basis. Does the auditor qualify the accounts?
No. Usage of either net recoverable basis or liquidation basis of accounting in the preparation of financial statements, in circumstances when the Going Concern assumption is not valid, does not lead to a qualification in the audit report. However, the audit report should include two points, namely,
(a) that GC assumption has not been adopted and the reasons, therefore, and
(b) that realisable value basis of accounting has been adopted.
These two points are incorporated in a Highlighted paragraph without qualifying the audit report.
4. An entity has appropriately disclosed all the accounting policies, including changes made in such policies, in a complete manner. However, in preparing the financial statements, the treatment of certain items is not in accordance with the policy. Does this violate AS 1?
Yes. It does. Merely disclosing the policies that show the correct accounting treatment is not the end in itself. In disclosing “significant accounting policies” in its financial statement, the entity, by implication, makes a representation that the financial statements have been prepared in conformity with such disclosed policies.
This representation would be rendered false if the accounting deviates from the policy. Therefore, there is a violation of AS 1. The auditor should either have the inappropriate accounting rectified or, failing which, should qualify the accounts.
5. An entity that owns a building has classified and accounted for it as PPE as per AS 10. The entity has adopted a Cost Model for this item of PPE. In a subsequent year, the entity changes the accounting from Cost Model to Fair Value (Revaluation) model. Does this change require to be treated as a change in Accounting policy?
AS 10 (PPE) provides that an entity should choose either the cost model or revaluation model as its accounting policy and apply that policy to the entire class of assets. Be it a cost model policy or a revaluation model, the entity should apply this policy consistently.
A change can be made only for a better and more appropriate presentation. If the entity can establish that movement from Cost Model to Revaluation Model is for better presentation, it can do so. It would thus be a change in accounting policy.
6. An entity that adopts the WDV method of depreciation moves to the SLM method. Does this change mean a change in accounting policy?
No. A change in the method of depreciation is a change in accounting estimate and not a change in accounting policy.
7. An entity effects a change in accounting policy. Should the effect of such a change be accounted for retrospectively, covering each and every previous year?
Prior to the withdrawal of AS 6 (Depreciation Accounting), a change in accounting policy was given a hybrid treatment. That is, the cumulative financial effect is computed retrospectively but accounted for in the year of change in accounting policy. However, after the withdrawal of AS 6, this aspect has not been specifically addressed either in AS 1 or in AS 5.
The current practice for NON-IND-AS entities is to continue with this hybrid methodology by accounting for the cumulative retrospective effect of such a change in the year of change. However, entities covered by IND-AS have to give effect to the change in accounting policy on a retrospective basis.
8. An entity is engaged in two different sets of activities, carrying assets and liabilities in each of these establishments in which such activities are carried on. Does the entity need to adopt two different sets of accounting policies?
So long as these different sets of activities are not comparable, and there are specific standards or guidance covering such activities, the entity is under obligation to adopt accounting policies to implement such pronouncements.
For example, if an entity is engaged in the manufacturing and sale of goods, as also as a construction contractor, the accounting for revenue for each of these activities will differ. The entity, therefore, necessarily has to adopt different policies as are appropriate for each type of activity.
9. An entity that has assessed the remaining useful life of PPE items as 7 years in year 1 makes a change in year 2 as 8 years (instead of continuing with 6). Does this change mean a change in accounting policy?
No. A change in the determination of the remaining useful life of PPE items is not a change in accounting policy since this change merely results in a change in the quantum of depreciation. This is to be treated as a change in accounting estimate and not as a change in accounting policy. In fact, remaining useful life is appropriately referred to as “estimated remaining useful life”.
10. An entity has selected and adopted accounting policies in respect of certain transactions and events to be in line with Accounting Standards. How does the auditor ensure that such policies reflect a true and fair view?
The true and fair view is achieved by being in strict conformity with the measurement and recognition prescriptions laid down in Accounting Standards. If the policy deviates from the measurement or recognition principles governing the transactions and events, the policy does not reflect a true and fair view. The entity should ensure that there is no deviation from Standards. The auditor should prompt and assist in such compliance.
11. An entity has disclosed in its accounting policy that all borrowing costs are recognised as an expense in the year in which it is incurred. Is this appropriate?
No. This is not an appropriate accounting policy. Borrowing costs should be capitalised subject to compliance with AS 16 Borrowing Costs. That means an element of capitalisation would be involved if these costs are incurred during the development period and are attributable to the development of qualifying assets.
12. An entity has prepared its financial statements otherwise than under the assumption of Going Concern being valid. The auditor notices that there are still some deviations, such as interest on Inter Corporate Deposits not being provided for. How this aspect would be covered in Auditor’s Report?
Auditors’ Report (draft)
We draw your attention to Note No.xxx of Schedule XXX. In view of the current and accumulated losses, the company has prepared the accounts on the assumption that the company is not a Going Concern and has accordingly shown investments and fixed assets at their current realizable value and made provisions for all known liabilities, except interest. No provision has been made in the accounts in respect of the interest of Rs. 300 lacs on Inter Corporate Deposits (ICDs) accepted by the Company. Had these provisions been made, the effect would have been that the loss for the year would have been higher by Rs. 300.000 lacs, and Current Liabilities and Provisions would have been higher by Rs.300 lacs.
—- Subject to the above, we are of the opinion that —
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