AS 1 – DISCLOSURE OF ACCOUNTING POLICIES

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.

OBJECTIVE OF AS 1 :
Accounting standard cannot and do not cover all possible areas of accounting and enterprise have reasonable degree of freedom in adopting accounting policies in areas not covered by standard.
Also, since entities operate in diverse situations, it is impossible to develop a single set of policies applicable to all enterprises for all time.
Accounting standard therefore permits more than one policy even in the areas covered by it. Such difference in accounting policies lead to difference in reported information even if underlying transactions are same.
Due to the above reasons AS 1, requires enterprise to disclose significant accounting policies actually adopted by them in preparation of financial statements.

FUNDAMENTAL ACCOUNTING ASSUMPTIONS:

Going concern:
It is assumed that the enterprise will continue its operations for the foreseeable future. The enterprise has neither the necessity nor the intention of liquidation or of curtailing materially the scale of operations.

Consistency
It is assumed that accounting policies are consistent from one period to another.

Accrual
Revenues and costs are accrued, i.e. , recognized as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate.

AREAS IN WHICH DIFFERENT ACCOUNTING POLICIES ARE ENCOUNTERED :
Method of depreciation
Valuation of inventories
Treatment of goodwill
Valuation of investments
Treatment of retirement benefits
Valuation of Fixed Assets
Treatment of contingent liabilities

SELECTION OF ACCOUNTING POLICIES :
Financial statements are prepared to present true and fair view of performance and position of the entity. In selecting a policy, alternative accounting policies should be evaluated keeping the above objective in mind. Major consideration governing the selection of accounting policies are

Prudence
Substance over form
Materiality

Prudence (Conservatism) :
Profits are not anticipated, but losses are provided for. Exercise of prudence will help in ensuring that

Profits are not overstated
Losses are not understated
Assets are not overstated
Liabilities are not understated
Example :

A trader is holding 100 units of its product in closing stock. Cost is 10,000 and NRV is 15,000
A trader is holding 100 units of its product in closing stock. Cost is 15,000 and NRV is 10,000

Substance over form :
Transactions and Events should be governed by their substance (actual facts) and not merely by legal form.

Example : When an asset is leased, in case of finance lease, the lessee charges the depreciation in the asset and not the lessor, the owner of the asset.

Materiality :
Financial statements should disclose all ‘material items’ i.e the items the knowledge of which might influence the users of financial statements.

SELECTION OF ACCOUNTING POLICIES :
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 the part of financial statements and significant accounting policies should normally be disclosed in one place.

Note : Being a part of the financial statements, the opinion of auditors should cover the disclosures of accounting policies.

CHANGES IN ACCOUNTING POLICIES :

PRACTICAL QUESTIONS

Question 1 : M/s Prashant Ltd.

In the books of M/s Prashant Ltd., closing inventory as on 31.03.2015 amounts to Rs 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 2014-15.

On the basis of weighted average method, closing inventory as on 31.03.2015 amounts to Rs 1,47,000. Realisable value of the inventory as on 31.03.2015 amounts to Rs 1,95,000. Discuss disclosure requirement of change in accounting policy as per AS-1.

Question 2 : ABC Ltd.

ABC Ltd. was making provision for non-moving inventories based on issues for the last 12 months up to 31.3.2016.

The company wants to provide during the year ending 31.3.2017 based on technical evaluation:

Total value of inventory: Rs 100 lakhs

Provision required based on 12 months issue: Rs 3.5 lakhs

Provision required based on technical evaluation: Rs 2.5 lakhs

Does this amount to change in Accounting Policy?

Can the company change the method of provision?

Question 3 : Jagannath Ltd.

Jagannath Ltd. had made a rights issue of shares in 2004. In the offer document to its members, it had projected a surplus of Rs. 40 crores during the accounting year to end on 31st March, 2015. 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 Rs. 10 crores. The board in consultation with the managing director, decided on the following:

Value year-end inventory at works cost (Rs. 50 crores) instead of the hitherto method of valuation of inventory at prime cost (Rs. 30 crores).
Provide depreciation for the year on straight line basis on account of substantial additions in gross block during the year, instead of on the reducing balance method, which was hitherto adopted. As a consequence, the charge for depreciation at Rs. 27 crores is lower than the amount of Rs. 45 crores which would have been provide had the old method been followed, by Rs. 18 cores.
Not to provide for “after sales expenses” during the warranty period. Till the last year, provision at 2% of sales used to be made under the concept of “matching of costs against revenue” and actual expenses used to be charged against the provision. The board now decided to account for expenses as and when actually incurred. Sales during the year total to Rs. 600 crores.
Provide for permanent fall in the value of investments – which fall had taken place over the past five years – the provision being Rs. 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 2014-2015.

ANSWERS

Answer1 :

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 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 i.e. 2014-15, 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 Rs 16,000.

Answer2 :

The decision of making provision for non-moving inventories on the basis of technical evaluation does not amount to change in accounting policy. 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.

In the given case, considering the total value of inventory, the change in the amount of required provision of non-moving inventory from Rs 3.5 lakhs to Rs 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 2016-17: “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 Rs 1 lakh.”

Answer3 :

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 to accounts should properly disclose the change and its effect.

Notes to Accounts:

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. Thus has been done to take cognizance of the more capital intensive method of production in account of heavy capital expenditure during the year. As a result of this change, the year–end inventory has been valued at Rs. 50 crores and the profit of the year is increased by Rs. 20 crores.
In view of the heavy capital intensive method of production introduced during the year, the company has decided to change the method of providing depreciation from reducing balance method to straight line method. As a result of this change, depreciation has been provided at Rs. 27 crores which is lower than the change which would have been made had the old method and the old rates been applied by Rs. 18 crores. To that extent, the profit for the year is increased.
So far, the company has been providing 2% of sales for meeting “after sales expenses during the warranty period. With the improved method of production, the probability of defects occurring in the products has reduced considerably. Hence, the company has decided not to make provision for such expenses but to account for the same as and when expenses are incurred. Due to this change, the profit for the year is increased by Rs. 12 crores than would have been the case if the old policy were to continue.
The company has decided to provide Rs. 10 crores for the permanent fall in the value of investments which has been taken place over the period of past 5 years. The provision so made has reduced the profit disclosed in the accounts by Rs. 10 crores.