Accounting Standards – Definition | Objectives | Importance

Accounting Standards are authoritative guidelines issued to standardize accounting practices and policies, ensuring consistency, comparability, and reliability of financial statements. They prescribe the principles, rules, and disclosures for preparing and presenting financial information. In India, the Institute of Chartered Accountants of India (ICAI) develops these standards, which are mandated under the Companies Act, 2013, and apply to various entities based on their size and nature. Accounting Standards aim to eliminate discrepancies in accounting treatments and provide transparency for stakeholders.

Table of Contents

1. Objective of Accounting Standards
2. Compliance with the Accounting Standards
3. Accounting Standards and the Auditors
4. Accounting Standard and Board’s Report
5. Procedure for Issuing Accounting Standards by the Institute of Chartered Accountants of India (ICAI)
6. Criteria for Classification of Non-company Entities for Applicability of Accounting Standards
7. Criteria for Classification of Non-company Entities as Decided by the Institute of Chartered Accountants of India
8. Applicability of Accounting Standards to Non-company Entities

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1. Objective of Accounting Standards

Objective of Accounting Standards is to standardize the diverse accounting policies and practices with a view to eliminate to the extent possible the non-comparability of financial statements and add the reliability to the financial statements.

The Institute of Chartered Accountants of India, recognizing the need to harmonize the diverse accounting policies and practices, constituted an Accounting Standard Board (ASB) on 21st April, 1977.

2. Compliance with the Accounting Standards

• The Accounting Standards will be mandatory from the respective date(s) mentioned in the Accounting Standard(s). The mandatory status of an Accounting Standard implies that while discharging their attest functions, it will be the duty of the members of the Institute to examine whether the Accounting Standard is complied with in the presentation of financial statements covered by their audit. In the event of any deviation from the Accounting Standard, it will be their duty to make adequate disclosures in their audit reports so that the users of financial statements may be aware of such deviation.
• Ensuring compliance with the Accounting Standards while preparing the financial statements is the responsibility of the management of the enterprise. Statutes governing certain enterprises requires the enterprises that financial statements should be prepared in compliance with the Accounting Standards, e.g., the Companies Act, 2013 (section 133), and the Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2000.
• Financial Statements cannot be described as complying with the Accounting Standards unless they comply with all the requirements of each applicable Standard.

2.1 Advantages and Disadvantages of Accounting Standards

The setting of Accounting Standards has the following advantages:—

• Standards reduce to a reasonable extent or eliminate altogether confusing variation in the accounting treatments used to prepare the financial statements.
• There are certain area where important information are not required by law to be disclosed, standards may call for disclosure beyond that required by law.
• It facilitates comparison of financial statements of different companies situated at different places.

The disadvantages of setting accounting standards are:—

• There may be a trend towards rigidity and away from flexibility in applying accounting standards.
• Differences in accounting standards are bound to be because of differences in the traditions and legal system from one country to another.
• Accounting standards cannot override the law. The standards are required to be framed within the ambit of prevailing statute even though it is not an acceptable standard.
• The choice between better alternative Accounting treatment in a particular situation is eliminated.

3. Accounting Standards and the Auditors

Auditors are duty bound while discharging their attest function to ensure the Accounting Standards issued and made mandatory by the Central Government are complied with. Section 143(3)(e) of Companies Act, 2013 requires that the auditors to report whether in his opinion the financial statements comply with the Accounting Standards referred in section 133 of Companies Act, 2013.

4. Accounting Standard and Board’s Report

Section 134(5)(a) of Companies Act, 2013 states that Directors responsibility statement should include that in the preparation of the annual accounts the applicable Accounting Standards had been followed along with proper explanations relating to material departure.

5. Procedure for Issuing Accounting Standards by the Institute of Chartered Accountants of India (ICAI)

Broadly the following procedure is adopted for formulating the Accounting Standard:

• Accounting Standard Board (ASB) shall determine the broad areas in which Accounting Standards need to be formulated and the priority in regard to the selection thereof.
• In the preparation of Accounting Standards, ASB will be assisted by Study Groups constituted to consider specific subjects. In the formation of Study Groups, the members of the Institute and others will make provision for wide participation.
• ASB will also hold a dialogue with the representatives of the Government, Public Sector Undertakings, Industry and other organizations for ascertaining their views.
• On the basis of the work of the Study Groups and the dialogue with the organizations referred to above, an exposure draft of the proposed standard will be prepared and issued for comments by members of the Institute and the public at large.
• The draft of the proposed standard will include the following basic points:

1. 1. A Statement of concepts and fundamental accounting principles relating to the Standard.
   2. Definitions of the terms used in the Standard.
   3. The manner in which the accounting principles have been applied for formulating the Standard.
   4. The presentation and disclosure requirements in complying with the standard.
   5. Class of entities to which the Standard will apply.
   6. Date from which the Standard will be effective.

• After taking into consideration the comments received, the draft of the proposed Standard will be finalised by ASB and submitted to the Council of the Institute.
• The Council of the Institute will consider the final draft of the proposed Standard, and if found necessary, modify the same in consultation with ASB. The Accounting Standard on the relevant subject will then be issued under the authority of the Council.

So far ICAI has issued 29 Accounting Standards. However AS-8 on “Research & Development” and AS-6 on Depreciation was withdrawn consequent to issue of AS-26 and AS-10 (Revised) “respectively”.

Effectively there are 27 Accounting Standards at present the AS-1 to AS-5, AS-7 and AS-9 to AS-29 and these are notified by the Central Government u/s 133 of the Companies Act, 2013.

5.1 Scope of Accounting Standards

• Efforts will be made to issue Accounting Standards which are in conformity with the provisions of the applicable laws, customs, usages and business environment in India. However, if a particular Accounting Standard is found to be not in conformity with law, the provisions of the said law will prevail and the financial statements should be prepared in conformity with such law.
• The Accounting Standards by their very nature cannot and do not override the local regulations which govern the preparation and presentation of financial statements in the country. However, the ICAI will determine the extent of disclosure to be made in financial statements and the auditor’s report thereon. Such disclosure may be by way of appropriate notes explaining the treatment of particular items. Such explanatory notes will be only in the nature of clarification and therefore need not be treated as adverse comments on the related financial statements.
• The Accounting Standards are intended to apply only to items which are material. Any limitations with regard to the applicability of a specific Accounting Standard will be made clear by the ICAI from time to time. The date from which a particular Standard will come into effect, as well as the class of entities to which it will apply, will also be specified by the ICAI. However, no standard will have retroactive application, unless otherwise stated.
• The Institute will use its best endeavour to persuade the Government, appropriate authorities, industrial and business community to adopt the Accounting Standards in order to achieve uniformity in preparation and presentation of financial statements.
• In formulation of Accounting Standards, the emphasis would be on laying down accounting principles and not detailed rules for application and implementation thereof.
• The Standards formulated by the ASB include paragraphs in bold italic type and plain type, which have equal authority. Paragraphs in bold italic type indicate the main principles. An individual standard should be read in the context of the objective stated in that standard and the Preface.

5.2 National Advisory Committee on Accounting Standard (NACAS)

Under section 210A of Companies Act, 1956, the Central Government by notification has constituted a committee to advise the Central Government on the formulation and laying down of accounting policies and accounting standards for adoption by companies or class of companies specified under the Act. Based on the recommendations of NACAS, the Central Government has notified AS-1 to AS-5, AS-7 and AS-9 to AS-29 in December 2006 in the form of Companies (Accounting Standards) Rules, 2006.

Section 132 of the Companies Act, 2013 provides that a National Financial Reporting Authority (NFRA) will be constituted and Accounting Standards will be notified by the Central Government in consultation with National Financial Reporting Authority in place of NACAS. However till the NFRA is constituted under new Companies Act, 2013 the Central Government may prescribe the Standard of Accounting as recommended by the ICAI in consultation with NACAS constituted under section 210A of the Companies Act, 1956. The Central Government has reconstituted the NACAS in October 2016 till the NFRA comes in force.

6. Criteria for Classification of Non-company Entities for Applicability of Accounting Standards

The Council, at its 400th meeting, held on March 18-19, 2021, considered the matter relating to applicability of Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI), to Non-company entities (Enterprises). The scheme for applicability of Accounting Standards to Non-company entities shall come into effect in respect of accounting periods commencing on or after April 1, 2020.

1. For the purpose of applicability of Accounting Standards, Non-company entities are classified into four categories, viz., Level I, Level II, Level III and Level IV.
   Level I entities are large size entities, Level II entities are medium size entities, Level III entities are small size entities and Level IV entities are micro entities. Level IV, Level III and Level II entities are referred to as Micro, Small and Medium size entities (MSMEs). The criteria for classification of Non-company entities into different levels are given in Annexure 1.
   The terms ‘Small and Medium Enterprise’ and ‘SME’ used in Accounting Standards shall be read as ‘Micro, Small and Medium size entity’ and ‘MSME’ respectively.
2. Level I entities are required to comply in full with all the Accounting Standards.
3. Certain exemptions/relaxations have been provided to Level II, Level III and Level IV Non-company entities. Applicability of Accounting Standards and exemptions/relaxations to such entities are given in Annexure 2.
4. This Announcement supersedes the earlier Announcement of the ICAI on ‘Harmonisation of various differences between the Accounting Standards issued by the ICAI and the Accounting Standards notified by the Central Government’ issued in February 2008, to the extent it prescribes the criteria for classification of Non-company entities (Non-corporate entities) and applicability of Accounting Standards to non-company entities, and the Announcement ‘Revision in the criteria for classifying Level II non-corporate entities’ issued in January 2013.
5. This Announcement is not relevant for Non-company entities who may be required to follow Ind AS as per relevant regulatory requirements applicable to such entities.
6. The changes arising from this Announcement will be incorporated in the Accounting Standards while publishing the updated Compendium of Accounting Standards.

7. Criteria for Classification of Non-company Entities as Decided by the Institute of Chartered Accountants of India

Level I Entities

Non-company entities which fall in any one or more of the following categories, at the end of the relevant accounting period, are classified as Level I entities:

1. Entities whose securities are listed or are in the process of listing on any stock exchange, whether in India or outside India.
2. Banks (including co-operative banks), financial institutions or entities carrying on insurance business.
3. All entities engaged in commercial, industrial or business activities, whose turnover (excluding other income) exceeds rupees two-fifty crore in the immediately preceding accounting year.
4. All entities engaged in commercial, industrial or business activities having borrowings (including public deposits) in excess of rupees fifty crore at any time during the immediately preceding accounting year.
5. Holding and subsidiary entities of any one of the above.

Level II Entities

Non-company entities which are not Level I entities but fall in any one or more of the following categories are classified as Level II entities:

1. All entities engaged in commercial, industrial or business activities, whose turnover (excluding other income) exceeds rupees fifty crore but does not exceed rupees two-fifty crore in the immediately preceding accounting year.
2. All entities engaged in commercial, industrial or business activities having borrowings (including public deposits) in excess of rupees ten crore but not in excess of rupees fifty crore at any time during the immediately preceding accounting year.
3. Holding and subsidiary entities of any one of the above.

Level III Entities

Non-company entities which are not covered under Level I and Level II but fall in any one or more of the following categories are classified as Level III entities:

1. All entities engaged in commercial, industrial or business activities, whose turnover (excluding other income) exceeds rupees ten crore but does not exceed rupees fifty crore in the immediately preceding accounting year.
2. All entities engaged in commercial, industrial or business activities having borrowings (including public deposits) in excess of rupees two crore but does not exceed rupees ten crore at any time during the immediately preceding accounting year.
3. Holding and subsidiary entities of any one of the above.

Level IV Entities

Non-company entities which are not covered under Level I, Level II and Level III are considered as Level IV entities.

Additional requirements

1. An MSME which avails the exemptions or relaxations given to it shall disclose (by way of a note to its financial statements) the fact that it is an MSME, the Level of MSME and that it has complied with the Accounting Standards insofar as they are applicable to entities falling in Level II or Level III or Level IV, as the case may be.
2. Where an entity, being covered in Level II or Level III or Level IV, had qualified for any exemption or relaxation previously but no longer qualifies for the relevant exemption or relaxation in the current accounting period, the relevant standards or requirements become applicable from the current period and the figures for the corresponding period of the previous accounting period need not be revised merely by reason of its having ceased to be covered in Level II or Level III or Level IV, as the case may be. The fact that the entity was covered in Level II or Level III or Level IV, as the case may be, in the previous period and it had availed of the exemptions or relaxations available to that Level of entities shall be disclosed in the notes to the financial statements. The fact that previous period figures have not been revised shall also be disclosed in the notes to the financial statements.
3. Where an entity has been covered in Level I and subsequently, ceases to be so covered and gets covered in Level II or Level III or Level IV, the entity will not qualify for exemption/relaxation available to that Level, until the entity ceases to be covered in Level I for two consecutive years. Similar is the case in respect of an entity, which has been covered in Level II or Level III and subsequently, gets covered under Level III or Level IV.
4. If an entity covered in Level II or Level III or Level IV opts not to avail of the exemptions or relaxations available to that Level of entities in respect of any but not all of the Accounting Standards, it shall disclose the Standard(s) in respect of which it has availed the exemption or relaxation.
5. If an entity covered in Level II or Level III or Level IV opts not to avail any one or more of the exemptions or relaxations available to that Level of entities, it shall comply with the relevant requirements of the Accounting Standard.
6. An entity covered in Level II or Level III or Level IV may opt for availing certain exemptions or relaxations from compliance with the requirements prescribed in an Accounting Standard:
   Provided that such a partial exemption or relaxation and disclosure shall not be permitted to mislead any person or public.
7. In respect of Accounting Standard (AS) 15, Employee Benefits, exemptions/relaxations are available to Level II and Level III entities, under two sub-classifications, viz., (i) entities whose average number of persons employed during the year is 50 or more, and (ii) entities whose average number of persons employed during the year is less than 50. The requirements stated in paragraphs (1) to (6) above, mutatis mutandis, apply to these sub-classifications.

8. Applicability of Accounting Standards to Non-company Entities

The Accounting Standards issued by the ICAI, as on April 1, 2020, and such standards as issued from time-to-time are applicable to Non-company entities subject to the relaxations and exemptions in the announcement. The Accounting Standards issued by ICAI as on April 1, 2020, are:

(1) Applicability of the Accounting Standards to Level 1 Non-company entities.

Level I entities are required to comply in full with all the Accounting Standards.

(2)  Applicability of the Accounting Standards and exemptions/relaxations for Level II, Level III and Level IV Non-company entities

(A)  Accounting Standards applicable to Non-company entities:

(B) Accounting Standards in respect of which relaxations/exemptions from certain requirements have been given to Level II, Level III and Level IV Non-company entities:

(i) Accounting Standard (AS) 10, Property, Plant and Equipments

Paragraph 87 relating to encouraged disclosures is not applicable to Level III and Level IV Non-company entities.

(ii) AS 11, The Effects of Changes in Foreign Exchange Rates (revised 2018)

Paragraph 44 relating to encouraged disclosures is not applicable to Level III and Level IV Non-company entities.

(iii) AS 13, Accounting for Investments

Paragraph 35(f) relating to disclosures is not applicable to Level IV Non-company entities.

(iv) Accounting Standard (AS) 15, Employee Benefits (revised 2005)

(1) Level II and Level III Non-company entities whose average number of persons employed during the year is 50 or more are exempted from the applicability of the following paragraphs:

(a) paragraphs 11 to 16 of the standard to the extent they deal with recognition and measurement of short-term accumulating compensated absences which are non-vesting (i.e., short-term accumulating compensated absences in respect of which employees are not entitled to cash payment for unused entitlement on leaving);

(b) paragraphs 46 and 139 of the Standard which deal with discounting of amounts that fall due more than 12 months after the balance sheet date;

(c) recognition and measurement principles laid down in paragraphs 50 to 116 and presentation and disclosure requirements laid down in paragraphs 117 to 123 of the Standard in respect of accounting for defined benefit plans. However, such entities should actuarially determine and provide for the accrued liability in respect of defined benefit plans by using the Projected Unit Credit Method and the discount rate used should be determined by reference to market yields at the balance sheet date on government bonds as per paragraph 78 of the Standard. Such entities should disclose actuarial assumptions as per paragraph 120(l) of the Standard; and

(d) recognition and measurement principles laid down in paragraphs 129 to 131 of the Standard in respect of accounting for other long-term employee benefits. However, such entities should actuarially determine and provide for the accrued liability in respect of other long-term employee benefits by using the Projected Unit Credit Method and the discount rate used should be determined by reference to market yields at the balance sheet date on government bonds as per paragraph 78 of the Standard.

(2) Level II and Level III Non-company entities whose average number of persons employed during the year is less than 50 and Level IV Non-company entities irrespective of number of employees are exempted from the applicability of the following paragraphs:

(a) paragraphs 11 to 16 of the standard to the extent they deal with recognition and measurement of short-term accumulating compensated absences which are non-vesting (i.e., short-term accumulating compensated absences in respect of which employees are not entitled to cash payment for unused entitlement on leaving);

(b) paragraphs 46 and 139 of the Standard which deal with discounting of amounts that fall due more than 12 months after the balance sheet date;

(c) recognition and measurement principles laid down in paragraphs 50 to 116 and presentation and disclosure requirements laid down in paragraphs 117 to 123 of the Standard in respect of accounting for defined benefit plans. However, such entities may calculate and account for the accrued liability under the defined benefit plans by reference to some other rational method, e.g., a method based on the assumption that such benefits are payable to all employees at the end of the accounting year; and

(d) recognition and measurement principles laid down in paragraphs 129 to 131 of the Standard in respect of accounting for other long-term employee benefits. Such entities may calculate and account for the accrued liability under the other long-term employee benefits by reference to some other rational method, e.g., a method based on the assumption that such benefits are payable to all employees at the end of the accounting year.

(v) AS 19, Leases

(a) Paragraphs 22 (c),(e) and (f); 25 (a), (b) and (e); 37 (a) and (f); and 46 (b) and (d) relating to disclosures are not applicable to Level II Non-company entities.

(b) Paragraphs 22 (c),(e) and (f); 25 (a), (b) and (e); 37 (a), (f) and (g); and 46 (b), (d) and (e) relating to disclosures are not applicable to Level III Non-company entities.

(c) Paragraphs 22 (c),(e) and (f); 25 (a), (b) and (e); 37 (a), (f) and (g); 38; and 46 (b), (d) and (e) relating to disclosures are not applicable to Level IV Non-company entities.

(vi) AS 22, Accounting for Taxes on Income

(a) Level IV Non-company entities shall apply the requirements of AS 22, Accounting for Taxes on Income, for Current tax defined in paragraph 4.4 of AS 22, with recognition as per paragraph 9, measurement as per paragraph 20 of AS 22, and presentation and disclosure as per paragraphs 27-28 of AS 22.

(b) Transitional requirements

On the first occasion when a Non-company entity gets classified as Level IV entity, the accumulated deferred tax asset/liability appearing in the financial statements of immediate previous accounting period, shall be adjusted against the opening revenue reserves.

(vii) AS 26, Intangible Assets

Paragraphs 90(d)(iii); 90(d)(iv) and 98 relating to disclosures are not applicable to Level IV Non-company entities.

(viii) AS 28, Impairment of Assets

(a) Level II and Level III Non-company entities are allowed to measure the ‘value in use’ on the basis of reasonable estimate thereof instead of computing the value in use by present value technique. Consequently, if Level II or Level III Non-company entity chooses to measure the ‘value in use’ by not using the present value technique, the relevant provisions of AS 28, such as discount rate etc., would not be applicable to such an entity. Further, such an entity need not disclose the information required by paragraph 121(g) of the Standard.

(b) Also, paragraphs 121(c)(ii); 121(d)(i); 121(d)(ii) and 123 relating to disclosures are not applicable to Level III Non-company entities.

(ix) AS 29, Provisions, Contingent Liabilities and Contingent Assets (revised 2016)

Paragraphs 66 and 67 relating to disclosures are not applicable to Level II, Level III and Level IV Non-company entities.

(C) In case of Level IV Non-company entities, generally there are no such transactions that are covered under AS 14, Accounting for Amalgamations, or jointly controlled operations or jointly controlled assets covered under AS 27, Financial Reporting of Interests in Joint Ventures. Therefore, these standards are not applicable to Level IV Non-company entities. However, if there are any such transactions, these entities shall apply the requirements of the relevant standard.