Chapter 4

Accounting, Standards of Accounting

What is accounting?

Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions
and information related to an organization's business activities. It involves the systematic and
methodical recording of financial data, the preparation of financial statements, and the interpretation
of financial information to facilitate decision-making, financial management, and accountability.

Here are the key components and functions of accounting -

a) Recording Transactions : Accounting begins with the recording of financial transactions, which
involve the exchange of goods, services, or assets between parties. Transactions are recorded
in chronological order using standardized accounting principles and practices to ensure
accuracy and consistency.
b) Classification and Categorization : Recorded transactions are classified and categorized into
various accounts based on their nature, such as assets, liabilities, equity, revenue, and
expenses. Each account represents a specific type of financial activity and is organized in a
chart of accounts for easy reference and analysis.
c) Double-Entry System : Accounting follows the double-entry system, which requires every
transaction to be recorded with at least two entries—a debit and a credit—that balance each
other. Debits and credits affect different accounts and must equal each other to maintain the
fundamental accounting equation: Assets = Liabilities + Equity.
d) Journal Entries : Transactions are initially recorded in a journal, known as the general journal,
using journal entries that document the date, accounts affected, and amounts debited and
credited. Journal entries provide a chronological record of transactions before they are posted
to the general ledger.
e) General Ledger : The general ledger is a master accounting record that contains all the
accounts used by an organization, along with their respective balances. Transactions recorded
in the journal are posted to the appropriate accounts in the general ledger, updating the
balances of each account.
f) Trial Balance : The trial balance is a summary of all the account balances in the general ledger,
prepared at the end of an accounting period to ensure that debits equal credits and that the
 accounting records are in balance. The trial balance serves as a preliminary step before
preparing financial statements.
g) Financial Statements : Financial statements are formal reports that summarize the financial
position, performance, and cash flows of an organization for a specific period. The main
financial statements include the balance sheet, income statement, statement of cash flows,
and statement of changes in equity. These statements provide valuable information to
investors, creditors, management, and other stakeholders for decision-making and analysis.
(i) Balance Sheet : The balance sheet presents the financial position of an organization
at a specific point in time, showing its assets, liabilities, and equity.
(ii) Income Statement : The income statement (also known as the profit and loss
statement) reports the revenues, expenses, and net income or loss generated by an
organization during a period.
(iii) Statement of Cash Flows : The statement of cash flows summarizes the cash inflows
and outflows from operating, investing, and financing activities, providing insights into
an organization's liquidity and cash flow management.
(iv) Statement of Changes in Equity : The statement of changes in equity explains the
changes in shareholders' equity over a period, including contributions, distributions,
net income or loss, and other adjustments.

(h) Analysis and Interpretation : Accounting information is analyzed and interpreted to assess the
financial performance, financial position, and cash flow dynamics of an organization. Financial
ratios, trend analysis, comparative analysis, and other analytical techniques are used to
evaluate profitability, solvency, liquidity, efficiency, and other aspects of financial
performance.

(i) Compliance and Reporting : Accounting ensures compliance with applicable accounting
standards, regulations, and reporting requirements established by regulatory authorities such
as Accounting Standard Board (ASB) of ICAI, National Financial Reporting Authority (NFRA),
disclosures, and statements are prepared and communicated to stakeholders in accordance
with these standards and regulations.

Overall, accounting plays a vital role in providing accurate, reliable, and timely financial information to
stakeholders, supporting decision-making, accountability, transparency, and regulatory compliance,
and facilitating the efficient operation and management of organizations across various industries and
sectors.
Accounting Conventions

Accounting conventions, also known as accounting principles or accounting standards, are a set of
guidelines, rules, and practices that govern the preparation, presentation, and interpretation of
financial statements and accounting information. These conventions provide a framework for
consistent and reliable financial reporting, ensuring that financial statements are prepared in
accordance with generally accepted accounting principles (GAAP) and are comparable, transparent,
and understandable to users.

Here are some commonly recognized accounting conventions -

(a) Historical Cost Principle : The historical cost principle states that assets should be recorded on
the balance sheet at their original cost at the time of acquisition, rather than their current
market value. This convention ensures objectivity and reliability in financial reporting by using
verifiable, objective, and historical transaction data.
(b) Revenue Recognition Principle : The revenue recognition principle dictates when and how
revenue should be recognized in the financial statements. According to this convention,
revenue should be recognized when it is earned and realized or realizable, regardless of when
cash is received. Revenue is generally recognized when goods are delivered or services are
rendered to customers.
(c) Matching Principle : The matching principle requires that expenses be recognized in the same
period as the revenues they help generate, regardless of when cash is paid. This convention
ensures that expenses are properly matched with the revenues they contribute to, resulting
in accurate determination of net income and financial performance.
(d) Conservatism Principle : The conservatism principle suggests that when there are
uncertainties or alternative accounting treatments available, accountants should choose the
option that results in lower profits or more conservative financial statements. This convention
helps mitigate the risk of overstatement of assets and income, promoting prudence and
reliability in financial reporting.
(e) Consistency Principle : The consistency principle states that accounting methods, practices,
and policies should be applied consistently from one accounting period to another to ensure
comparability and reliability of financial information. Changes in accounting methods or
policies should be disclosed and explained to users of the financial statements.
 (f) Materiality Principle : The materiality principle requires that financial statements disclose all
significant information that could influence the economic decisions of users. Information is
considered material if its omission or misstatement could affect the judgment of reasonable
users of the financial statements.
(g) Full Disclosure Principle : The full disclosure principle requires that all relevant and material
information be disclosed in the financial statements and accompanying notes to provide users
with a complete and accurate understanding of the organization's financial position,
performance, and cash flows. This convention promotes transparency and disclosure of
important information to stakeholders.
(h) Entity Concept : The entity concept, also known as the entity assumption, states that the
business entity is separate and distinct from its owners or other entities. This convention
ensures that the financial transactions and affairs of the business are recorded separately from
those of its owners, allowing for accurate measurement and reporting of the entity's financial
position and performance.

These accounting conventions form the foundation of financial reporting and help ensure the
reliability, comparability, transparency, and relevance of financial information for decision-making,
accountability, and stakeholder communication. Adherence to these principles promotes trust and
confidence in financial statements and enhances the integrity and credibility of the accounting
profession.

What is Accounting Standards

Accounting standards are a set of principles, rules, guidelines, and procedures established by
regulatory bodies or standard-setting organizations to govern the preparation, presentation, and
disclosure of financial statements and accounting information. These standards ensure consistency,
comparability, transparency, and reliability in financial reporting, enabling users of financial statements
to make informed decisions and assessments about the financial position, performance, and cash
flows of an organization.

Accounting standards serve several important purposes -

(a) Promoting Consistency : Accounting standards provide a uniform framework for recording,
measuring, and reporting financial transactions and events. By establishing consistent
accounting principles and practices, standards help ensure that financial information is
 prepared and presented in a standardized manner across different organizations and
industries.
(b) Enhancing Comparability : Accounting standards facilitate comparability of financial
statements by requiring similar transactions and events to be recorded and reported using
consistent methods and criteria. This allows users to compare the financial performance and
position of different entities over time or across industries, enabling more meaningful analysis
and decision-making.
(c) Ensuring Transparency : Accounting standards promote transparency and disclosure by
requiring organizations to provide relevant, reliable, and timely information about their
financial position, performance, and cash flows. Standards mandate the disclosure of
significant accounting policies, estimates, judgments, and other information necessary for
users to understand and interpret the financial statements.
(d) Improving Accountability : Accounting standards enhance the accountability of management,
directors, auditors, and other stakeholders by establishing clear expectations and
responsibilities for financial reporting and governance. Standards help ensure that financial
statements fairly represent the economic substance of transactions and events, reducing the
risk of misleading or deceptive practices.
(e) Facilitating Regulation and Oversight : Accounting standards support regulatory compliance
and oversight by providing a framework for evaluating the quality and integrity of financial
reporting. Regulatory bodies, such as the Accounting Standard Board of ICAI, National
Financial Reporting Authority (NFRA), the International Accounting Standards Board (IASB)
globally, and other national standard-setting organizations, develop and promulgate
accounting standards to guide organizations in meeting regulatory requirements and fulfilling
their reporting obligations.

Examples of widely recognized accounting standards include ->

(i) Generally Accepted Accounting Principles (GAAP) : GAAP is a set of accounting principles,
standards, and procedures used in the United States to prepare and present financial
statements for public and private companies.

(ii) International Financial Reporting Standards (IFRS): IFRS is a set of accounting standards
developed and issued by the International Accounting Standards Board (IASB) for use in the
preparation of financial statements by entities worldwide. IFRS aims to harmonize accounting
practices and promote consistency and comparability in financial reporting across countries
and jurisdictions.
 (iii) Generally Accepted Accounting Principles in India (Ind AS): Ind AS is a set of accounting
standards converged with IFRS and adopted by companies in India for the preparation of
financial statements. Ind AS is prescribed by the Ministry of Corporate Affairs (MCA) in India
and aims to improve the quality, transparency, and reliability of financial reporting in the
country.

These accounting standards are regularly updated and revised to reflect changes in business practices,
economic conditions, regulatory requirements, and emerging issues in accounting and financial
reporting. Compliance with accounting standards is essential for organizations to ensure the accuracy,
integrity, and credibility of their financial statements and to meet their obligations to stakeholders,
regulators, and investors.

Few Important Accounting Standards

Certainly! Here are a few important accounting standards widely recognized and used globally

(a) International Financial Reporting Standards (IFRS): IFRS is a set of accounting standards
developed and issued by the International Accounting Standards Board (IASB). IFRS
provides a common global language for financial reporting, aiming to enhance
comparability, transparency, and reliability in financial statements across countries and
industries.
(i) Some key IFRS standards include :

- IFRS 9 Financial Instruments: Provides guidance on the classification, measurement,

and recognition of financial assets and liabilities.

- IFRS 15 Revenue from Contracts with Customers: Sets out principles for recognizing
revenue from contracts with customers and improves consistency and comparability
in revenue recognition practices.

- IFRS 16 Leases: Establishes principles for the recognition, measurement,

presentation, and disclosure of leases by lessees and lessors.

(b) Generally Accepted Accounting Principles (GAAP): GAAP refers to a set of accounting
principles, standards, and practices used in the United States for financial reporting purposes.
GAAP is established by the Financial Accounting Standards Board (FASB) and provides a
framework for preparing and presenting financial statements in accordance with recognized
accounting principles.
 Some key GAAP standards include:

- ASC 606 Revenue from Contracts with Customers: Aligns revenue recognition
practices with IFRS 15 and establishes comprehensive principles for recognizing
revenue from contracts with customers.

- ASC 842 Leases: Requires lessees to recognize lease assets and lease liabilities on the
balance sheet for most leases, resulting in improved transparency and comparability
in lease accounting.

(c) Generally Accepted Accounting Principles in India (Ind AS): Ind AS is a set of accounting
standards converged with IFRS and adopted by companies in India for financial reporting
purposes. Ind AS aims to improve the quality, transparency, and reliability of financial
reporting in India and enhance comparability with international standards.

Some key Ind AS standards include:

- Ind AS 109 Financial Instruments: Provides guidance on the classification,

measurement, and recognition of financial assets and liabilities, aligning with IFRS 9.

- Ind AS 115 Revenue from Contracts with Customers: Aligns with IFRS 15 and
establishes principles for recognizing revenue from contracts with customers,
promoting consistency and comparability in revenue recognition practices.

These are just a few examples of important accounting standards that are widely recognized and used
by companies and organizations around the world. Compliance with accounting standards is essential
for preparing accurate, reliable, and transparent financial statements and ensuring consistency and
comparability in financial reporting practices.

Challenges in Implementation of Accounting Standards -

Implementing accounting standards can pose several challenges for organizations due to various
factors such as complexity, resource constraints, changes in regulatory requirements, and cultural
differences. Here are some common challenges in the implementation of accounting standards :

(a) Complexity of Standards : Accounting standards, especially international standards like IFRS,
can be complex and technical, requiring a deep understanding of accounting principles,
concepts, and practices. Implementing complex standards may require significant time, effort,
and expertise, particularly for organizations with limited resources or accounting expertise.
(b) Transition and Adoption Costs : Transitioning to new accounting standards or adopting
changes in existing standards can entail substantial costs associated with training, software
upgrades, system modifications, and compliance efforts. Organizations may incur expenses for
hiring consultants, conducting impact assessments, and implementing new processes and
controls to comply with the requirements of the standards.
(c) Data and Information Challenges : Implementing accounting standards may require
organizations to collect, analyze, and interpret large volumes of financial data and information
to ensure compliance and accuracy in financial reporting. Organizations may encounter
challenges related to data quality, integrity, availability, and compatibility with accounting
standards, requiring improvements in data management and information systems.
(d) Interpretation and Application Issues : Accounting standards may contain ambiguous or
subjective guidance, leading to differences in interpretation and application among preparers,
auditors, regulators, and users of financial statements. Organizations may face challenges in
applying judgment and making accounting estimates, leading to inconsistencies or
discrepancies in financial reporting practices.
(e) Training and Education Needs : Implementing accounting standards effectively requires
training and education for accounting professionals, finance staff, and other stakeholders to
ensure understanding and compliance with the requirements of the standards. Organizations
may need to invest in training programs, workshops, seminars, and certification courses to
enhance the skills and knowledge of their workforce.
(f) Resource Constraints : Small and medium-sized enterprises (SMEs) and organizations with
limited financial resources or expertise may face challenges in implementing accounting
standards due to resource constraints. These organizations may lack the necessary
infrastructure, technology, personnel, and financial resources to effectively implement and
comply with complex accounting standards.
(g) Regulatory Changes and Updates : Accounting standards are subject to frequent changes,
updates, and revisions by standard-setting bodies and regulatory authorities, leading to
challenges in keeping pace with evolving requirements and staying compliant. Organizations
may need to monitor regulatory developments, stay informed about changes in accounting
standards, and adapt their accounting practices accordingly.
(h) Cultural and Institutional Differences : Organizations operating in diverse geographical
locations or cultural contexts may encounter challenges in implementing accounting standards
due to differences in accounting practices, legal frameworks, cultural norms, and institutional
 arrangements. Harmonizing accounting practices across different jurisdictions or subsidiaries
may require sensitivity to cultural differences and effective communication and coordination.

Addressing these challenges requires proactive planning, investment in resources and capabilities,
collaboration with stakeholders, and ongoing monitoring and review of accounting practices.
Organizations should develop robust implementation strategies, establish clear accountability and
oversight mechanisms, and seek guidance from accounting professionals, regulators, and standard-
setting bodies to navigate the complexities of implementing accounting standards effectively.

Sustainability Standards

Sustainability standards are a set of guidelines, criteria, and performance indicators that organizations
use to measure and report their environmental, social, and governance (ESG) practices and impacts.
These standards aim to promote sustainable development, responsible business practices, and long-
term value creation by integrating environmental, social, and governance considerations into business
strategies, operations, and decision-making processes.

Sustainability standards cover a wide range of issues and topics related to sustainability, including
but not limited to -

(a) Environmental Performance : Sustainability standards address environmental issues such as

climate change, resource conservation, pollution prevention, waste management, biodiversity
conservation, and energy efficiency. They require organizations to measure, monitor, and
report their environmental impacts, set targets for reducing greenhouse gas emissions and
other pollutants, and implement strategies to minimize environmental risks and enhance
environmental stewardship.
(b) Social Responsibility : Sustainability standards focus on social issues such as labor rights,
human rights, employee welfare, diversity and inclusion, community engagement, and
stakeholder relations. They require organizations to promote fair labor practices, ensure safe
and healthy working conditions, respect human rights and indigenous rights, support
community development initiatives, and engage with stakeholders to address social concerns.
(c) Corporate Governance : Sustainability standards emphasize good corporate governance
practices, including board oversight, transparency, accountability, and integrity. They require
organizations to adopt sound governance structures, establish ethical codes of conduct,
disclose relevant information to shareholders and stakeholders, and ensure alignment
between business objectives and societal expectations.
 (d) Ethical Business Conduct : Sustainability standards promote ethical business conduct and
responsible business practices, including anti-corruption, anti-bribery, anti-money laundering,
and compliance with laws, regulations, and international standards. They require
organizations to uphold ethical principles, conduct due diligence on business partners and
suppliers, and maintain integrity and transparency in all business dealings.
(e) Supply Chain Management : Sustainability standards address supply chain sustainability
issues such as responsible sourcing, fair trade, supply chain transparency, and supply chain
resilience. They require organizations to assess and mitigate environmental and social risks in
their supply chains, promote sustainable sourcing practices, and collaborate with suppliers to
improve sustainability performance.
(f) Reporting and Disclosure : Sustainability standards mandate organizations to disclose relevant
ESG information and performance metrics in their sustainability reports, annual reports, and
other communications. They provide guidelines for reporting on key sustainability indicators,
such as carbon emissions, water usage, employee turnover, diversity metrics, and community
investments, to enable stakeholders to assess the organization's sustainability performance
and impacts.

There are several organizations and initiatives that develop and promote sustainability standards,
including:

- Global Reporting Initiative (GRI) : GRI develops guidelines and standards for sustainability
reporting, including the GRI Standards, which provide a comprehensive framework for
reporting on economic, environmental, and social performance.

- Sustainability Accounting Standards Board (SASB) : SASB develops industry-specific

standards for disclosing financially material sustainability information to investors, focusing on
key ESG issues that are relevant to each industry.

- International Organization for Standardization (ISO) : ISO develops international standards

for environmental management (e.g., ISO 14001) and social responsibility (e.g., ISO 26000) to
help organizations address sustainability challenges and improve their sustainability
performance.

- Task Force on Climate-related Financial Disclosures (TCFD) : TCFD develops

recommendations for voluntary climate-related financial disclosures to help organizations
assess and disclose their climate-related risks and opportunities.
 - United Nations Global Compact (UNGC) : UNGC provides principles and guidelines for
responsible business conduct in areas such as human rights, labor, environment, and anti-
corruption, encouraging companies to align their strategies and operations with universal
sustainability principles.

Adopting and adhering to sustainability standards can help organizations demonstrate their
commitment to sustainability, build trust with stakeholders, enhance reputation and brand value,
mitigate risks, drive innovation, and create long-term value for shareholders and society. By integrating
sustainability into their business practices and reporting, organizations can contribute to sustainable
development goals and address pressing global challenges such as climate change, social inequality,
and environmental degradation.