The main objective of the preparation of financial statements is to summarise the financial position of a business enterprise for an accounting period in monetary terms. In order to compare the financial position of an enterprise with that of another enterprise, there needs to be consistency in the method of preparation of financial statements across various companies. In order to make these methods and principles uniform and consistent across organizations, the accounting standards have evolved.
Accounting Standards are the statements of code of practice from the regulatory accounting bodies that are to be observed within the preparation and presentation of monetary statements. In layman’s terms, accounting standards are the written documents issued by the expert institutes (ICAI) or other regulatory bodies covering various aspects of measurement, treatment, presentation, and disclosure of accounting transactions.
According to Kohler, “A code of conduct imposed on an accountant by customs, law and professional bodies”
Nature & Scope of Accounting Standards
The below mentioned are the essential points explaining the character of accounting standards.
- Accounting standards are a group of guidelines that help in the preparation of reliable financial statements.
- They help in bringing a standardization of presentation and help in the removal of variations that exist in the treatment of accounting information.
- They depend on the environment and legal structure of the country in which the business operates. Due to constant changes in the environment of our country, they are updated by the ICAI from time to time. In case of dispute between the Law of Land and Accounting Standards, the law will prevail.
- It is compulsory for various companies to adopt accounting standards.
- They are flexible, as alternate presentations and practices are acceptable and an enterprise is free to adopt any method as long as it follows it consistently. In case the accounting practices are changed, the change must be quantified and disclosed within the financial statements.
Need for Accounting Standards
Accounting Standards are required to ensure the compliance of the following information with the qualitative characteristics of accounting:
- Profit or Loss of the business enterprise
- Financial Position of the business enterprise
- Inflow and outflow of Cash
All the above information must suit the qualitative characteristics of accounting i.e. Reliability; Relevance; Understandability; and Comparability. Accounting Standards also assure its various users about the truth and fairness of the information contained in the Financial Statements of the business enterprise.
These standards maintain uniformity in the process of accounting records as well as assist in the comparison of books of accounts of different business enterprises.
Uses of Accounting Standards
Accounting standards serve the following purposes.
- They provide a standardized format that is to be followed while preparation of accounts, minimizing the variations in the method of preparation of accounts.
- They provide the basic rules on the basis of which financial statements are prepared.
- They make it compulsory for the businesses to form disclosure of the accounting policies followed while preparation of monetary statements.
- When a corporation complies with the accounting standards while preparation of monetary statements it creates a way of confidence among the users of monetary statements.
- They help the auditors in auditing the books of accounts as consistent use of the same accounting policies helps an auditor in forming an opinion about the financial statements.
Objectives of Accounting Standards
We establish standards in order that we will compare our performance with something which is uniform for all. For example, Our marks are expressed in percentage which is a common unit of measurement for all so that the students can compare their performance with other students during the year. Similarly, these accounting standards are followed universally and this thus, makes a comparison between the two firms possible.
Financial statements are the only source for the stakeholders to know about the business. These accounting standards ensure that they are prepared in a manner that people can rely on and make sense out of them. For example, researchers trying to understand the corporate governance practices of the business can rely on these statements.
Imagine a situation wherein a classroom the teacher asks her students to study at their own will. In such a case, it would only lead to a ruckus in the class. Similarly, if accounting policies and practices are left at the discretion of the business entities then they could go haywire and there’ll be no uniformity in the least. As a result, of these standards, the diverse practices have been kept at bay.
Benefits of Accounting Standards
Elimination of variation in accounting treatment: Accounting standards eliminate variations in accounting treatment as it works on a set of accounting principles and methods which are followed throughout the entire accounting fraternity. These standards are uniformly followed which further eliminates variation in the preparation and presentation of books of accounts.
Full disclosure of accounting principles: AS-1 requires full disclosure of accounting principles and policies which are helpful for the various users of accounting information such as present and potential investors of a business. However, such information may not be compulsory for disclosure by the law of the country.
Inter and Intra firm comparison: They form a strong base for comparison of books of accounts maintained by different departments within firms (Intra) or between two different firms (inter).
Limitations of Accounting Standards
Inflexible Framework: An accountant has to follow that method only which is mentioned in the accounting standards while preparing accounts. It is not necessary that a method appropriate in one situation would be applicable in other situations as well.
Biased: Accounting standards may be subject to lobbying or government pressure. Thus, in order to give unfair advantages to big corporate houses, the standards might be compromised.
Cost to Comply: We live in a dynamic environment and in order to keep up with the needs of business from time to time, new accounting standards are issued by the ICAI and in order to comply with these the company has to incur various costs.
Sometimes a company has to design new procedures, which require large financial investment in the form of employee training cost, labour cost, system up-gradation, etc.
Conceptual Weakness: Earlier standards were not based on a sound conceptual framework of accounting but the ICAI is committed to rectify these.
Affected by errors: They have been developed by human beings. So, there can be a chance of errors while developing these standards.
Drafted within the ambit of law: They must adhere to the law of the country. It cannot go beyond the boundaries prescribed by the law of the country.
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