Evolution Of Accounting
1 Introduction
1.1 Financial
accounting and reporting remains the core tool of entities for communication
with its stakeholders. It is the semantics for such communication. Accounting
standards are the grammar of such language used by entities in such
communication. The separation of ownership and management in the growing
businesses and modern day complexities added the importance of timely and
accurate communications. The grammar (i.e. Accounting Standards) blends
uniformity in reporting and facilitation of unambiguous communication with the
variety of stakeholders including but not limited to owners/shareholders,
employees, regulators, trade/business relations, revenue authorities etc.
1.2 The subject of accountancy and its
importance has a long history in India e.g. a treatise on economics and
political science titled ‘Kautilya’s (also known as Chanakya) Arthshasthra’,
has elaborate prescriptions on accounting (and accountability) aspects for a
treasury and government which have features of universal utility. In line with
the evolution and changes in the scale and texture of economies and society,
financial reporting and accounting standards have also evolved and witnessed
path-breaking changes.
1.3 The earliest treatise on accounting is
generally thought to be Pacioli’s Summar of 1494. However, Bahi-khata (a
double-entry system of bookkeeping) predates the ‘Italian’ method by many
centuries. Its existence in India prior to the Greek and Roman empires suggests
that Indian traders took it with them to Italy, and from there the double-entry
system spread through Europe, which then evolved itself to accrual from cash
and gradually to present day modern reporting.
2 Evolution of accountancy in major jurisdictions
2.1 America:
After
the U.S. stock market crash in 1929, many investors and market participants
felt that insufficient and misleading accounting and reporting had inflated
stock prices that eventually crashed the stock market followed by the Great
Depression. Whether that perception was true or not is a separate debate, but
those feelings made accounting world more alert and agile about its role and
the continuing pressures on the accounting profession to establish accounting
standards prompted the American Institute of Accountants (now known as the
AICPA) and the New York Stock Exchange to review financial reporting
requirements.
2.2 A few years later, the Securities Act of
1933 and the Securities Exchange Act of 1934 were passed into law to restore
investor confidence, which set forth the accounting and disclosure requirements
for the initial offering of stocks and bonds and for secondary market offerings
respectively.
2.3 The 1934 Act also created the U.S.
Securities and Exchange Commission (SEC), which was mandated with standard
setting of financial accounting and reporting for publicly-traded companies.
However, the SEC while keeping the power to set standards chose to delegate its
rule-making responsibilities to the private sector. This means that if the SEC
did not conform to a specific standard issued by the private sector, it had the
authority to change that standard. Despite delegating its
rule-making responsibility, the SEC issued its own accounting pronouncements
called Financial Reporting Releases (FRRs).
2.4 The Committee on Accounting Procedure (CAP)
and American Institute of Accountants (now AICPA) were the very first
private-sector standard setting bodies. During 1938 to 1959, the CAP issued 51
Accounting Research Bulletins (ARBs). Since, it had not established a financial
accounting conceptual framework, its rule-making approach of dealing with
accounting and reporting problems and issues was subjected to severe criticism.
2.5 The CAP was then replaced by the Accounting
Principles Board (APB) set up under the recommendation of a special committee
appointed by AICPA which issued 31 Accounting Principles Board Opinions
(APBOs), 4 Statements and several interpretations during its tenure from 1959
to 1973. In contrast to its predecessor, it attempted to establish a conceptual
framework with its APB Statement No. 4 but failed. In addition to its
unsuccessful efforts to create a framework, it was also under fire for its
apparent lack of independence because its board members were supported by the
AICPA and other interest groups or stakeholders were not represented in its
rule-making process.
2.6 Emphasizing the significance of an
independent standard-setting structure, the APB was reorganized in 1973 into a
new body called the Financial Accounting Standards Board (FASB). As compared to
APB’s 18-21 part-time members who mostly represented public accounting firms,
the FASB has 7 full-time members representing the accounting profession,
industry and other various interest groups/stakeholders such as the government
and accounting educators.
2.7 In 1984, FASB formed the Emerging Issues
Task Force (EITF) with members of the FASB, auditing firms and industries with
the role of responding to emerging accounting and financial reporting issues
and publish its pronouncements in the form of EITF Issues – considered to form
part of US GAAP. The function of the EITF is important because it makes the
standard-setting process more efficient and allows the FASB to concentrate on
much broader and long-term problems.
3 UK/ Europe
3.1 Meanwhile, efforts in the UK and Europe to
create an international body to establish international accounting standards
were also gaining widespread support, which led to the creation of the
International Accounting Standards Committee (IASC) in mid-1973. Just like the
FASB’s EITF, the IASC established the Standing Interpretations Committee (SIC)
in 1997 to study accounting issues and problems that required authoritative
guidance.
3.2 In 1977, the International Federation of
Accountants (IFAC) came into existence as a result of an agreement signed by 63
accounting bodies representing 49 countries. The main objective of IFAC is ‘the
development and enhancement of a co-ordinated worldwide accountancy profession
with harmonized standards’. ICAI is a member of the IFAC since its
inception.
3.3 In 2001, the IASC reorganized itself to act
as an umbrella organisation to a new standard-setting body – the International
Accounting Standards Board (IASB). The accounting standards issued by the IASB
were designated as International Financial Reporting Standards (IFRS). The IASB
continued to adopt the 41 International Accounting Standards (IAS) issued by
the IASC between 1973 and 2002. It also adopted all SIC Interpretations which
were renamed as International Financial Reporting Interpretations Committee
(IFRIC).
3.4
IASB has no authority to enforce
compliance with IFRS and its adoption is entirely voluntary. In 2001, the
International Organization of Securities Commission (IOSCO) approved the use of
IAS/IFRS for cross-border offerings and listings and IFRS/IAS was also adopted
in 2005 by listed companies in the European Union. This adoption of IFRS/IAS by
EU companies gave a big filip for them to become gradually being adopted and
accepted across other jurisdictions.
3.5 Since October 2002, the IASB and FASB have
been working to remove differences between IFRS/IAS and US GAAP towards a
common set of high quality global accounting standards. Their commitment to the
convergence effort was embodied in a memorandum known as the Norwalk Agreement.
3.6 After 10 years of working together, some
notable convergence projects have been successfully completed. Major joint
projects completed include converged standards on Business Combinations,
Consolidation, Fair Value Measurement, Revenue Recognition and Leases.
3.7 Other projects were discontinued because
the two boards could not agree on some issues such as standards on
de-recognition, financial statement presentation, insurance contracts,
liabilities and equity, and post-employment benefits.
3.8 The major prevalent Accounting Practices in
the world today can be bifurcated to two broad categories:
i. International Financial Reporting Standards
(IFRS) issued by International Accounting Standards Board (IASB), which are
prevalent in more than 100 countries including European Union, Australia,
Canada etc.;
ii. US GAAP i.e. Generally Accepted Accounting
Principle followed in United States of America.
4 History & Evolution of Accounting and
Auditing in modern India
4.1 The evolution of India’s present-day
accounting system can be traced back to as early as the sixteenth century with
India’s trade links to Europe and central Asia through the historic silk route.
Earlier Indian accounting practices reflect its diversity as India has many
official languages and scores of dialects spread over numerous states.
1857:
The first ever Companies Act in India legislated.
1866:
Law relating to maintenance of accounts and audit thereof introduced. Formal
qualification as auditor was now required.
1913:
New Companies Act enacted. Books of accounts required to be maintained
specified. Formal qualifications to act as auditor were named and a Certificate
from the local government was required to act as an auditor – An unrestricted
Certificate to act as auditor throughout British India and a restricted
Certificate to act as auditor only within the Province concerned and in the
languages specified in the certificate.
1918:
Government Diploma in Accounting (GDA) was launched in Mumbai. On
completion of articleship of 3 years under an approved accountant and passing
of the Qualifying examination, the candidate would become eligible for the
grant of an Unrestricted Certificate.
1920:
The issue of Restricted Certificates discontinued.
1930:
Register of Accountants to be maintained by the Government of India to exercise
control over the members in practice. Those whose names found entry here were
called Registered Accountants (RA).
The
Governor General in Council replaced the local government as the statutory authority
to grant certificates to persons entitling them to act as auditors. Auditors
were allowed to practice throughout India.
1932:
First Accountancy Board was formed. The Board was to advise the Governor
General in Council on matters relating to accountancy and to assist him in
maintaining standards of qualification and conduct required of auditors.
1933:
First examination held by the Indian Accountancy Board. GDAs were exempted from
taking the test.
1935:
The first Final examination was held. GDAs were exempted from taking the test.
1943:
GDA was abolished.
1948:
Expert Committee formed to examine the scheme of an autonomous
association of accountants in India.
1949:
The Chartered Accountants Act, 1949 passed on 1st May. The term
Chartered Accountant came to be used in place of Indian Registered Accountants.
The Chartered Accountants Act was brought into effect on 1st July and The
Institute of Chartered Accountants of India (ICAI) was born on 1st
July 1949.
4.2
The ICAI, being the premier
standard-setting body in India, constituted Accounting Standard Board (the
‘ASB’) on April 21, 1977, with the objective to formulate Accounting Standards
to enable the Council of ICAI to establish a sound and robust financial
reporting standards framework in India.
The
ASB takes into consideration the Accounting Standards at the International
Level (IFRS/IAS) and sets National Standards based on those so that National
Standards are broadly aligned to Global Accounting Principles. ASB is
represented not merely by members of ICAI but also representatives from
Government including Revenue Departments, RBI, IRDA, MCA, Chambers of Commerce.
From
1977 to 1988, ICAI notified 11 Accounting Standards (‘AS’), made in
consultative manner by ASB, but these notified AS lacked statutory recognition.
4.3 The statutory recognition and legal force
was provided to Accounting Standards by amendment made in 1999 to the Companies
Act, 1956. New sub-sections (3A), (3B) and (3C) were inserted in section 211,
which required that every balance sheet and profit & loss account of the
Company complied with the accounting standards, prescribed by the Central Government
in consultation with the National Advisory Committee on Accounting Standards
(NACAS).
The
accrual method of accounting in India also gradually evolved with growth and
evolvement of the ‘Company’ form of business organisation and mandatory
requirement prescribed under the law [Section 209(3) of 1956 Act] for the
Companies to follow ‘accrual’ basis and according to double entry system of
accounting.
5 Accounting Standards
5.1 Accounting Standards are “written
documents, policies, procedures issued by expert accounting body or government
or other regulatory body covering the aspects of recognition, measurement,
treatment, presentation and disclosure of accounting transactions in the
financial statement”.
5.2 Objective of Accounting Standards:
– Standardise the diverse accounting policies.
– To eliminate non-comparability of financial
statements to the possible extent.
– Add to the reliability to the financial
statements.
– Help understand Accounting Treatment in
financial statements.
5.3 Advantages of Accounting Standards:
– Reduce or eliminate confusing variations in
the accounting treatments used to prepare the financial statements.
– Disclosures beyond that required by law.
– Facilitating comparison of financial
statements of across different companies.
– Uniformity of accounting treatment of
identical transactions
5.4 Procedure for issuing
Accounting Standards by ICAI:
The
following procedure is adopted for formulating the accounting standards:
– ASB constitutes Study Group to formulate
preliminary draft.
– ASB considers the preliminary draft and
issues Exposure draft (ED) for public comments. ED is also specifically sent
for comments to specified bodies such as industry associations, regulators,
stock exchanges and others.
– ASB considers comments received on ED and
finalises the draft AS for consideration of Council.
– Draft approved by council is recommended to
NACAS.
– NACAS recommends the Standard to the
Government of India (MCA) after its review and modifications, if any, in
consultation with ICAI.
– Government of India (MCA) notifies the AS on
acceptance of recommendations made by NACAS.
6 Important Milestones of Accounting
Standards in India
– 1979 – Preface to Statements of AS & AS
1 issued.
– 1987 – Mandatory status of AS 4 & AS 5.
– 1991 – Mandatory status of AS 1, AS 7, AS 8,
AS 9, AS 10 and AS 11 (Corporate Entities)
– 1993 – Mandatory status of AS 1, AS 7, AS 8,
AS 9, AS 10 and AS 11 (Non Corporate Entities)
– 1999
Legal recognition to ASs issued by ICAI under Companies Act, 1956.
– 2000-2003 – 12 AS were issued based on
IASs-major step towards convergence with IASs.
– 2002 – Insurance Regulatory and Development
Authority (IRDA) required Insurance Companies to comply with the Accounting
Standards issued by the ICAI.
– 2003 – Reserve Bank of India (RBI) issued
Guidelines on compliance with Accounting Standards (ASs) advising banks to
ensure strict compliance with the Accounting Standards issued by the ICAI.
– 2006 – MCA notified separate AS under Companies
(AS) Rules, 2006 which was based on work done by ASB of ICAI and approved by
NACAS. ASB decided to constitute a task force to develop a concept paper on
convergence with IFRS.
– 2007 – ASB and Council accepted
recommendations of Task Force for convergence with IFRS.
– 2010-11 Ind AS (IFRS Converged Standards)
prepared by ICAI, approved by NACAS and notified by MCA (Date not notified)
– 2015 – MCA issued the roadmap (dates of
implementation) for converged IFRS in phased manner & notified 39 Ind AS
formulated by ICAI and approved by NACAS.
– 2016 – MCA notified revised AS 2, AS 4, AS
10, AS 13, AS 14, AS 21, and AS 29 and Ind AS 11.
– 2018 – MCA notified Ind AS 115 replacing Ind
AS 11 and Ind AS 18.
7 Applicability
of Accounting Standards to Small and Medium Sized Enterprises (SMEs) and Small
and Medium-sized Companies (SMCs)
7.1 Under the Companies Act, 1956 Small and
Medium-Sized Company as defined in Clause 2(f) of the Companies (Accounting
Standards) Rules, 2006 were exempted from compliance of the Accounting
Standards AS 3 – Cash Flow Statement and AS 17 – Segment Reporting. Also AS 21
– Consolidated Financial Statements, AS 23 – Accounting for Investments in
Associates in Consolidated Financial Statements and AS 27 – Financial Reporting
of Interests in Joint Ventures (to the extent of requirements relating to
Consolidated Financial Statements were not applicable to SMCs since the
relevant Regulations did not require compliance with them. Relaxations in
respect to disclosures under certain Accounting Standards were also granted to
SMCs.
7.2 As per
‘Applicability of Accounting Standards’, issued by the ICAI (published in ‘The
Chartered Accountant’, November 2003), there are three levels of entities.
Level II entities and Level III entities are considered to be the small and
medium enterprises (SMEs). On the other hand, as per the Accounting Standards
notified by the Government, there are two levels, namely, SMCs as defined in
the Rules and companies other than SMCs. Non-SMCs are required to comply with
all the Accounting Standards in their entirety, while certain exemptions/
relaxations have been given to SMCs. Certain differences in the criteria for
classification of the levels were also noted.
Globalisation
of Accounting Standards
8.1 Globalisation of economies and evolution of
a highly interconnected world has had far reaching changes impact on economy
and the ‘accounting’ world also cannot remain unaffected there from. Since the
beginning 21st century, there was renewed demand for global
harmonisation of accounting standards and to converge or adopt single set of
high quality standards that require transparent and comparable information in
the financial statements. There is also a significant transformation in the
fundamental accounting principles and concepts fair value measurements,
prominence to fair and faithful presentation, new components in financial
statements and so on gained acceptance.
8.2 Further, the direction of accounting
standard setting has shifted towards ‘Principles’ based standards rather
than ‘Prescriptive Rule’ based ones. There are two other major
developments also impacting standard-setting viz., the unprecedented global
financial crisis starting in 2007-08 and birth of integrated reporting
framework in 2010 having core objective of more effective communication with
stakeholders. Policy makers and Regulators are following the developments in
standard-setting area with keen interest. Therefore, accounting
standard-setting role has assumed greater responsibility and accountability.
8.3 International Financial Reporting Standards
(IFRS) area set of high quality principle-based standards and has become the
global financial reporting language with more than hundred countries accepting
or requiring IFRS based financial reporting. The U.S. Securities and Exchange
Commission has also allowed Foreign Private Issuers to file financials
statements prepared under IFRS without reconciliation to the US GAAP.
8.4 It is the primary duty of any company
irrespective of Indian company or foreign company to prepare financial
statements at the end of accounting period. While preparing financial
statements some accounting standards needs to be followed that is laid down by
Accounting Standard Board of the respective country. Subsidiary/Joint
Venture/Associate of a company located in another country need to prepare its
financial statements according to accounting standards of the country where it
is located, which leads to variation in profits. This variation in profits is
due to difference in accounting standards, which differs from country to
country. In order to remove these variation/difference in profits,
International Accounting Standard Board introduced International Financial
Reporting Standards called as IFRS. IFRS
are the common accounting standards followed by member countries of IASB in
preparing their financial statements. IFRS helps in arriving at similar profits
regardless of the location of an entity. Before any new IFRS are issued or
amendments are made in IFRS, IASB issues exposure drafts, discussion papers and
conducts out-reach events.
9 Advantages of convergence to IFRS
– Easy Comparison: Companies always
would like to compare their performance with other companies’ performance. IFRS
make this work easier because most companies are / will follow same accounting
standards in preparing their financial statements.
– One Accounting language company-wide:
Company with subsidiaries in foreign countries can use IFRS as common business
language in preparing its financial statements as most of the countries are
adopting / converging with IFRS.
– IFRS facilitates Cross border movement of
capital and cross border acquisitions, enables partnerships & alliance with
foreign entities.
– Availability of professionals
internationally: IFRS enhances the mobility of professionals internationally.
– IFRS provides more compatibility:
IFRS provide more compatibility among sectors, industry, & companies. This
would improve relationship with investors, suppliers, customers and other
stakeholders across the globe.
– Increased investment opportunities:
Common accounting standards help investors to understand available investment
opportunities better as opposed to financial statements prepared under
different set of national accounting standards.
– Lower cost of capital: Greater
willingness on the part of investors to invest across borders will enable
entities to have access to global capital markets which lowers the cost of
capital.
– Higher economic growth: Increased
investment opportunities lead to attraction of more investments which result in
higher economic growth.
– Better quality of financial reporting:
Convergence will place better quality of financial reporting due to consistent
application of accounting principles and reliability of financial statements.
10 Road to Indian Accounting Standards (Ind-AS i.e.
IFRS Converged Standards
in India)
10.1 The Leaders’ Statement at G-20 Summit held in
September 2009 attended by our Prime Minister Dr. Manmohan Singh at Pittsburgh
contained a commitment by the G-20 nations for convergence of accounting
standards globally.
10.2 In 2010-11, the ASB of ICAI after a
tirelessly effort came out with 35 Ind AS which, after NACAS consultation were
notified by Ministry of Corporate Affairs (MCA) in February 2011. However the
date of implementation which was scheduled to be 1st April, 2011 was
not notified by the Government possibly, amongst other reasons, due to
tax-related concerns by corporates.
10.3 The current
government in its very first budget in July 2014 announced its intention of
implementing Ind AS from 2015 onwards. On 2nd January 2015, the
Ministry of Corporate Affairs (MCA) issued a press release which laid down a
roadmap for adoption of Ind AS in India. 16th February 2015 marked
the dawn of new era in accounting standards in India when MCA notified the
final roadmap for adoption of new generation accounting standards, “Indian
Accounting Standards – Ind AS” based on the size of the companies and sectors
like Banking, NBFC & Insurance.
10.4 Between 2011, when MCA deferred the
implementation of Ind ASs and this notification, the International Financial
Reporting Standards (IFRSs) had gone through a significant rejig – the biggest
ones being the new accounting standards on Consolidation (IFRS 10, 11 and 12),
Fair Value Measurement (IFRS 13), Revenue (IFRS 15) and Financial Instruments
(IFRS 9). These developments have been incorporated in the standards notified
by the MCA based on the updation by ICAI with consultation of NACAS.
11 Indian Accounting Standards (Ind AS)
11.1 The key features of Ind-AS which are
principle-based IFRS converged standards include fair value measurement, use of
time value of money and reliance on robust disclosures. These Standards are
applicable for separate as well as consolidated financial statements.
11.2 The implementation of Ind-AS has led to
enhanced qualitative reporting due to additional information requirements and
more transparency. This will help the investors to better understand the risks
and rewards associated with the investment in an entity and, therefore, it
would make investment decisions easier.
11.3 Ind AS also require greater use of judgements
and estimates. Therefore, greater disclosure requirements are prescribed under
these Standards.
– For estimates: focus on the most difficult,
subjective and complex estimates including details of how the estimate was
derived, key assumptions involved, the process for reviewing and a sensitivity
analysis.
– For judgements: provide sufficient
background information on the judgement, explain how the judgement was made and
the conclusion reached.
– There is emphasis on substance over form
under these standards as they require us to look into the economic reality of a
transaction. Therefore, the substance of a financial instrument needs to be
looked into, rather that its legal form to determine its classification in the
balance sheet. For example, a compulsorily redeemable preference share is to be
classified as a financial liability under Ind AS while under Indian GAAP it was
classified as per its form i.e., it was classified as a part of equity.
11.4 Ind-AS thus, leads to more truthful
representation of transactions, e.g.
– Where goods are sold on extended credit
terms, i.e., extending the term beyond the normal credit period; then the
financing element built into the price is segregated and considered as
‘interest’ income. For example, goods that are normally sold at price of Rs.
100 for a credit period of 3 months. If, however, they are sold for Rs. 110 for
15 months credit then Rs. 10 will be considered as ‘interest’ (say @10%) income
under Ind AS. Similarly, fixed assets or inventories purchased on deferred
credit terms having financing element, namely ‘interest’ is also to be
segregated from the ‘purchase price’.
– Derivatives and hedge accounting was earlier
done on settlement-based approach rather than deferral approach. Ind-AS
requires fair value approach in case of these instruments.
– Accounting for time value of money, the true
position of financials closer to reality is depicted. There are many instances
where Ind-AS requires discounting of future amounts to arrive at the present
value. Some of these instances are discounting of long term provisions,
measurement of asset retirement obligations, measurement of liability in
defined benefit plans etc.
11.5 There are several fundamental changes that
the new standards bring in when compared to the earlier Standards. One key
fundamental change is the significant increase in focus on fair value
accounting. Ind AS requires application of fair value principles, which is
resulting in significant differences from financial information being presented
earlier. Complying with fair value principles of Ind AS will also require
assistance from professionals with valuation skills to arrive at reliable fair
value estimates.
The
following four Ind AS will have substantial impact with significant operational
and procedural changes specially for Banks, NBFCs and Insurance Companies:
– Ind AS 109, Financial Instruments which
provides the accounting and reporting norms for Financial Instruments.
Presently,
companies follow a provisioning matrix for impairment losses of financial
assets which is based on ‘incurred loss’ model wherein impairment losses were
recognised on occurrence of a credit risk trigger or event indicating objective
evidence of impairment. This could include a past due or default, significant
financial difficulty and so on.
After
Ind AS comes into place, the ‘expected loss’ model will be followed which is
based on estimating Credit Risk since initial recognition. Ind AS 109 requires
entities to recognise and measure a credit loss allowance or provision based on
an expected credit loss model.
The
new impairment model based on the expected credit losses as compared to
current percentage-based provisioning
requirements will have a significant impact on the entities’ estimation of the
probabilities of default.
– Ind AS 32, Financial Instruments:
Presentation which will change the presentation by the issuer of a financial
instrument as liability or equity based on principles of classification.
– Ind AS 113, Fair Value Measurement which
defines how fair value will be measured.
– Ind AS 115, Revenue from Contracts with
Customers which is effective from 1st April 2018, replacing Ind AS
11, Construction Contracts and Ind AS 18, Revenue.
11.6 Carve-Outs from IFRS: The Ind AS contain
some carve-outs as compared to IFRS as mentioned below. These carve-outs have
been made either due to conceptual issues or considering Indian economic
conditions and existing accounting practices being followed in the country.
– Events after the Reporting Period – Ind AS
10 vis-à-vis IAS 10As per IFRS, Rectification of any breach of a loan
agreement after the end of Reporting period is a non-adjusting event. Whereas,
as per Ind AS, if the lender, before the approval of Financials Statements for
issue, agrees to waive the breach, it shall be considered as an adjusting
event.
– Leases – Ind AS 17 vis-à-vis IAS 17:
As per IFRS, all leases rentals to be charged to statement of profit and loss
on straight-line basis. Whereas, as per Ind AS, no straight-lining for
escalation of lease rentals is to be done in line with expected general
inflation.
– Employee Benefit – Ind AS 19 vis-à-vis
IAS 19: As per IFRS, corporate bond rates are to be used as discount rate for
determining Actuarial Liabilities. Whereas, as per Ind AS, mandatory use of
government securities yields rate is to be done.
– The Effects of changes in Foreign Exchange
rates – Ind AS 21 vis-à-vis IAS 21: As per IFRS, recognition of exchange
rate fluctuations on long-term foreign currency monetary items is to be done in
the statement of profit and loss. Whereas, as per Ind AS, there is an Option to
defer exchange rate fluctuations on long-term foreign currency monetary items
existing as at the transition date.
– Investment in Associates and Joint Ventures
– Ind AS 28 vis-à-vis IAS 28: As per IFRS, for the purpose of applying
equity method of accounting in the preparation of investor’s financial
statements, uniform accounting policies should be used. In other words, if the
associate’s accounting policies are different from those of the investor, the
investor should change the financial statements of the associate by using same
accounting policies. Whereas, as per Ind AS, the phrase, ‘unless impracticable
to do so’ has been added in the relevant requirements.
– Financial Instruments: Presentation – Ind AS
32 vis-à-vis IAS 32: As per IFRS, equity conversion option in case of
foreign currency denominated convertible bonds is considered a derivative
liability, which is embedded in the bond. Gains or losses arising on account of
change in fair value of the derivative need to be recognised in the statement
of profit and loss as per IAS 32. Whereas, as per Ind AS, an exception has been
included to the definition of financial liability, whereby conversion option in
a convertible bond denominated in foreign currency to acquire a fixed number of
entity’s own equity instruments is classified as an equity instrument if the
exercise price is fixed in any currency.
– First time
Adoption – Ind AS 101 vis-à-vis IFRS 1: As per IFRS, on the date of
transition, either the items of Property, Plant and Equipment shall be
determined by applying IAS 16 ‘Property, Plant and Equipment’ retrospectively
or the same should be recorded at fair value. Whereas, as per Ind AS, an
additional option is given to use carrying values of all items of property,
plant and equipment on the date of transition in accordance with previous GAAP
as an acceptable starting point under Ind AS.
– Business Combinations – Ind AS 103 vis-à-vis
IFRS 3:
As
per IFRS, bargain purchase gain arising on business combination is to be
recognised in Statement of profit or loss as income, whereas, as per Ind AS, it
is to be recognised in Capital Reserve.
It
is proposed to minimise carve-outs in the future in course of time. In order to
minimise the carve-outs which are due to conceptual issues, ICAI is
continuously in dialogue with IASB and raising concerns at appropriate
international forums.
The
objective of carve-outs made due to Indian economic conditions and existing
accounting practices was to smoothen the transition to Ind AS and are proposed
to be removed over a period of time when Ind AS get stabilised in India and an
environment compatible with the requirements under IFRS is developed.
12 The way forward
12.1 Changes in Accountancy, due to change in
Technology: Globalization of national
economies and their interdependence had been strengthened by the internet,
which brings people living across the globe together in no time. This had an
impact on the working of the different professions and the profession of
accounting has not been left unaffected by this global revolution of
networking. New technologies spawn new applications and possibilities, which in
turn inspire changes to accounting methods and methodologies. The advent of
cloud-enabled computing has brought improvements to mobility and connectivity
for accountants. As a result, one is able to work with clients across the globe
from the comfort of one’s home, remotely access one’s data from a variety of
devices regardless of one’s location or the time, perform advanced computations
on the fly and retrieve real-time analytics. Technological changes to
accounting have automated many of the inputs and calculations that accountants
once had to perform manually. This allows one to play a more analytical and
consultative role in one’s interactions with clients. Of course, these advances
also require one to remain flexible, adaptable and perpetually learning in
order to keep up with the rapid pace. The evolving Block Chain technology and Artificial
Intelligence will also impact the way accounting is done, in times to come.
These are interesting times in the Accounting arena.
12.2 India has come a long way through evolving
the accounting rules towards better governance and globalization of its rapidly
growing economy. The couple of years of experience by several hundred Indian
companies ushering in IFRS converged accounting, to the say the least, is
encouraging. The existing Standards for SME/SMCs are also being upgraded to
make them compatible with Ind AS except for the complexities of Fair Value,
time value of money, etc. and this could be next era of big changes in
Indian context.
Origin
and Evolution of Auditing
13. Origin of Audit
13.1
The word audit comes from the word
“Audire” (means to hear). In general, it is a synonym to control, check,
inspect, and revise. In early days an auditor used to listen to the accounts
read over by an accountant in order to check them. Auditing is as old as
accounting. It was in use in all ancient countries such as Mesopotamia, Greece,
Egypt, Rome, U.K. and India. The Vedas contain reference to accounts and
auditing. Arthasashthra by Kautilya also detailed rules for accounting and
auditing of public finances.
13.2
In general, it is a synonym to control,
check, inspect, and revise. Auditing existed primarily as a method to maintain
governmental accountancy, and record-keeping was its mainstay. It wasn’t until
the advent of the Industrial Revolution, from 1750 to 1850, that auditing began
its evolution into a field of financial accountability. Checking clerks were
appointed in those days to check the public accounts and to find out whether
the receipts and payments are properly recorded by the person responsible.
13.3
As trade and commerce grew extensively
globally, the involvement of public money therein also increased manifold. This
in turn created a demand from the investors to have the accounts of the
business ventures examined by a person independent of the owners and management
of the business to ensure that they were correct and reliable. Such a demand
laid down the foundation for the profession of auditing.
13.4
Over the years, the extent of reliance
placed by the public on the auditors has increased so much with time that it
is, unreasonably, felt by the public that nothing can go wrong with an
organisation which has been audited. Though the fact that an audit has been
carried out is not a guarantee as to the future viability of an enterprise, it
is extremely important that the auditors carry out their assignments with
utmost professional care and sincerity, to uphold the faith posed by the public
in them.
13.5
Over the years, auditing has undergone
some critical developments. A change in audit approach from “verifying
transaction in the books” to “relying on system” also evolved due to the
increase in the number of transactions which resulted from the continued growth
in size and complexity of companies where it was unlikely for auditors to play
the role of verifying transactions. As a result, auditors started placing much
higher reliance on companies’ internal controls in their audit procedures.
Furthermore, auditors were required to ascertain and document the accounting
system with particular consideration to information flows and identification of
internal controls. When internal control of the company was effective, auditors reduced the level of detailed testing.
13.6
There was also a readjustment in auditors’ approaches where the assessment of
internal control systems was found to be an expensive process and so auditors
began to cut back their systems work and make greater use of analytical
procedures. An extension of this was the development during the mid-1980s of
Risk-Based Auditing (RBA). RBA is an audit approach where an auditor will focus
on those areas which are more likely to contain errors. To adopt the use of
RBA, auditors are required to gain a thorough understanding of their audit
clients in term of the organisation, key personnel, policies, and their
industries. The use of RBA places strong emphasis on examining audit evidence
derived from a wide variety of sources that is both internal and external
information for the audit client.This period also involved Introduction of
Computer Assisted Audit Techniques (CAATs) that facilitated data extraction,
sorting, and analysis procedures.
14. Advent of computerization and auditing
14.1
Before the advent of the computer, bookkeeping was done by actual bookkeepers.
The bookkeeper would record every financial transaction the company made in a
journal, the then book of primary entry. The transaction didn’t just need to be
entered into the journal but also copied to other ledgers, for example, the
company’s general ledger.
14.2
Prior to the advent of computers, to
ensure accounts were in balance, a ‘Trial Balance’ was used. If this internal
document revealed that the accounts were not balanced then the bookkeeper had
to undertake the arduous task of going through each transaction, check the
castings, carry-forwards, etc. until the root cause of the disparity was
located and rectified so that the accounts again balanced.
14.3
The advent of computerisation
dramatically changed the manner in which the business was conducted. It had
significant effect on organization control, flow of document information
processing and so on. Auditing in a Computerised environment however did not
change the fundamental nature of auditing, though it caused substantial change
in the method of evidence collection and evaluation. This also required auditors
to gain knowledge about computer environment (hardware, software, etc.)
and keep pace with rapidly changing technology, even to the extent of using
sophisticated Audit software.
14.4
Auditors generally followed an “auditing
around the computer” approach by comparing the machine’s input with its
output (parallel processing), just as he/she had compared the voucher files
with the ledger books in the early 1900s.
14.5
With the introduction of computers,
conventional accounting systems and methods using papers, pens, etc. underwent
drastic changes, therefore exerting a great impact on internal control and
audit trails in following audit procedures. Auditors could no longer depend on
visible records but only check the existence of adequate internal control
system to ensure accuracy of operations; the number of records which could be
read only when processed by computers increased while intermediary and legible
records which existed in conventional manual accounting processes decreased and
there were many cases in which audit trails were not available. Therefore,
audit procedures had to be revised to cope with
these problems.
14.6
With rapid changes in the business world, auditors only slowly realised they
needed to be technologically proficient and, perhaps, adopt new approaches. The
21st Century forced auditors to rather “work through the computer”
in performing their functions as virtually all business transactions were
conducted via the information technology. Computer Assisted Audit Techniques
(CAATs) were developed for using technology to assist in the completion of an
audit. CAATs automated working papers and auditors used software to perform
audits. CAATs were very useful when
large amounts of data were involved or complex relationships of related data
were needed to be reviewed to gather appropriate audit evidence from the
aggregated data. It also increased the efficiency of the conclusions about data
analysis. Several CAATs were developed like Generalized Audit Software, Data
analysis software; Network security evaluation software/utilities; OS and DBMS
security evaluation software/utilities; Software and code testing tools”,
Interactive Data Extraction and Analysis, and Audit Command Language.
15. Auditing in future and use of technology
for audit
15.1
For the past two decades, auditors have
been seeking less and less audit evidence from detailed substantive testing.
Better accounting systems and the greater use of IT by clients has meant that
very few material transaction errors are being discovered by external auditors.
Therefore, audit emphasis is increasingly shifting from the detailed
examination of the routine transactions to the internal controls and the
potential of risk. These developments have to be viewed in terms of a change
from audit efficiency to audit effectiveness. There has been resurgence in the
emphasis on judgement regarding the assessment of risks and controls, judgement
regarding the interpretation of analytical reviews, and judgement in relation
to any testing (albeit on limited basis). The focus, by some firms, on the
high-level risks and controls, together with the justification of very limited
amounts of detailed substantive testing based on their risk analyses and
analytical reviews, has completely altered previous conceptions of the external
audit.
15.2
The functions of auditors have changed
over the years unlike its antecedent “accounting”. Much later in history, this
duty changed since auditors are not guarantors and there is no way they can
ascertain 100% that the financial statements prepared and presented are free
from fraud, therefore, the auditors were expected to give reasonable skill and
care in giving their opinion on whether the financial statements faithfully
represent the financial situation of the business. The roles of auditors were
seen to be changing due to changes in the world at large. Due to this, the
assertion in an audit report has changed from “True and correct” in the past to
the present concept of “True and Fair”.
15.3 Given the
recent advances in business technologies, the continuing emphasis on the
backward-looking or historical audit is now being seen as an outdated
philosophy. Instead, the thought is that real-time solutions are needed. As
such, it is felt that auditing firms that successfully experimented with the
CAATs should give eventual consideration to more advanced programs which
contain functionalities resembling the audit of the future and provide a higher
level of assurance. Furthermore, these programs may assist in optimizing the
audit function by analyzing all financial transactions as they occur. This has
also resulted in the evolution of different fields of audit viz., Statutory
Audit, Internal Audit, Management Audit, Systems Audit, Forensic Audit and so
on. Clearly, within the overall audit function, the scope and end result or the
reporting is different in the different types of audit.
15.4
The extent to which data, controls, and
processes are automated must be considered and discussed with the client, for
example a company that is overburdened by manual audit processes will need to
confront this issue at some point if the objective is to yield optimal benefits
from the audit. An enterprise that moves toward greater automation relative to
data, processes, controls, and monitoring tools begins to naturally structure
itself for the coming of the future audit. There are a variety of methodologies
like Embedded Audit Modules (EAM), Monitoring and Control Layer (MCL), Audit
Data Warehouse (ADW), and Audit Applications Approach that will need to
progressively adopted and used to meet the users’ expectations.
15.5 New technological
tools have the potential to enable the auditor to mine and analyze large
volumes of structured and unstructured data related to a company’s financial
information. This capability may allow auditors to test 100% of a company’s
transactions instead of only a sample of the population. Major accounting firms
have asserted that the use of these tools will enhance the audit by automating
time-consuming tasks, which are more manual and rote in nature. For example,
through the use of artificial intelligence, robotic systems could interface
with a client’s systems to transfer and compile data automatically, something
previously done manually by a junior auditor. Other areas where such
technologies may introduce efficiencies include processing of confirmation
responses or using drones for physical inventory observations.
15.6
As a result, the auditor should have
more time to carefully examine the more complex and higher risk areas that
require increased auditor judgement and contain high levels of estimation
uncertainty. Such tools, will also enable auditors to perform advanced
analytics which will provide them with greater awareness and deeper insights
into the company’s operations. Data analytics may also allow auditors to better
track and analyze their client’s trends and risks against industry or
geographical datasets, allowing them to make more informed decisions and
assessments throughout the audit process.
15.7
Further, through the power of big data,
auditors will be able to correlate disparate data information to develop
predictive indicators to better identify areas of higher risk, which in turn
could lead to early identification of fraud and operational risks. For example,
firms will have the ability to develop predictive models to forecast financial
distress in order to better assess the future financial viability of a company
or improve fraud detection by helping auditors assess the risk of fraud as part
of their risk assessment.
15.8
The use of these technological tools and
methods also raise certain challenges. For example, it is important that the
data being used is reliable, complete and accurate. That is true for general
ledger data, other financial and operating data, and data from outside the
company. Data security and quality control over these tools, whether developed
in-house or by vendors, are also factors for firms to consider. And ensuring
consistency of approaches across group audits may become difficult if such
tools are not readily available to, or used by, affiliate offices. Also,
auditors should take care that they are not over relying on data analytics. As
powerful as these tools are, or are expected to become, they nonetheless are
not substitutes for the auditor’s knowledge, judgement, and exercise of
professional scepticism.
16. Changing role of Auditors
In
the last two decades, rapid and vast development in corporate governance has
consolidated the auditor’s position as a watchdog. The perpetual accounting and
auditing failures like Enron, WorldCom, Paramalt, and more recently Satyam has
exposed serious lacuna in the auditing. India’s largest accounting fraud
“Satyam” has dented auditing profession and surfaced the inherent conflicting
position of auditors in the Indian business scenario. The recent ‘PNB’ scam and
the more recent resignation of auditors in several listed entities just before
the financial statements were to be adopted has also put the auditors; and
their role in the limelight.
16.1
According to IFAC, objective of an audit
is to enable the auditor to express an opinion on whether the financial
statement is prepared in all material respects, in accordance with an
identified financial reporting framework. The auditor’s opinion helps to
determine the true and fair financial position and operating results of an
enterprise. This is considered as most accepted role of the auditorsand
mandated so by the corporate laws of most countries of the world. In India
also, the auditor is cast with the responsibility of ensuring this aspect.
16.2
With development of stricter corporate
governance codes and new reporting standards both in accounting and auditing,
the auditor’s role has implicitly enhanced to a great extent as against the
traditional role of merely assessing the true and fair value of a corporation.
With financial reporting standards now focusing on concepts of ‘fair value’,
‘impairment’ and ‘going concern’, which involve a high level of judgement, the
role of auditors is becoming much more relevant than ever.
16.3
External auditors are the oldest
watchdogs, to protect the interest of the shareholders by verifying the
financial accounts and presenting their opinion on it. In India, in the recent
decade, capital markets have grown tremendously, open access of market has been
given to foreign nationals / investors, numerous corporate frauds (including
Satyam, Ricoh, and PNB) happened, and vast developments in the field of
corporate governance have taken place. All these increase theauditor’s
responsibilities and make them an integral part of corporate governance
framework. They are now professed to play different roles and responsibilities,
other than their statutory responsibilities in this contemporary business
environment. The corporate governancereforms by SEBI in the form of Clause 49
and the more recent LODR has improved the status of auditing and given much
needed significance to the role of auditors.
17. Standards on Auditing in India
17.1
In simplest possible terms, auditing standards represent a codification of the
best practices of the profession, which already exists. Auditing standards help
the members in proper and optimum discharge of their profession duties.
Auditing standards also promote uniformity in practice as also comparability.
Standards on Auditing help to:
– compensate for the lack of observability of
the audit outcome by focusing on the audit process;
– partially mitigate the information advantage
possessed by the auditor as a professional expert that might motivate the
auditor to under-audit;
– counter balance the diversity of demand
across multiple stakeholders that might drive the audit to the lowest common
denominator and create a market based on adverse selection; and
– provide a benchmark that facilitates the
calibration of an auditor’s legal liability in the event of a substandard
audit.
17.2
However, the Standards does not:
– discourage the use of judgement by auditors;
– limit the potential demand for alternative
levels of assurance;
– lead to excessive procedural routine or standardisation
in the conduct of the audit; or
– be set based on an enforcement agenda.
17.3
Since its establishment, the ICAI has
taken numerous steps to ensure that its members discharge their duties with due
professional care, competence and sincerity. One of the steps is the
establishment of the Auditing Practices Committee (APC) in September
1982. Representatives from the Reserve Bank of India, the Securities and
Exchange Board of India (SEBI) and industry were part of APC and had their say
before the ICAI formulated its guidance and statements on `Standard Auditing
Practices’. APC issued Statements on Standard Auditing Practices (SAPs) and
guidance notes without involving the public in the entire process.
17.4 In July 2002,
the central council of ICAI renamed the existing APC as Auditing and Assurance
Standards Board (AASB) to reflect the activities being undertaken by the
committee. To bring about more transparency in the auditing standards setting
process, the council also stipulated that the AASB would have four special
invitees.. Further, all exposure drafts issued by AASB are sent to specific
bodies such as the stock exchanges, Insurance Regulatory & Development
Authority (IRDA) and the Indian Banks’ Association (IBA) for their views and
comments.
17.5 The Standards
on Auditing (SAs) issued by ICAI are based on International Standards on
Auditing (ISAs) issued by IFAC.Since, ICAIis one of the founder members of
IFAC, the Standards issued by the AASB under the authority of the council of the
ICAI are in conformity with the corresponding International Standards issued by
the International Auditing and Assurance Standards Board (IAASB) established by
the IFAC. The only exception to this is SA 600 ‘Using the work of another
auditor’ which, looking to the Indian scenario where auditors can rely on
branch auditors or subsidiary auditors, is not converged with ISA 600.
Currently, the Standards on Auditing issued by the ICAI
are:
|
|
Title
|
|
SQC-1
|
Quality control for Firms that perform audits and
reviews of historical financial information and other assurance and related
services engagement
|
|
Standards on Auditing (SA)
|
|
SA 100-199
|
Introductory Matters
|
|
SA 200-299
|
General Principles and Responsibilities
|
|
SA 300-499
|
Risk Assessment and Response to
Assessed Risks
|
|
SA 500-599
|
Audit Evidence
|
|
SA 600-699
|
Using Work of Others
|
|
SA 700-799
|
Audit Conclusions and Reporting
|
|
800-899
|
Specialized Areas
|
|
Standards on Review Engagements (SREs)
|
|
SRE 2000 -2699
|
|
|
Standards on Assurance Engagements (SAEs)
|
|
SAE 3000-3699
|
Applicable to All Assurance Engagements
|
|
SAE3400-3699
|
Subject Specific Standards
|
|
Standards on Related Services (SRSs)
|
|
4000-4699
|
Standards on Related Services
|
18. Revised Audit Reporting (Effective
for
periods beginning on or after 1st April 2018)
18.1
The ICAI has issued revised standards on audit reporting. The same are based on
the ISAs issued by IFAC in 2016. The reason stated by IFAC for issue of the
revised ISAs is as under:
– Continued relevance of audit
– Improve audit quality and
professional scepticism
– Enhance preparer focus on key
financial statement risk areas and disclosures
– Enhance communicative value to users
– Stimulate more robust auditor
interactions and user engagement
– Improve users’ understanding of what
an audit is and what the auditor does.
18.2
Key Audit Matters (KAM):
Mentioning
KAM in an audit report is one of the major changes brought about in audit
reporting from financial year 2018-19 onwards. KAM are defined as those matters
that, in the auditor’s professional judgement, were of most significance in the
audit of the financial statements of the current period. KAM are selected from
matters communicated with TCWG. KAM are required to be communicated for audits
of financial statements of all listed entities – however an auditor may also
voluntarily, or at the request of management communicate KAM. The following
considerations are used in determining matters of most significance:
– Importance
to intended users’ understanding of the FS
– Nature and extent of audit effort needed to
address
– Nature of the underlying accounting policy,
its complexity or subjectivity
– Nature and materiality, quantitatively or
qualitatively, of corrected and accumulated uncorrected misstatements due to
fraud or error (if any)
– Severity of any control deficiencies
identified relevant to the matter (if any)
– Nature and severity of difficulties in
applying audit procedures, evaluating the results of those procedures, and
obtaining relevant and reliable evidence
18.3
It is felt that the introduction of KAM
in the audit reports will usher in more transparency in disclosures and
improvement in audit quality.
conclusion
19.
Over the last decade, the users’
expectations from financial statements and audit report thereon have undergone
a sea-change. From a time where concise financial statements and crispaudit
reports were favoured, the trend now is clearly towards more disclosures and
transparency in financial statements and audit reports with more details. An
attempt has been in this article to discuss the evolution of accounting and
auditing to meet these ever-growing expectations.
