Accrual basis of accounting :
The financial statements are prepared on the accrual basis of accounting, i.e., the effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
Going concern :
The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future.
Prudence :
Unlike Indian GAAP, IFRS does not consider ‘Prudence’ as an underlying assumption. For instance, the unrealised gains on an ‘available-for-sale financial asset’ is required to be recognised under IFRS, whereas the same is prohibited under Indian GAAP on the grounds of prudence. The framework makes it clear that prudence means exercising a degree of caution in making judgments under conditions of uncertainty, but that it should not lead to the creation of hidden reserves or excessive provisions.
Qualitative characteristics of financial statements :
The qualitative characteristics are the attributes that make the information provided in financial statements useful to users. There are four principal qualitative characteristics
(1) understandability, (2) relevance, (3) reliability, and (4) comparability, of which some are divided into sub-categories.
1. Understandability :
Information should be presented in a manner that it is readily understood by users.
2. Relevance :
Information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. Financial statements must have both predictive value and confirm past events.
Materiality :
The relevance of information is affected by its nature, and materiality. In some cases the nature of information alone is sufficient to determine its relevance (e.g., managerial remuneration). In other cases both nature and materiality are important (e.g., estimates of provisions that involve significant judgment). Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements (e.g., no provision made on non-performing assets in case of banks). As materiality depends on the size and nature of the item or error judged in the surrounding circumstances, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.
Either the size or the nature of the item, or a combination of both, could be the determining factor. Consideration of materiality is relevant to judgments regarding both the selection and application of accounting policies and to the omission or disclosure of information in the financial statements.
Materiality needs to be assessed on disclosures in case when items may be aggregated, the use of additional line items, headings and sub-totals. Materiality also is relevant to the positioning of these disclosures (on the face of the financial statements or in the notes). As such, IFRSs are not intended to apply to immaterial items.
3. Reliability:
Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading. Reliability depends on:
a) Faithful representation:
To be reliable, information must represent faithfully the transactions and other events it either purports to represent or could reasonably be expected to represent, e.g., a statement of financial position should represent faithfully the transactions and other events that result in assets, liabilities and equity at the reporting date which meet the recognition criteria.
b) Substance over form:
Information must be accounted for and presented in accordance with its substance and economic reality and not merely its legal form.
c) Neutrality:
Information must be free from bias. Financial statements are not neutral, if by the selection or presentation of information, they influence the making of a decision or judgment in order to achieve a predetermined result or outcome.
d) Prudence:
Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty. However, the exercise of prudence does not allow, for instance, the creation of hidden reserves or excessive provisions, the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial statements would not be neutral and, therefore, not have the quality of reliability.
e) Completeness:
To be reliable, the information must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance.
4. Comparability:
Users must be able to compare the financial statements of an entity (a) through time — internal comparability and (b) with different entities — external comparability. The measurement and display of the financial effect of like transactions and other events must be carried out in a consistent manner throughout an entity and over time for that entity and in a consistent manner for different entities. It is important that the accounting policies used and changes to these are disclosed. It also is important that the financial statements present corresponding information for the preceding periods.
Constraints on relevant and reliable information:
1. Timeliness:
If there is undue delay in the reporting of information it may lose its relevance. Management may need to balance the relative merits of timely reporting and the provision of reliable information.
2. Benefit and cost:
The benefits of information should be greater than the cost of providing it. The evaluation of benefits and costs is, however, a judgmental process.
3. Balance between qualitative characteristics:
In practice, a balancing or trade-off between qualitative characteristics is often necessary. The relative importance of the characteristics in different cases is a matter of professional judgment.
Definitions of assets, liabilities and equity:
1. Assets:
An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. Like Indian GAAP, the physical form is not essential to the existence of an asset, e.g., patents and copyrights. However, unlike Indian GAAP, the legal ownership is not of primary concern under IFRS; economic ownership is the essential characteristic.
2. Liabilities:
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. It is important to note here the term ‘present obligation’ (as opposed to ‘future commitment’), i.e., a decision by management to buy an asset in the future does not give rise to a present obligation — an obligation normally arises only when the asset is delivered or when management enters into an irrevocable agreement to acquire the asset.
3. Equity:
Equity is the residual interest in the assets of the entity after deducting all its liabilities. Although equity is defined as a residual, it may be sub-classified in the balance sheet. For instance, in a corporate entity, funds contributed by shareholders, retained earnings, reserves representing appropriations of retained earnings and reserves representing capital maintenance adjustments may be shown separately.
Recognition criteria for assets and liabilities: Assets and liabilities must be recognised if the recognition criteria are satisfied. Items are to be recognised as assets or liabilities (or as income and expenses) if:
1. it is probable that any future economic benefit associated with the item will flow to or from the entity, and
2. the item has a cost or value that can be measured with reliability.
The recognition criteria stresses on the ‘probability’ rather than ‘certainty’ of occurrence of future economic benefits. The probability of future economic benefits is to be assessed when the financial statements are prepared. The concept of probability refers to the degree of uncertainty that the future economic benefits associated with the item will flow to or from the entity. Assessments of the degree of uncertainty attaching to the flow of future economic benefits are made on the basis of the evidence available when the financial statements are prepared.
Specific criteria for recognition of assets:
- Probable that future economic benefits will flow to the entity, and
- The cost or value can be reliably measured.
The future economic benefits may flow to the entity in a number of ways. For instance:
- Inventories, fixed assets and know-how may be used in the production of goods or services to be sold by the entity;
- Cash and cash equivalents, receivables or marketable securities may be exchanged for other assets;
- Cash and cash equivalents may be used to settle a liability; or
- Cash and cash equivalents may be distributed to the owners of the entity.
Specific criteria for recognition of liabilities:
- Probable outflow of resources will result from settlement of a present obligation, and
- The amount can be measured reliably. The settlement of a present obligation usually involves the entity giving up assets in order to satisfy the claim of the other party.
Settlement may occur in a number of ways, for instance, by:
- The payment of cash or cash equivalents as is the case with most payables;
- The transfer of other assets, for example, in a barter transaction or in some business combination;
- The rendering of services to the other party as is the case with a liability for warranty repairs; or
- The replacement of the obligation with another obligation.
Definition of income and expense:
Income:
Income is an increase in economic benefits during the accounting period, in the form of direct inflow, enhancement of assets, or decrease in liabilities; and that results in increase in equity, other than those relating to contributions from equity participants.
The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity, including sales, fees, interest, dividends, royalties and rent. Gains represent other items that meet the definition of income and may not arise in the course of the ordinary activities of an entity (e.g., gains on the disposal of non-current assets). Gains represent increase in economic benefits and as such is no different in nature from revenue. Hence, gains are not regarded as constituting a separate element in the framework. Unlike Indian GAAP, the definition of income also includes unrealised gains (e.g., unrealised gains arising on the revaluation of marketable securities).
Expense:
The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity. Losses represent other items that meet the definition of expense and may, or may not, arise in the course of the ordinary activities of the entity.
Recognition criteria for income and expense: The recognition criteria for income and expense are the same as for the recognition of assets and liabilities.
Income is recognised in the profit and loss account when increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect, that recognition of income occurs simultaneously with the recognition of increase in assets or decrease in liabilities.
Expenses are recognised in the profit and loss account when decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets.
Measurement of elements of financial statements:
Different measurement bases mentioned in the framework are historical cost, current cost, realisable (settlement) value and present value.
Historical cost:
Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.
Current cost:
Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.
Realisable (settlement) value:
Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.
Present value:
Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business. This is different from Indian GAAP, where the assets and liabilities are recognised at transaction values without reference to the time value of money.
Key GAAP differences in the frameworks:
- The primary financial statement is consolidated financial statement under IFRS framework, unlike Indian GAAP where the primary financial statement is standalone financial statements.
- Unlike Indian GAAP, IFRS does not identify ‘Prudence’ as one of the fundamental accounting assumptions in preparation of financial statements. Thus unrealised gains of available-for-sale securities are recognised under IFRS, unlike Indian GAAP.
- As compared to Indian GAAP, IFRS places more importance on the statement of cash flows as it provides information on the ability of an entity to generate cash and cash equivalents and of the timing and certainty of their generation.
- Unlike Indian GAAP, the legal ownership is not a criterion for recognition of an asset. IFRS recognises an asset based on the assessment of ‘control’ over the economic benefits accruing from the asset.
- Unlike Indian GAAP, certain assets and liabilities are recognised at the present value of future cash flows when the time value of money is significant.
While barring the above differences, the framework under Indian GAAP and IFRS are similar, the said differences will have far-reaching implications on the Indian industry. Some of the accounting and reporting GAAP differences have their roots in the differences in the underlying frameworks.
