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CHAPTER 3 : Applicability of Accounting Standards

Overview

  • Understanding the status and applicability of accounting standards in India, particularly for corporate and non-corporate entities.
  • Identifying the criteria for classification of entities based on their size and nature of activities.

Key Topics

Status of Accounting Standards

  • Accounting Standards are developed by the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI).
  • They are issued under the authority of the ICAI’s Council and must be approved by the Ministry of Corporate Affairs (MCA).
  • The standards cannot override local laws and regulations, but they are mandatory once notified by the MCA.
  • The applicability depends on whether the governing statute requires compliance with the standards (e.g., Companies Act, 1956 or 2013).
  • Three main questions to assess applicability: 1) Does it apply to the enterprise? 2) Does it apply to the financial statements? 3) Does it apply to the specific financial items?

Deep Dive

  • As of 2013, Section 129 (1) of the Companies Act requires companies to present financial statements per accounting standards under Section 133.
  • Auditors must report compliance with accounting standards, ensuring transparency and accountability in financial reporting.
  • The Institute emphasizes the need for stakeholders to understand deviations from standards through sufficient disclosures.

Applicability for Non-Corporate Entities

  • Non-corporate entities are classified into four levels (I to IV) based on size and activities.
  • Criteria include turnover and borrowings; Level I includes large entities and Level IV comprises micro entities.
  • Accounting standards apply fully to Level I entities, while Levels II, III, and IV enjoy partial exemptions.
  • An enterprise engages in activities considered commercial or industrial is generally subject to Accounting Standards, even charitable organizations if they perform such activities.
  • The applicability of accounting standards emphasizes materiality—items omitted or misstated must be significant to economic decisions.

Deep Dive

  • The classification of entities helps streamline compliance and reduce unnecessary regulatory burdens on smaller firms.
  • Level IV entities are exempt from numerous standards, allowing them to focus on essential compliance requirements.
  • Practices of financial reporting are adapted to the context of the business’s size and complexity, promoting effective management and oversight.

Criteria for Classification

  • Entities are classified based on turnover and borrowings to determine the level of regulatory compliance required.
  • Level I: Entities with turnover exceeding ₹250 crores or borrowings over ₹50 crores.
  • Level II: Turnover over ₹50 crores, but less than ₹250 crores; borrowings must not exceed ₹10 crores.
  • Level III and IV: Smaller entities dealing with turnovers under ₹50 crores and borrowings below ₹2 crores are further classified accordingly.
  • This tiered system ensures that smaller firms are not overwhelmed by compliance burdens inappropriate for their size.

Deep Dive

  • This classification is crucial for policy-making, shaping regulations to support business growth while ensuring accountability.
  • It reflects a broader global shift towards proportional regulation favoring smaller enterprises without compromising financial transparency.
  • Regulatory frameworks like this often correlate with overall economic health, impacting small business growth and operational effectiveness.

Accounting Standards and Income Tax Act

  • Accounting Standards aim to harmonize financial reporting but do not directly determine tax liabilities.
  • For instance, deductions allowed for expenses under tax law may differ from accounting treatments (e.g., depreciation).
  • Accounting for income must be recognized in financial statements even if exemptions exist under income tax.
  • The interplay between accounting standards and tax regulations necessitates careful consideration by accountants and financial managers.
  • For tax purposes, specific provisions allow for a different treatment of accounting methods, influencing a company’s overall reporting.

Deep Dive

  • In practice, the divergence between accounting and tax standards can lead to discrepancies in reported profits, thereby complicating financial planning.
  • This aspect forms a critical part of financial strategy, necessitating skilled tax advisory to navigate potential pitfalls in compliance.
  • The financial results, influenced by these differences, impact stakeholder perceptions and investment decisions.

Income Computation and Disclosure Standards (ICDS)

  • ICDS promulgated by the Central Government under Section 145(2) of the Income Tax Act aim to provide standards for income computation.
  • Ten ICDs were notified effective 2017-18 spanning various accounting areas including revenue recognition and fixed assets.
  • These standards are crucial for entities not required to follow Ind AS, ensuring uniformity in financial reporting.
  • ICDS align closely with the objectives of accounting standards, albeit with divergent focuses when dealing with taxation.
  • Periodic updates to these standards reflect changes in economic policies and accounting practices.

Deep Dive

  • ICDS serves to enhance comparability across industries by enforcing standardized accounting treatment of income and expenses.
  • There exists an ongoing dialogue among professionals regarding the implications and challenges of reconciling ICDS with existing accounting standards.
  • Stakeholders must stay informed on changes to ensure compliance and adapt financial strategies effectively.

Exemptions and Relaxations

  • Exemptions from certain accounting requirements are provided for small and medium-sized companies (SMCs) under the Companies (Accounting Standards) Rules, 2021.
  • The ICAI provides guidelines for recognizing entities exempt from various standards based on their size and complexity, simplifying compliance processes.
  • Certain enhancements to disclosures may still apply even where exemptions exist, fostering transparency and dutiful reporting.
  • SMCs must clearly disclose their compliance status and any exemptions utilized in their financial statements.
  • Exceptions ensure that while adhering to basic standards, smaller entities can operate with sufficient flexibility.

Deep Dive

  • The recognition of SMCs in the regulatory framework serves to promote small business viability and longevity.
  • It demonstrates a conscious approach toward scaling back regulatory pressure without sacrificing necessary oversight, enabling better resource allocation.
  • Future modifications to exemptions may be based on the evolving economic climate, affecting SMC operations and compliance dynamics.

Summary

Accounting Standards in India are developed by the ICAI’s ASB and require compliance for corporate entities through MCA mandates. Non-corporate entities are classified into four levels based on size and turnover, with varying standards applicable. Materiality significantly influences the recognition of financial items. Additionally, exemptions are designed for smaller entities to facilitate compliance, reflecting a regulatory balance between oversight and operational agility. Understanding the interrelation between accounting standards and taxation further shapes financial reporting and strategic planning. This comprehensive understanding empowers students and professionals in the accounting domain to navigate the complexities of accounting standards effectively.