List of Accounting Principles

The Institute of Chartered Accountants and Provisions of Company Act, along with the guidelines under the Act govern the accounting principles and practices, followed in India.

The knowledge of the more important principles involved is an asset for the financial analyst.

The majority of the companies follow these right principles of accounting, which are prudent and conservative.

Some of these accounting principles are set out below:

1. Conservatism:

This principle embodies prudence whereby all losses, whether likely or realised are recognized while profits are recognized when they are actually earned. As per the RBI guidelines to NBFCs, the prudential norms for income recognition are- Income part due but not received within 6 months of due date is not to be booked, until actually received. Similarly non-performing assets (NPA) are to be separated. The definition for the NPA is a credit instrument in respect of which, interest and principal installments have been due for a period of more than 6 months.

Such assets are required to be provided at the rate of 10 to 50% of the amount (depending upon period of overdue from 6 months to 3 years). An asset considered uncollectable has to be provided for at a rate of 100% of the amount, as per the RBI guidelines to finance companies.

In respect of valuation of inventory or any asset, the market price or cost price whichever is lower is to be taken. There should not be undue overvaluation or undervaluation of assets and valuation should be realistic. Prudence also dictates the need for making provision on anticipation of doubtful debt or bad debts, adoption of written down values for charging the depreciation and amortization of intangible assets. Similarly liabilities should not be undervalued as assets should not be overva­lued.

2. Consistency:

Whatever method is adopted for valuation of assets or for charging depreciation, the same should be adopted throughout the years for com­parison and consistency. Some companies change the accounting practice with a small footnote at the end. Thus excise duty paid in some assets deducted from sales income and sometimes shown separately as expenditure.

Similarly cash discount received on purchase is treated in one year as revenue and in another year a reduction in purchase price. If any change is needed for window dressing, the change should be explained with adequate reason giving the implications of the same to the company’s financial position. The same practice should be followed uniformly every year instead of changing year after year.

3. Sound Practices in Reporting:

Every expense item is to be supported by a voucher and if that is not possible with petty cash, that has to be maintained separately and debit and credit vouchers should be passed, supported by proper receipts, wherever possible. This is called objective evidence approach.

Besides, accounts should be kept on the basis of either accruals or realization. The interest accrued is generally taken as credit, while payments made are on a cash basis. This leads to overestimation of revenue, relative to expenditure. There should be a uniform policy of reporting either on approval basis or on cash basis and not a mixture depending on the circumstances.

4. Materiality:

As there may be minor expense or credit items, all major items are to be recorded individually and minor events to be clubbed together. Reporting of minor stationery items and minor petty cash items can be clubbed into a major reporting items by putting an indent for use of a section or a division. In respect of such events, the section and division will record the minor details and the minor items of expense or revenue will go to the accounting books. What is major or minor or what is material or not has to be decided by the accountant and is a matter of judgement. Only consistency in treatment is to be maintained.

5. Disclosure:

This principle of disclosure refers to full and fair disclosures of all material facts in company finances. Through proper accounting methods, certain disclosures are made compulsory by law and formats are laid down by the Compa­nies Act for income expenditure statements and balance sheet statements with a view to force full disclosures by the company.

Even by practice good companies have always followed these principles, in giving detailed notes and footnotes on any changes in practices and in the case of intangible assets or contingent liabilities, etc. The various schedules to the income expenditure statement and balance sheet, as per the Companies Act, provide the necessary disclosures by the companies.

As per the Govt., guidelines, under the Companies Act, all companies have to have a uniform accounting year of April to March and departure from this rules should be an exception. Similarly listed companies have to provide half yearly unaudited results to the public and in the balance sheets disclose the sources and users of funds and achievements vis-a-vis the targets or projections, given at the time of new issues. The companies have to finalize all their financial statements and annual report within six months from the date of the closure of accounts, namely, by September for the accounts closed in March.

Other Disclosures:

Disclosure requirements are laid down in the Companies Act, government guidelines and the listing agreement with the Stock Exchange, which all listed companies have to observe. The Financial Analysts and Treasury Managers have to be familiar with the guidelines from April 1996 onwards.

As per the latest guidelines the companies have to keep accounts on cash basis or mercantile basis. All the companies have to follow the prevailing guidelines and be familiar with these requirements under the law.

The following details are to be provided in the Directors’ Report, as per the Companies (Disclosure of Particulars in the Report of Board of Directors) Rules 1988:

1. Measures taken for pollution Control and abatement under Water Pollu­tion and Control of Pollution Act.

2. Conservation of energy and measures taken in the direction of economizing the use of electricity.

3. Technology absorption and measures adopted for saving Scarce Water and energy resources.

4. Research and Development efforts to absorb the foreign technology and development of import substitutes.

5. Insurance of all insurable interests of the company.

6. Foreign exchange earnings and outgo during each of the years.

As per the Section 217 (2A) of Companies Act each company has to reveal the names of employees drawing above Rs. 25,000 P.M. in the Balance Sheet.

All accounts are kept in nominal rupees and although rupees of last year or a few years back are not comparable with the Present Rupee no attempts are made to present inflation adjusted figures in the balance sheets, which are more scientific.

Under Section 212 of the Companies Act, the subsidiaries of companies and their details are to be given separately specifying their holdings in these subsidiaries. Investments in non-traded assets and those of non-marketable nature are to be presented separately. Uniformity and consistency in practices is also required to be adhered. Any changes have to be explained and their implications for the accounts and their comparison are to be set out in the Auditor’s Report or foot notes.

Some Accounting Misconceptions:

1. There is need to distinguish the cash from funds flow as there is a difference between them.

2. Premium on issues made, although received in cash do not form part of profits of the company but are to be shown as free reserves in Balance Sheet.

3. Profits are a liability and losses are assets and reduce the capital available.

4. Work in progress and miscellaneous expenditure not written off form part of the assets.

5. Depreciation is another accounting concept, much abused by the compa­nies and financial analyst has to note the methods of depreciation adopted, and examine consistency and comparability of their figures. In fact cash profits should include depreciation figures with net profits.

6. Ability of current assets and the non-performing nature of these assets are to be noted. Not all current assets are of the same quality as some may be substandard and some may be bad debts.

7. Inventories of yester years may not be valued as the inventories of the current years as the costs per unit may differ for each year.

8. The RBI guidelines for income recognition and provisioning for bad and substandard debts are to be observed by all companies.

9. Some companies show huge cash and bank balances and they are not necessarily creditworthy or efficient as they may be having arrears of P.F. contributions, tax payments, etc. In fact may be inefficient in the use of cash balances.

10. Sales income is sometimes presented with and is also clubbed with other income, which is in the nature of trading, or speculation.

11. Financial Analyst has to take care of the accounting malpractices, changes in accounting systems and practices of companies.

12. Revalued assets may be put along with other assets not revalued and no indication may be given about why revaluation is done.

13. Profit figures can be manipulated by showing changing provisions for taxation, depreciation, DRR, CRRF etc.

14. The company’s treatment of depreciation, secret reserves, contingent li­abilities and intangible assets are the items where the financial analysts have to be careful in their analysis and interpretation.