The Hindu Business Line : Cross-border comparability

Mohan R. Lavi on the efforts by the FASB and the IASB to improve financial reporting by eliminating certain narrow differences in their accounting standards

ACCOUNTING is simply an art of recording all financial transactions in a suitable manner. Since the basic job of accounting is to provide information, there should be certain rules/guidelines, which could be labelled accounting principles or policies, so that this information is understood by one and all. The intricacies of accounting permitted companies to alter their accounting principles if they felt that a particular accounting policy was not in sync with the requirements of the day.

However, the impact of the change in the accounting principle was to be recognised in the profit and loss (P&L) account. Accounting Standard 5 issued by the Institute of Chartered Accountants of India (ICAI), APB Opinion No 20 along with FASB Statement No 3 issued in the US and IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors) issued by the International Accounting Standards Board (IASB) all postulated the same treatment. Recently, the Financial Accounting Standards Board (FASB) in the US, through Statement No 154, made an amendment to Opinion No 20, asking companies to reflect the effect of their changes in accounting policies retrospectively.

This Statement is the result of a broader effort by the FASB to improve the comparability of cross-border financial reporting by working with the International Accounting Standards Board (IASB) toward development of a single set of high-quality accounting standards. As part of that effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting standards. Reporting of accounting changes was identified as an area in which financial reporting in the US could be improved, by eliminating differences between Opinion 20 and IAS 8.

Opinion 20 previously required that most voluntary changes in accounting principle be recognised by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.

When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement.

When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable.

This Statement defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. This Statement also redefines restatement as the revising of previously issued financial statements to reflect the correction of an error.

This Statement requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in non-discretionary profit-sharing payments resulting from an accounting change, should be recognised in the period of the accounting change.

This Statement also requires that a change in depreciation, amortisation, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle.

Under the provisions of Opinion 20, most accounting changes were recognised by including in net income of the period of the change the cumulative effect of changing to the newly adopted accounting principle.

This Statement improves financial reporting because its requirement to report voluntary changes in accounting principles via retrospective application, unless impracticable, enhances the consistency of financial information between periods. Improved consistency enhances the usefulness of the financial information, especially by facilitating analysis and understanding of comparative accounting data.

Accounting Standard 5 in India, modelled largely on the lines of IAS 8, still suggests reflecting the net change of an alteration in an accounting principle in the P&L account. With IAS set to be the norm for global accounting standards sooner rather than later, it would be preferable to toe that line instead of having to make frequent amendments.

(The author is a Hyderabad-based chartered accountant.)