The Hindu Business Line : There should be accounting for policies

Published annual reports of enterprises include significant accounting policies in accordance with the requirements of Accounting Standard (AS) 1 — `Disclosure of Accounting Policies'. The purpose is that the users of the financial statements should be able to appreciate the policies by which the financial statements are prepared. Also, the accounting policies indicate the extent to which the accounting standards and the legal requirements governing the enterprise have been followed in the presentation of financial statements. Thus, it is imperative that the accounting policies are properly presented.

A proper accounting policy is complete, unambiguous, user-friendly and is in accordance with the requirements of law and accounting standards. However, on a perusal of the annual reports of various companies, it is noted that the accounting policies generally do not meet the aforementioned characteristics.

Some simple guidelines, suggested below, can be followed for drafting proper accounting policies.

Review accounting policies every year

In the last few years, a number of accounting standards have been revised by the Institute of Chartered Accountants of India (ICAI).

Yet, the accounting policies included in the financial statements continue to follow the pre-revised accounting standards. For example, in the accounting policy related to the effects of fluctuations in foreign exchange rates, various companies continue to state that the `current assets' and `current liabilities' are translated at the closing rates. It may be noted that AS 11 — Accounting for the Effects of Changes in Foreign Exchange Rates (1991) — was first revised in 1994 and then in 2003 and issued as `The Effects of Changes in Foreign Exchange Rates'.

These revised standards nowhere use the term `current assets' and `current liabilities', but `monetary assets' and `monetary liabilities'.

Companies using the terms `current assets' and `current liabilities' would seem to be following the accounting policy based on AS 11 issued in 1991; using these expressions could also mean that certain current assets which are not monetary assets and certain current liabilities which are not monetary liabilities are translated at the closing rate and would not be in accordance with the revised (2003) AS 11 and, accordingly, the accounting treatment followed would be incorrect.

An example in this regard would be a non-refundable advance paid to a supplier for the purchase of an asset, which would be classified as a current liability but is not a `monetary liability' as defined by the revised AS 11. In respect of such an advance, the original rate, and not the closing rate, should be used.

Stick to the language of AS

It has been noted certain companies use their own language, rather than that used in the relevant Accounting Standard.

This may, in certain cases, create an impression that the accounting policy followed by the company is not in accordance with the Accounting Standard.

For example, the accounting policy relating to investments, in certain cases, states that the "Long-term investments, are valued at cost.

However, a decline in their value is provided for in case the decline is permanent." Paragraph 32 of AS 13 — Accounting for Investments — does not use the term `permanent', but requires that a provision be made to recognise a decline `other than temporary' in the value of the investments.

Meanings of the terms `permanent' and `other than temporary' are different. As nothing is permanent, a permanent decline in the value of investments may not happen, which is not so in case of `other than temporary'. Accordingly, usage of the term `permanent' is not in accordance with the requirements of AS 13 and the treatment would be incorrect if a decline in the value is not provided for where the decline is `other than temporary'.

Accounting policies should strictly be in accordance with the requirements of law/accounting standards: In certain cases, it has been noted that the accounting policies are in clear violation of this requirement.

For example, the accounting policy of some companies relating to depreciation provides that no depreciation is charged on the assets acquired during the year or disposed of during the year. In this regard, Schedule XIV to the Companies Act, 1956, clearly requires that pro-rata depreciation should be charged on the fixed assets.

Thus, the aforesaid depreciation policy is clearly in violation of the requirements of Schedule XIV.

It may be argued that the aforesaid accounting policy might have been followed because the amounts involved are not material. If that be the case, the accounting policy should specifically state that "The company does not provide for pro-rata depreciation on the fixed assets acquired/disposed of during the year as the amounts involved are not material".

(To be concluded)

(The author is Technical Director, ICAI.)