14 Oct 2015 17:44 IST

Are accounting policies consistent across companies?

Here is how usage of different accounting policies would impact the financial statements

The financial statements of a company are important for investors and stakeholders to understand its financial performance during any period. In preparing them, companies are required to follow the Accounting Standards (AS) as given under the Companies Act, 2013. In this article, we take a look at the AS given in the Companies (Accounting Standards) Rules, 2006, which prescribes the accounting treatment to be followed by companies and disclosures to be made in its financial statements, such as disclosure of accounting policies, revenue recognition, valuation of inventories, cash flows, events occurring after balance sheet date, items recognised in the statement of profit and loss, goodwill, borrowing costs, fixed assets, depreciation, intangible assets and impairment.

While the basis of preparation of financial statements remains the same for all companies, there are areas where each company views certain items in its financial statements differently, leading to differing accounting policies and different positions being taken in its financial statements.

Ways they differ

Let us take an example of the accounting policy for the treatment of transaction costs incurred by a company on its borrowings as envisaged in AS 16, Borrowing Costs. While these costs are in the nature of expenses to be accounted in the statement of profit and loss, some companies may take a view that, in the absence of clearly prescribed accounting treatment, such expenses should be amortised over the period of the borrowings. Thus, while some companies adopt an accounting policy of recognising the expenditure wholly in the year of incurrence itself, other companies recognise these expenses over the period of such borrowing, thus, causing an uneven basis for comparison of performance.

Another area where companies could have differing policies is with regard to the accounting treatment of goodwill. In line with AS 10, Accounting for Fixed Assets, in a case where a company purchases a business, the excess of consideration paid over the net assets acquired is accounted as goodwill. AS 10 further states that such goodwill may, as a measure of financial prudence, be written off during a period. Accordingly, certain companies adopt the accounting policy of writing off the goodwill over a period as estimated by the management, or recognise it as an expense if it does not fulfil the definition of an asset. However, certain companies may continue to present such goodwill as an asset in its financial statements and on perceiving indicators, test it for impairment as per AS 28, Impairment of Assets.

The different accounting policy adopted by these companies impacts their financial position as compared to the companies amortising goodwill over a specified period.

Foreign exchange variance

Different accounting policies are also encountered in accounting for foreign exchange differences as dealt with in AS 11, The Effects of Changes in Foreign Exchange Rates. This standard presently gives an option to companies having exchange differences arising from long term foreign currency borrowings at the end of each reporting period to recognise these exchange differences in the statement of profit and loss, or as part of the depreciable fixed assets for which the borrowings were availed. Where these long term borrowings are not for depreciable fixed assets, the exchange differences arising thereon can be accumulated in a foreign currency monetary item translation difference account, to be amortised over the period of the borrowing. Therefore, companies can either capitalize the exchange differences arising on such borrowings as cost of depreciable fixed assets; or, where these borrowings are not for fixed assets, amortise the accumulated exchange differences over the period of borrowing. Alternatively, the company may choose to recognise such exchange differences in the statement of profit and loss.

The above examples illustrate how usage of different accounting policies would impact the financial statements.

The company’s choice of accounting policy is driven by the business model, the operating model and prevalent market practices. Awareness of different accounting policies and familiarity with the policy choices of the company is a step forward in understanding its financial statements better.

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