Compliance with accounting standards has been made mandatory. Sub-section (3A) to Section 211 (inserted by the Companies Amendment Act, 1999) requires that every profit and loss account and balance sheet shall comply with the accounting standards.
Accounting standards means the standards of accounting recommended by the Institute of Chartered Accountants of India (ICAI) and prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards (NACAS) constituted under sub-section 210A (1).
Until the Central Government prescribes accounting standards under this section, accounting standards issued by the ICAI shall be deemed to be the accounting standards. As per newly inserted Clause 50 of the Listing Agreement it is mandatory for the companies listed in a recognized stock exchange to comply with all applicable accounting standards in the preparation and presentation financial statements.
(i) Establishment of NACAS:
Section 210A (inserted vide the Companies Amendment Act, 1999) discusses about the establishment of the NACAS, The Central Government is empowered by virtue of the provision of section 210A (1) to establish NACAS which would advise the Central Government on the formulation and laying down of accounting policies and accounting standards for adoption by companies or class of companies under the Act.
The NACAS shall give its recommendation to the Central Government on such matters of accounting policies and standards and auditing as may be referred to it for advice from time to time.
The ICAI is free to set Accounting Standards as it has been doing since 1977. For the purpose of the Companies Act, the Central Government enjoys the authority to prescribe such accounting standards which are recommended by the ICAI. While prescribing any accounting standard, the Central Government may consult the NACAS.
Under Section 210A (2), the NACAS shall consist of the following twelve members:
i. A chairman, who shall be a person of eminence well versed in accountancy, finance, business administration, business law, economics or similar discipline;
ii. One member each nominated by the Institute of Chartered Accountants of India, Institute of Cost and Works Accountants of India and Institute of Company Secretaries of India;
iii. One representative of the Central Government to be nominated by it;
iv. One representative of the Reserve Bank of India to be nominated by it:
v. One representative of the Comptroller and Auditor General of India to be nominated by him;
vi. A person who holds, or has held the office of professor in accountancy, finance or business management in any University or deemed university;
vii. The chairman of the Central Board of Direct Taxes, constituted under Central Board of Revenue Act, 1963, or his nominee;
viii. Two members to represent the chambers of commerce and industry to be nominated by the Central Government;
ix. One representative of the Securities and Exchange Board of India to be nominated by it.
(ii) Deviation from Accounting Standards:
Sub-section (3B) to section 211 requires that in case the profit and loss account and balance sheet of a company do not comply with the requirements of the accounting standards, disclosure should be made stating—
i. Deviations from the accounting standards;
ii. The reasons for such deviation; and
iii. The financial effect, if any, arising due to such deviation.
The disclosure requirement as stated in Section 211(3A) will bring transparency but such deviations may be material enough to affect the truth and fairness of the financial statements. Accordingly, it is necessary for the statutory auditors to give negative report in case truth and fairness of the financial statements are violated by virtue of such deviations. This needs a change in the auditors’ reporting norm.
(iii) Duties of the Statutory Auditors as Regards Mandatory Accounting Standards:
The statutory auditors are required to make qualification in their report in case any item is treated differently from the prescribed treatment in the relevant accounting standard. However, while qualifying they should consider the materiality of the relevant item.
In case of non-disclosure of significant accounting policies the auditors are required to specify the fact in their report. The ICAI suggests that it should be in the following lines:
“The company has disclosed those accounting policies the disclosure of which is required by the Companies Act, 1956. Other significant accounting policies, viz., those relating to method of accounting followed for recognising revenue of the long-term construction contracts and recognition of warranty expenses have not been disclosed nor have all the policies been disclosed at one place, which is contrary to Accounting Standard-1 “Disclosure of Accounting Policies” issued by the ICAI.”
Similarly, an auditor is required to specify the fact in case a non-corporate body prepares financial statements on cash basis. The ICAI suggests that specifying the fact is sufficient and the auditors may state that accounts give true and fair view on the cash basis if it is so.
The newly inserted Sub-section (3) of Section 227 requires the auditors to report whether, in his opinion, the profit and loss account and balance sheet comply with the accounting standards referred to in Section 211 (3C).
(iv) Income-Tax Act, 1961:
Pursuant to an amendment to the Income-tax Act, 1961 in 1995, it has been provided that the Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income Two accounting standards, viz., (1) Disclosure of Accounting Policies and (2) Disclosure of Prior Period and Extraordinary items and changes in accounting policies have been issued.
These standards are more or less in conformity with the parallel standards issued by the ICAI. The main reason advanced for the necessity for the amendment of the Income-tax Act was the belief that the standards issued by the ICAI permitted alternative treatment in various situations. ICAI has already initiated action to reduce the alternatives.
The RBI as a regulatory authority also issues directions to banks and financial institutions as also to Non-Banking Finance Companies (NBFCs) on the manner in which certain accounting matters should be dealt with.
An equally significant development is the establishment by the Securities and Exchange Board of India (SEBI) of a Standing Committee on Accounting Standards. This committee monitors the existence of relevant accounting standards and their harmonization with the corresponding International Accounting Standards.
It mandates the adherence to the standards and enforces the same through the listing agreements between the companies and stock exchanges. Therefore, at least in so far as listed companies are concerned, a better enforcement mechanism has been put in place.
In case, standards do not enjoy mandatory supports, auditors and accountants are expected to observe accounting standards or to seek observance of standards by business enterprises. As the formulation of accounting standards is only a means to an end, the ultimate objective should be the acceptance and implementation of the standards.