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Some theoretical Concept of Financial Accounting

Accounting is an information system and its ultimate objective is to provide relevant financial information, through financial statements, to the users such as creditors, investors, employees, Government, owners, management and so on. It becomes therefore necessary that financial statements provide a true and fair view of the net worth and profitability of the business entity. Moreover, the financial statements must be readable and comparable with the financial statements of other entities.

Over a period of time, a number of Generally Accepted Accounting Principles (GAAP) or basic concepts and conventions had been developed and accepted by the accounting profession to achieve uniformity and consequent comparability of the financial information. But the difficulty with the GAAP had been that they were optional and the management or owners, as the case may be adopted them only when they suited them. Moreover, GAAP permitted a variety of alternative treatments for the same item(s). For example. Recommendation 22 (I960), based on GAAP, made by Institute of Chartered Accountants in England and Wales in respect of inventory valuation, recommended five different methods of computing the cost of inventory. Furthermore, four of these methods could be computed differently for partly and fully finished goods or inventories. To complicate matters further, Recommendation 22 stated that cost could be defined in three different ways. These recommendations were not mandatory but issued for the guidance of the Chartered Accountants. Thus different companies followed different accounting policies for the accounting treatment of the like or similar transactions or the same company adopted different accounting policies for the same item over different accounting periods. Such practices caused a great problem to the external users of accounting information which then becomes inconsistent and incomparable. Hence there was need to harmonies and standardise these diverse accounting practices and to impart an element of compulsion in the implementation of GAAP. But there was a general hesitation on the part of all concerned to make the adoption of GAAP mandatory.

The result was increase in number of accounting scandals and failure of business enterprises on a large scale. The impasse (deadlock) was broken by the rude shock inflicted on the western economy by the fall in the share prices in 1929 when the professional accounting bodies felt the need to standardise generally accepted accounting principles and to make basic principles compulsory for adoption by the accounting profession. U.S.A. took lead in this direction followed by U.K., Australia, Canada and other countries. American Institute of Accountants, since renamed as American Institute of Certified Public Accountants (AICPA) was entrusted with the task of codifying the accounting principles to be adopted as a guide by the accountants. Finally in 1973, Financial Accounting Standard Board (FASB) was established. U.S.A. U.K., Australia, Canada and other countries formed the international Accounting Standards Committee, now renamed as international Accounting Standard Board (IASB) with the responsibility of formulating international accounting standards.


As a result of globalisation with increasing number of multinational corporations, their subsidiary and branches, the public is becoming international in outlook. It becomes necessary that the financial statements of a company in one country are comparable with the financial statements of same type of company in another country. Thus the desirability of uniform accounting has become more compelling since 1970 or so and more recently the pressures for uniformity have become irresistible. The reasons are :

(i) The increasing globalisation of business : Economic cooperation between countries is bringing more and more incentives to encourage genuine international operations. The multinational companies with subsidiaries and branches in different parts of the world are multiplying. All countries are fast expanding their economic relations with one another. If businesses are multinational in scope or activities, it is likely that they will wish and need to raise their capital in many different countries. The globalisation of capital markets and cross-border raising of capital by companies—more particularly by developing countries from the developed countries—is facilitated by listing of companies in foreign stock exchanges. The financial statements prepared in one country therefore are accepted in other countries for the smooth flow of international capital or investment. 
It has therefore been a long-felt need that countries world over communicate using a common accounting language. Country-specific principles are so varied that the aspiration of an integrated capital market can be fulfilled only through a uniform financial reporting system.
If a company reports dramatically different results for its operations for a given accounting period because it has to prepare its income statement and balance sheet according to rules in different countries, confidence in accounting will suffer.

(ii) The move towards privatisation : The transfer of public utilities or services etc. such as power, transportation, banking, insurance, oil and natural gas etc. from the government ownership to private ownership in many countries including India since 1990 has created new demands for private sector capital. There is a need for creditable financial statements based on uniform and consistent accounting practices. Thus motivations for companies seeking uniform accounting systems
are strong. If companies were to prepare their financial statements according to different set of rules, that would affect the credibility of the accounting itself. Useful comparative analysis is not possible unless uniform and consistent accounting methods or procedures in financial reporting are adopted. This is evident from the following specific cases.


After World War II, it was felt that a degree of uniformity in financial accounting matters was necessary. Consequently in 1967, an Accountants International Study Group (AISG) was formed by Canada, U.S.A. and United Kingdom. The group began to publish papers every few months on important topics. Within five or six years from 1963 a number of malpractices in accounting led to failure of many business enterprises with the result that public began to demand higher and more definitive accounting standards. At the time of the tenth International Congress of Accountants in 1971, the need for international cooperation in accounting standards was stressed by all accounting bodies of the several countries which participated in the conference. As a result, on 29 June, 1973, International Accounting Standards Committee (IASC) came into existence with its secretariat and headquarters at London. The agreement to form IASC was signed by representatives of sixteen accounting bodies from nine countries namely Canada, U.K., U.S.A., Australia, France, Germany, Japan, the Netherlands and Mexico, called the founder members.

The objectives of IASC are :
(i) To formulate and publish, in the public interest, standards to be observed in the presentation of audited financial statements and to promote their world wide acceptance;

(ii) To work generally for the improvement and harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements. In U.K., Institute of Chartered Accountants of England and Wales in association with Associations of Certified Accountants, the Institute of Cost and Management Accountants and Chartered Institute of Public Finance and Accountancy has set up Accounting Standards Committee which issues standards under the title : Statement of Standard Accounting Practices (SSAP). In U.S.A., Financial Accounting Standards Board (FASB), was established in 1972 to develop financial accounting standards for business enterprises and non-profit organisations. This independent body has seven members who are appointed by the trustees of the Financial Accounting Foundation. They serve on a full time basis and must severe all relations with their previous employers. Accounting standards for corporate sector in India owe their origin to the Companies Act, 1956 which requires that the financial statements of a company should give true and fair view of its profits and financial position vide Section 209(1). The auditor has to make report on these financial statements stating that the published accounts give true and fair view. But unfortunately the term true and fair has not been defined anywhere in the Companies Act. However, according to Accounting Standards Committee in the U.K. : "Accounts will not be true and fair unless the information they contain is sufficient in quantity and quality to satisfy the reasonable expectations of the readers (users) to whom they are addressed." The term true and fair therefore refers not only to the information that is qualitatively and quantitatively sufficient but also requires accounting profession to specify the standards for the same. Thus the role of legal requirements in presenting the accounting information to its users is of great importance in the standard setting process in India.


Accounting standards tend to serve the following objectives :
(i) The main purpose of accounting standards is to provide information to the users as to the basis on which the accounts have been prepared. In fact accounting standards dictate the manner in which accounts should be prepared.

(ii) Accounting standards remove the effect of diverse accounting practices and policies so that financial statements become more meaningful and comparable under various heads. The absence of accounting standards may lead to inappropriate, incomplete, inexact and misleading information affecting the financial decisions of the users of accounting information.

(iii) Accounting standards increase the comparability, credibility and understandability of the financial statements in the hands of the users.

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