Session 6 & 7

1. Session 6 & 7 Session Title: Introduction to Accounting Standards, its objective, basis of accounting, Accounting Standards issued by ICAI and IPSAS Standards (Accrual basis and Cash Basis) with their objective, Revisiting Accounting Framework, International efforts and reforms made in India. TFC and formation of GASAB, Operational Framework issued by GASAB, Progress of GASAB so far, list of IGASs and IGFRSs with their objectives.

2. SESSION OVERVIEW: In order to make accounting methods and principles uniform and comparable and financial reporting show true and fair view of all the activities of the government, to the extent possible, standards are necessary to be evolved. The basic objective of Accounting Standards is to remove variations in the treatment of several accounting aspects and to bring about standardization in accounting and its presentation. In this context, it is appropriate to discuss Accounting Standards issued by IPSAS (both accrual and cash basis). The twelfth Finance Commission (TFC) recommended Accrual Accounting for the Union and the State Governments. The GASAB in the office of the C&AG (2002) was set up to recommend an operational framework and detailed roadmap for its implementation. GASAB has so far developed five IGASs namely (i) IGAS 1-Guarantees given by governments: Disclosure requirements (ii) IGAS 2 - Accounting and classification of grants-in-aid (iii) IGAS 3- Loans and advances made by governments (iv) IGAS 7- Foreign currency transactions and loss or gain by exchange rate variations (v) IGAS 10- Public debt and other liabilities of governments : Disclosure requirements and four IGFRSs namely (i) IGFRS 2 (i) Property, plant and equipment (ii) IGFRS 3- Revenue from government exchange transactions (iii) IGFRS 4- Inventories (iv) IGFRS 5- Contingent liabilities (other than guarantees) and contingent assets: Disclosure requirements

3. Session Structure: • 1. Introduction to Accounting Standards. • 2. Objective of Accounting Standards. • 3. TFC, 13th Finance Commission, 14th report of 2nd Administrative Reforms Commission recommendations and formation of GASAB • 4. Road map and Operational Framework of GASAB. • 5. Accounting treatment and measurement procedures proposed by GASAB. • 6. ICAI Accounting Standards and IPSAS • 7. IGASs and IGFRS (Notified/Under Notification/ prepared/ Proposed by GASAB) • 8.Excercise and Group Discussion

4. Introduction: • Financial Statements specially Appropriation and Finance Accounts of governments are prepared to summarize the end-result of all the activities by the government during an accounting period in monetary terms. • Combined Finance Accounts compares the financial results of different state governments and union government. • The government accounting in India are on cash basis and accounting follows the rule based. • Though there is standardized classification structure (List of Major and Minor heads) of government activities are available, but reporting governments may adopt divergent policies in methods and principles in their financial reporting. • In order to make accounting methods and principles uniform and comparable and financial reporting show true and fair view of all the activities of the government, to the extent possible, Standards are necessary to be evolved.

5. What is Accounting Standards? • Accounting Standards are the statements of code of practices of regulatory accounting bodies (C&AG, CGA for government accounting) that are to be observed in preparation and presentation of financial statements. • that Accounting Standards are rules according to which accounts have to be drawn up. • In layman terms, accounting standards are written documents issued by experts, institutes or other regulatory bodies covering various aspects of measurement, treatment, presentation and disclosure of accounting transactions, whether it is based on single entry cash basis or double entry accrual basis. What are the objectives of Accounting Standards? (i) The basic objective of Accounting Standards is to remove variations in the treatment of several accounting aspects and to bring about standardization in accounting and its presentation. (ii) They intent to harmonize the diverse accounting policies followed in the preparation and presentation of financial statements by different reporting entities.

6. Accounting Standards issued by various authorities:(A) Accounting Standards (Accrual basis) issued by the Institute of Chartered Accountant of India (ICAI) are as follows:

14. (B) International Public Sector Accounting Standards (IPSAS) issued by International Federation of Accountings (IFAC)[Effective from 01.01.2004] • The International Federation of Accountants — International Public Sector Accounting Standards Board (the IPSASB) develops accounting standards for public sector entities referred to as International Public Sector Accounting Standards (IPSASs). • The IPSASB recognizes the significant benefits of achieving consistent and comparable financial information across jurisdictions and it believes that the IPSASs will play a key role in enabling these benefits to be realized. • The adoption of IPSASs by governments will improve both the quality and comparability of financial information reported by public sector entities around the world. • IPSASs are being prepared for application by entities adopting the accrual basis of accounting and for application by entities adopting the cash basis of accounting.

15. (a) Accrual Basis

21. (b) Cash Basis IPSAS

34. REVISITING ACCOUNTING FRAMEWORK: International efforts on Standard setting: (1) In 1980’s INTOSAI emphasized standard setting for governments and in early 1990’s INTOSAI’s Accounting Standards Committee issued “Accounting Standards Framework”. (2) Similarly several national governments set up accounting standard boards/ committees (3) IFAC- Public Sector Committee takes lead in issuing IPSAS (Cash based and Accrual basis) (4) IMF issued Government Financial Standards (GFS) laying down statistical reporting standards for governments (5) In USA, FASAB (Federal Accounting Standard Advisory Board) framed SFFAS (Statement of Federal Financial Accounting Standards), GASAB(Governmental Accounting Standard Board) (State & Local as well as agencies) (6) In Canada, CICA’s (Canadian Institute of Chartered Accountant) & FSAB sets standards for government. (7) In Australia and New Zealand, AASB( Australian Accounting Standard Boards) framed FRS.( Financial Reporting Standards)

35. (8) In India: (i) Report of Admn. Reform commission on Accounts and Audit (1968). (ii)Multi-tier Classification System introduced (A.K.Mukherjee Committee) (iii) Management Accounting at the Union Government ( 1976 Budget speech of the Finance Minister) (iv) Departmentalization scheme of Union Government introduced in 1976. (v) Financial Advisory Unit (FA System) introduced in 1980. (vi) Classification system rationalized (R.C.Ghai Committee) in 1987 (vii) EAS Sarma Committee report on FRBM in 2000 (viii) Ahuwalia Committee, 2004 (RBI) on Medium term fiscal policy ( 3 year rolling target – receipts, payments, borrowing etc) Fiscal Policy Strategy Statement (Taxation, Borrowings, Pricing, Guarantees, Subsidy etc.) Macro economic framework statement (GDF, Fiscal balance, BOP etc) (ix) Lahiri Committee (2004) introduced Multidimensional classification) on functional and economic classification (x) Twelfth Finance Commission (TFC) recommends Accrual Accounting. (xi) New GFR (General Financial Rules) was introduced in 2005.

36. The Twelfth Finance CommissionTFC (2004) – Transition to Accrual Based Accounting and formation of GASAB: 1. The Twelfth Finance Commission (TFC) recommended Accrual Accounting for the Union and the State Governments. The Central Government has accepted the recommendation in Principle. At the same time, TFC recognized that transition to accrual based accounting is a time consuming process and suggested changeover only in medium term. 2. In the Interim period, TFC suggested to add some additional information to the present system of accounting to enable more informed decision making. TFC has suggested standardization of accounting classification upto object head level for all States to improve fiscal management. Additional eight statements relating to subsidies, expenditure on salaries, expenditure on pensions, committed liabilities, maintenance expenditure, segregation of salary and non-salary portions and liabilities and repayment schedule on outstanding debts. The TFC has also suggested that definition of revenue and fiscal deficits be standardized. 3. Accepting the recommendations in Principle, the GASAB in the office of the C&AG (2002) was set up to recommend an operational framework and detailed roadmap for its implementation. Apart from the Central Government, so far 23 State Governments have accepted the idea of accrual accounting in principle.

37. The Twelfth Finance CommissionTFC (2004) – Transition to Accrual Based Accounting and formation of GASAB: (cont…) 4. There are two fold mandate of GASAB: (i) To establish and improve standards of governmental accounting and financial reporting and formulate and propose standards that improve the usefulness of financial reports based on the needs of the users. (ii) Since the principles of accrual accounting being followed in commercial entities cannot be transposed in their entirely in Government accounting, GASAB was entrusted with preparation of a Roadmap for transition to Accrual Accounting System and Operational Framework of such a system that will prevail in Government.

38. The Twelfth Finance CommissionTFC (2004) – Transition to Accrual Based Accounting and formation of GASAB: (cont…) 5. The Operational Framework developed / to be improved by GASAB would detailed out the broad accounting heads and treatment of transactions relating to: Revenues and Expenditure Accounting Fixed Assets Accounting Long term Liability Accounting. Accounting for current Assets and Liabilities Accounting for period costs – Interest and Depreciation. Non-financial and Contingent Liabilities. 6. The design of framework suggested by GASAB indicates broad deviations from the conventional basis of accrual accounting due specific requirements emerging from the nature of transitions of the Government. The framework for transition spread over across five stages depending upon the recognition on accrual basis given to – expenses, revenue, assets and liabilities at different point of time.

39. A broad framework for transition to the accrual accounting is as under:

42. 7. Transition through these stages is likely to happen at varying pace in different departments of government entities. GASAB suggests that Stage I depicted in Table above should be the starting point for introduction of accrual basis of accounting in Governments. Accounting reforms should incrementally graduate to Stage V, which represents full accrual accounting. It is, however, noted that there could be certain entities within the Government, e.g. the Railways, which may like to straightaway adopt full accrual due to their preparedness and nature of activities (i) Stage-I introduces accrual based recognition principle for current expenses. Capital expenditures, as well as all revenues, will continue to be accounted for on cash basis as at present. Recognition of current expenses on accrual basis would lead to recognition of payables, which will be shown as a liability.

43. (ii) Stage-II introduces accrual recognition of non-tax revenues. Tax revenues will continue to be recognized on cash basis. Recognition of non-tax revenues on accrual basis would lead to recognition of receivables, which will be included in assets. Military assets will also be recognized on accrual basis at this stage and included in assets shown in the Statement of Financial Position. The remaining capital expenditure will continue to be shown on cash basis. Another change would be inclusion of all other liabilities except those on account of superannuation benefits, compensated leaves, provisions and social security (iii) Stage-III requires recognition of all expenses on accrual basis including recognition of depreciation. No provisions will be recognized at this stage. Assets recognized at this stage on accrual basis would include all financial and physical assets [with the exception of infrastructure, land, heritage, and intangibles] and inventories. Tax Revenue continues to be recognized on cash basis. There is no change in terms of liability over Stage-II. Disclosure of all explicit contingent liability is made.

44. (iv) Stage IV requires inclusion of provisions as expense and extension of physical assets to cover infrastructure and land on accrual basis. Other elements are same as that in the previous stage. (v) Stage V is introduction of full accrual accounting for all the four elements – expense, revenues, assets and liabilities. All expenses, all revenues, all assets and all liabilities are recognized on accrual principles and presented. (8) In the Road Map, the proposed transition was envisaged in three stages namely (i) Value addition within the existing system by additional statements – short term activity; (ii) Value addition in the existing system with minor modifications to enable greater disclosures such as arrears in revenue, committed liabilities, etc. This is a medium term activity; and (iii) Achieving the desired accounting system in the long-term based on accrual system. Note: Other modalities of Road Map have already been discussed in Session III.

45. (9) As the Operational Framework provides the overall architecture of the accounting model, these guidelines also aim at laying down the principles for recognition and measurement for General Purpose Financial Reporting (GPFR). (i) Objectives of General Purpose Financial Reporting: Provide financial information about the reporting entity which would be useful in making decisions about providing resources to the entity and in assessing whether the government has made efficient and effective use of the resources. Make financial reporting more transparent. Improve understandability of financial statement by users. Make financial statements more relevant. Improve performance reporting in keeping with Results Framework Document (RFD) (ii) Components of GPFR: GPFS + MDA = GPFR GPFS : General Purpose Financial Statements (a) The Conceptual Framework of International Accounting Standards (IPSAS) • On General Purpose Financial Statements (GPFS) provides guidance for the structure and minimum requirement for the contents of financial statements prepared under accrual basis of accounting.

46. GPFS • The complete set of financial statements, keeping in view the requirement as prescribed by the Government of India, may include the following statements: Statement of Financial Position Statement of Financial Performance Statement of changes in Net Assets Appro- priation Accounts Cash Flow Statements Accounting Policies and Notes to the Financial Statements MDA : Management and Discussion Analysis

47. A management report commenting on financial statements highlighting key performance indicators • To be signed by the Chief Accounting Authority as prescribed in GFR 64 (ii) For a complete set of General Purpose Financial Reporting (GPFR), Management Discussion and Analysis report is essential. (iii) Statement of Financial Position: The Statement of Financial Position exhibits the balance of assets and liabilities as on a particular date. The assets and liabilities may be further classified into current and non current categories. Statement of Financial Position must include the following: • Assets – This should include all physical and financial assets, cash and cash equivalents, investment, inventories, receivables from exchange and non exchange transactions, capital work in progress. • Liabilities – This should include all debts and borrowings of the government, payables, and benefits payables to employees. • The progressive total of capital expenditure available in Finance Accounts should reconcile with lump sum figure in the Statement of Financial Position after making adjustment for valuation of historical assets.

48. (iv)Statement of Financial Performance: The Statement of Financial Performance exhibits the revenue and expenses for an accounting period and the excess/deficit of revenue over expenses. The Statement of Financial Performance must include the following: • Revenue from exchange transactions • Revenue from non exchange transactions • Expenditure by function and nature. • Surplus/Deficit • Appropriation to earmarked funds • Cost of borrowings (v) Statement of Changes in Net Assets: The Statement of Changes in Net Assets represents the changes between two reporting dates reflecting the increase or decrease in its assets during the period.

49. (vi) Cash Flow Statements The Cash Flow Statement should provide cash flows during the period classifying them into operating, investing and financing activities. 1. Cash flows from operating activities are primarily derived from the principal cash-generating activities. This includes cash receipts from taxes, from non-tax revenues, cash payments to suppliers/contractors, grants in aid received or given. 2. Cash flows from investing activities are derived from acquisition and disposal of long term assets and other investments not included in cash equivalents. This includes cash payments to acquire or construct property, cash advances and loans made, etc. 3. Cash flow from financing activities represents the changes in the size and composition of the contributed capital and borrowings. (vii) Appropriation Accounts As part of GPFS, Appropriation Accounts would continue to reflect 1. Comparison of budget with actual 2. Original with final budget 3. Detailed reason for variations of actual with final budget

50. (viii) Accounting Policies and notes to the Financial Statements: 1. Accounting policies, rules and practices applied by an entity in preparing and presenting financial statements be stated 2. Use of reasonable estimates and valuation methods for assets and liabilities be stated 3. Stages and period of transition be stated (b) Various stages of Operational Framework highlight maintenance and recognition of Assets and Liabilities, recognition principles for Current Expenses and Receipts new head 'Payables', Revenue receipts and new head 'Receivables'.