Accounting Standards, GAAP & Cash Basis: Rules, Practices & Real-World Impact

TAKEAWAYS:

• Accounting standards (IAS/IFRS/GAAP) are global rules ensuring consistency, comparability, and transparency in financial reporting—critical for investors and regulators.
• Accrual vs. cash basis: Accrual accounting records revenue/expenses when earned/incurred (e.g., NTC’s monthly billing), while cash basis records transactions only when cash changes hands (used by small businesses like local kirana shops).
• Nepali context: NEPSE follows IFRS for listed companies, while SMEs often use simplified GAAP or cash basis due to lower compliance costs.
• Key standards: IAS 1 (Presentation), IAS 16 (Property, Plant & Equipment), and IAS 37 (Provisions) directly impact how assets, liabilities, and expenses are reported.
• Real-world tie-ins: WhatsApp’s revenue recognition (IAS 18) and Daraz’s inventory valuation (IAS 2) show how global standards shape tech and e-commerce.
• Exam focus: Compare accrual vs. cash basis, identify GAAP violations in transactions, and explain how standards like IAS 16 affect depreciation calculations.

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1. What Are Accounting Standards?

Accounting standards are formal rules that guide how financial transactions are recorded, summarized, and reported. They ensure consistency, transparency, and comparability across companies and countries. The three major frameworks are:

• International Financial Reporting Standards (IFRS): Used globally (including Nepal for listed companies like NEPSE).
• Generally Accepted Accounting Principles (GAAP): Predominantly used in the US but influences Nepal’s private sector.
• Nepali Accounting Standards (NAS): Aligned with IFRS but simplified for SMEs (e.g., local retailers, NGOs).

Why Do They Matter?

Example: When NEPSE-listed companies like Nabil Bank report profits, they must follow IFRS for revenue recognition (IAS 18) and impairment testing (IFRS 9). A deviation could lead to SEC penalties or loss of investor trust.

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2. Key Accounting Standards and Their Applications

A. IAS 1: Presentation of Financial Statements

• Rule: Requires a classified balance sheet (current/non-current assets/liabilities) and a comprehensive income statement.
• Nepali Example: Daraz Nepal must separate its inventory (current asset) from property (non-current asset) in its annual report.
• Visual: Classified Balance Sheet (Daraz Nepal, Hypothetical)

  Liabilities	Amount (Rs.)	Assets	Amount (Rs.)
  Current Liabilities		Current Assets
  Trade Payables	50,000,000	Inventory	120,000,000
  Bank Overdraft	10,000,000	Accounts Receivable	80,000,000
  Total Current Liabilities	60,000,000	Total Current Assets	200,000,000
  Non-Current Liabilities		Non-Current Assets
  Long-term Debt	200,000,000	Property, Plant & Eq.	500,000,000
  Total Liabilities	260,000,000	Total Assets	700,000,000
  Equity	440,000,000

B. IAS 16: Property, Plant & Equipment (PPE)

• Rule: Assets like machinery, buildings, or vehicles must be capitalized (recorded as assets) and depreciated over their useful life.
• Nepali Example: Pathao’s delivery bikes (cost: Rs. 200,000 each, useful life: 5 years) must be depreciated annually.
  • Journal Entry for Depreciation (Year 1):

    Dr. Depreciation Expense (P&L)       40,000
    Cr. Accumulated Depreciation (Balance Sheet) 40,000
    

  • Calculation: $\frac{200,000}{5\text{ years}}=40,000\text{ Rs./year}$.

C. IAS 37: Provisions, Contingent Liabilities, and Contingent Assets

• Rule: Companies must recognize liabilities for probable future costs (e.g., warranty claims, legal disputes).
• Nepali Example: Ncell must set aside a provision for warranty claims if it guarantees phone repairs for 1 year.
  • Journal Entry:

    Dr. Warranty Expense (P&L)          5,000,000
    Cr. Provision for Warranty (Liability) 5,000,000
    

D. IAS 18: Revenue Recognition

• Rule: Revenue is recognized when earned, not when cash is received.
• Nepali Example: eSewa recognizes revenue when a bill payment is processed, not when the merchant receives the cash.
  • Cash Basis (Incorrect): Records revenue only when eSewa receives payment from the user.
  • Accrual Basis (Correct): Records revenue immediately when the transaction is completed.

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3. Accrual vs. Cash Basis Accounting: A Critical Comparison

Worked Example: Kathmandu Retail Shop (Accrual vs. Cash)

Scenario: A shop buys inventory on credit (Rs. 500,000) and sells goods for Rs. 800,000 (Rs. 300,000 on credit, Rs. 500,000 cash). It also incurs Rs. 200,000 in rent (paid in advance).

Key Takeaway: Accrual shows true profitability (Rs. 260,000), while cash basis overstates profit (Rs. 300,000) by ignoring uncollected revenue and prepaid expenses.

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4. How Nepal Implements Accounting Standards

A. NEPSE and Listed Companies

• Mandatory: All companies listed on NEPSE (e.g., Nabil Bank, Global IME) must follow IFRS.
• Impact:
  • Consolidated financials (IAS 27) for subsidiaries.
  • Fair value accounting (IFRS 13) for investments.
• Example: Nepal Investment Bank’s 2079 annual report shows impairment losses on loans (IFRS 9).

B. SMEs and Cash Basis

• Simplified GAAP: Many SMEs (e.g., local garment factories) use cash basis for tax purposes.
• Risk: Underreporting liabilities (e.g., unpaid supplier bills) can lead to cash flow crises.

C. Government and NGOs

• NAS Alignment: Government audits (e.g., NTC’s financials) follow modified accrual basis for budgeting.
• NGOs: Must disclose donor restrictions (IAS 20).

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5. Real-World Applications of Accounting Standards

A. WhatsApp (Meta) – Revenue Recognition (IAS 18)

• Issue: WhatsApp offers free messaging but earns from business subscriptions.
• Solution: Revenue is recognized when businesses subscribe, not when Meta receives payment (accrual basis).
• Impact: Ensures consistent revenue reporting across quarters.

B. Daraz Nepal – Inventory Valuation (IAS 2)

• Issue: Daraz sells electronics, groceries, and fashion with high turnover.
• Solution: Uses FIFO (First-In-First-Out) to value inventory, ensuring cost of goods sold (COGS) matches actual sales.
• Example: If Daraz buys 100 smartphones at Rs. 50,000 each and sells 50, the COGS is Rs. 2,500,000 (not LIFO or weighted average).

C. Ncell – Provision for Bad Debts (IAS 37)

• Issue: Some customers default on postpaid bills.
• Solution: Ncell sets aside a provision for doubtful debts based on past defaults.
• Journal Entry:

  Dr. Bad Debt Expense (P&L)       10,000,000
  Cr. Provision for Doubtful Debts (Liability) 10,000,000
  

D. Kathmandu Traffic Police – Accrual for Road Maintenance

• Issue: Roads require continuous maintenance, but funds are collected annually.
• Solution: The Ministry of Physical Infrastructure records accrued expenses for future repairs, ensuring budget accuracy.

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6. Common Violations and Their Consequences

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7. The Accounting Cycle Under GAAP

Example: Adjusting Entry for Accrued Salary (Nepal Bank Ltd)

• Scenario: Employees worked in Chaitra 2079 but were paid in Baisakh 2079.
• Adjusting Entry:

  Dr. Salary Expense (P&L)       50,000,000
  Cr. Salaries Payable (Liability) 50,000,000
  

• Impact: Ensures expense is matched with the period incurred, not when paid.

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8. Cash Basis Accounting: When and How It’s Used

Who Uses It?

• Small businesses (e.g., Kathmandu’s local tailors).
• Freelancers (e.g., graphic designers paid per project).
• Tax purposes (IRD allows cash basis for businesses with < Rs. 5M annual revenue).

Limitations

1. Misleading Profitability: Shows cash inflows/outflows, not earned income.
2. No Asset/Liability Tracking: Ignores accounts receivable/payable.
3. Non-Compliance Risk: Cannot be used by public companies or those seeking loans from Nabil/Rashtriya Bank.

Example: Local Kirana Shop (Cash Basis)

Problem: The shop’s profit seems higher because it ignores unpaid supplier bills and uncollected receivables.

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9. Exam Tip: How to Score Full Marks

A. Common Exam Questions and How to Answer

1. Define GAAP/IFRS and compare with cash basis:

   • Use the table above and Kathmandu retail shop example.
   • Highlight revenue/expense recognition differences.

2. Identify violations in transactions:

   • Example Question: "A company records revenue when cash is received. Is this GAAP-compliant?"
   • Answer:

     No, this violates IAS 18 (Revenue Recognition). Under accrual basis, revenue must be recognized when earned, not when cash is received. Cash basis is only acceptable for small businesses or tax purposes, not for financial statements under GAAP/IFRS.

3. Journal entries for adjustments:

   • Example: "Show the adjusting entry for accrued interest on a loan (Rs. 500,000 at 10% per annum, unpaid)."
   • Answer:

     Dr. Interest Expense (P&L)       50,000
     Cr. Interest Payable (Liability) 50,000
     

     Explanation: The interest is incurred over time, so it must be recorded in the period it applies to, not when paid.

4. Real-world scenario questions:

   • Example: "How does Daraz apply IAS 2 for inventory valuation?"
   • Answer:

     Daraz uses FIFO (First-In-First-Out) to value inventory. This ensures that the cost of goods sold (COGS) reflects the actual flow of goods. For example, if Daraz buys 100 laptops at Rs. 60,000 each in 2078 and 50 laptops at Rs. 65,000 in 2079, selling 80 laptops would use the older (cheaper) stock first, reducing COGS and increasing reported profit.

B. Mark Distribution Tips

• Definitions (20%): Always cite the standard (e.g., "As per IAS 16...").
• Journal Entries (30%): Show T-accounts for debits/credits.
• Explanations (30%): Use real-world examples (NEPSE, Daraz, Ncell).
• Comparisons (20%): Use tables to contrast accrual vs. cash basis.

C. Avoid These Mistakes

• ❌ Mixing cash and accrual entries in the same answer.
• ❌ Ignoring adjustments (e.g., forgetting accrued expenses/revenues).
• ❌ Using incorrect standards (e.g., saying "GAAP is used globally" when IFRS is more common).

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10. Quick Revision Checklist

Before the exam, ensure you can: ✅ Explain IAS 1, IAS 16, IAS 18, IAS 37 and their business applications. ✅ Differentiate accrual vs. cash basis with a worked example. ✅ Identify GAAP violations in given transactions. ✅ Draw the accounting cycle flowchart. ✅ Apply depreciation (IAS 16) to a Nepali business (e.g., Pathao’s delivery bikes). ✅ Explain how NEPSE-listed companies comply with IFRS.