Advanced Accounting · Applicability of Accounting Standards

Exemptions and Relaxations for Level II and III Entities

Updated 5 October 2026

Smaller entities get relief. Under the Companies (Accounting Standards) Rules, a small and medium company (SMC) is exempt from AS 3. Under ICAI's classification, Level II and III non-company entities are exempt from AS 3 and outside AS 17 and AS 20, which apply to Level I only. AS 15, AS 18 and AS 29 have limited relaxations.

Understand Exemptions and Relaxations for Level II and III Entities

Accounting Standards (AS) were written for large entities. Applying every disclosure to a small business costs time and money and helps few readers. So ICAI and the Companies (Accounting Standards) Rules divide entities into classes and give the smaller ones relief.

Keep company and non-company entities apart. For a company, the Rules define a Small and Medium-sized Company (SMC). For a non-company entity, ICAI uses its Level I, II and III classification. Do not apply Level I, II and III to a company, and do not apply the SMC definition to a non-company entity. The relief is set out separately for each, so do not merge them into one uniform list. Check the ICAI table for the entity type in your question.

There are two kinds of relief. An exemption means the standard does not apply at all. A relaxation means the standard applies, but some paragraphs, usually disclosure or measurement paragraphs, need not be followed.

There is also a third idea: scope. Some standards apply only to entities whose securities are listed or being listed. An entity whose securities are not listed falls outside such a standard because of its scope, not because of an exemption. Keep this separate from exemption in your answers. An SMC is unlisted by definition, so it is outside these standards by scope. For a non-company entity, test the listing status from the facts. A listed entity is Level I and applies every AS in full.

The relief is not automatic. A company must first meet the SMC conditions, such as not being listed and not being a bank or financial institution. A non-company entity must first be Level II or III, so a Level I entity, such as a listed one, gets no relief and applies every AS in full. Learn the classification in the related topic and use the facts in the question to settle it first.

There is also a disclosure condition. An entity that uses the relief should disclose in its notes that it complies with the Accounting Standards applicable to small and medium entities. Do not treat this as fixed statutory wording; the idea is what matters. If it later stops qualifying, it must apply the full standards from that point.

The pattern to remember: for a company, the Companies (Accounting Standards) Rules exempt an SMC from cash flows (AS 3). Do not state this as a general rule for every small entity. For non-company entities, ICAI's table exempts Level II and Level III entities from AS 3, while a Level I entity must apply it. Confirm this against the ICAI table before you quote it. AS 17 and AS 20 apply to Level I non-company entities only, so Level II and Level III entities are both outside them. Do not single out Level III. For an SMC, segment reporting (AS 17) applies only where debt or equity securities are traded or being listed, so an SMC, being unlisted, is outside it by scope. AS 18 (related party disclosures) is not fully exempt for an SMC, but the Rules give an SMC limited disclosure relaxations. Check the ICAI/MCA table for the exact relaxation before you quote it. The other relaxations fall on selected disclosure and measurement paragraphs in standards such as AS 15 (employee benefits) and AS 29 (provisions and contingencies). Confirm the exact standards and paragraphs from the ICAI table before you quote them.

One scope point on EPS: AS 20 applies only where equity or potential equity shares are listed or in the process of listing. An SMC, being unlisted, is outside AS 20. If it voluntarily presents EPS, it should follow AS 20 in computing it.

Key rules to remember

Rule 1: Condition for any relief: Company: relief only if it is an SMC under the Companies (Accounting Standards) Rules. Non-company entity: relief only if it is Level II or III under ICAI's classification, not Level I.; Check the class before anything else. For a company, test the SMC conditions, such as not listed and not a bank or financial institution. For a non-company entity, test the Level I triggers. Entities that fail these tests apply all applicable AS in full.
Rule 2: Full exemption and scope: AS 3 (Cash Flow Statements): the Rules exempt an SMC (company). ICAI's table exempts Level II and Level III non-company entities; Level I entities must apply it. AS 17 and AS 20 apply to Level I non-company entities only, so Level II and Level III are both outside them. For an SMC, AS 17 (Segment Reporting) applies only where debt or equity securities are traded or being listed. AS 18 (Related Party Disclosures) is not fully exempt for an SMC, but limited disclosure relaxations are given.; The SMC exemption from AS 3 comes from the Rules, so do not state it as a general rule for every small entity. For non-company entities, confirm the AS 3 position against the ICAI table. An SMC is unlisted by definition, so it is outside AS 17 by scope. Do not call AS 17 a blanket SMC exemption. For a non-company entity, test the listing status from the facts. For AS 18, the SMC still discloses related parties and transactions, subject to the limited relaxations in the Rules. Check the ICAI/MCA table for the exact relaxation. Check whether your question concerns a company or a non-company entity, and use the matching table.
Rule 3: EPS and scope: AS 20 applies only if equity or potential equity shares are listed or in the process of listing. An unlisted entity is outside AS 20.; An SMC is unlisted, so it has no EPS requirement under AS 20. If an SMC voluntarily presents EPS, it should follow AS 20 in computing it. Any relief within AS 20 is for entities that are within its scope, so do not apply it to an unlisted SMC.
Rule 4: Relaxations in other standards: AS 15, AS 18, AS 29 and other standards in the ICAI table: selected measurement and disclosure paragraphs relaxed; The standard still applies. Only the named paragraphs are relaxed. Quote the standard and say the relief is for specified disclosure or measurement paragraphs. Confirm the standards and paragraphs from the ICAI table. AS 18 is not fully exempt for SMCs, but the Rules give limited disclosure relaxations.
Rule 5: Disclosure condition: Note: Accounting Standards followed as applicable to a small and medium entity; Disclose in substance that the entity complies with the AS applicable to small and medium entities. This is not exact statutory wording.
Rule 6: Loss of status: Entity ceases to qualify → apply the full standards; Do not keep claiming relief once the criteria are crossed.

How to solve Exemptions and Relaxations for Level II and III Entities questions

Use this method for any question that asks whether an entity must follow a particular Accounting Standard.

1Read the facts: company or non-company, listed or not, turnover, borrowings, and any holding or subsidiary link.
2Decide the class. For a company, test the SMC conditions, such as not listed and not a bank or financial institution; if one fails, stop and apply all standards in full. For a non-company entity, test the Level I triggers; if any is met, stop: all applicable standards apply, with no relief.
3If the entity qualifies, list the standards the question mentions and use the table for a company (SMC) or a non-company entity (Level II or III), as the facts require.
4For each standard decide: exempt, outside scope, partly relaxed, or fully applicable.
5For a partly relaxed standard, say which part is relaxed (for example selected disclosure paragraphs of AS 15 or AS 29) and which part still applies. For AS 17 and AS 20, first test scope: are the securities listed or being listed?
6State the disclosure condition: the note that the entity followed the AS as applicable to small and medium entities.
7Write a one-line conclusion for each standard, and mention that full compliance is needed if the entity ceases to qualify.

Quickest way: Entity type first, then standard, then relief type

When to use it: Use it for MCQs and for short written answers on applicability.

MCQ: first note whether the entity is a company or a non-company. For a company, look for an SMC failure such as listed or a bank or financial institution. For a non-company entity, look for a Level I trigger. If you find one, the answer is 'no relief'.
Eliminate options that claim AS 18 is fully exempt for an SMC, that AS 17 is a blanket SMC exemption, or that an unlisted small entity must give EPS under AS 20.
Match the words 'cash flow' with exemption for an SMC or a Level II or III non-company entity; a Level I entity must apply AS 3. Match 'segment' and 'EPS' with the listing scope test. Match 'related party' with 'applies, with limited disclosure relaxations for an SMC'.
Written: use a three-line format. Line 1: entity type and class with reason. Line 2: standard-wise treatment (exempt, outside scope, relaxed or applicable). Line 3: disclosure note and conclusion.
Always write the reason from the facts given. Step marks go for linking facts to the class.

Common mistakes in Exemptions and Relaxations for Level II and III Entities

Giving relief to an entity that fails the classification
Students jump to the exemption list without testing the classification.
Fix: Always test the class first. For a company, test the SMC conditions. For a non-company entity, test the Level I triggers. One failure, such as being listed, ends the relief.
Misstating the position on AS 17, AS 18 and AS 20
AS 3 is exempt, so students lump AS 17, AS 18 and AS 20 with it, or assume every small entity must report segments or EPS.
Fix: AS 17 and AS 20 apply only where securities are listed or being listed, so a small unlisted entity is outside them by scope. AS 18 is not fully exempt for an SMC; it applies with limited disclosure relaxations in the Rules. Check the table for the exact relaxation.
Mixing up exemption and relaxation
The two words sound alike.
Fix: Exemption: the standard does not apply. Relaxation: the standard applies minus named paragraphs. Use the right word in the answer.
Forgetting the disclosure note
Students think the relief ends once the standard is named.
Fix: Add the line that the entity should state it followed the AS as applicable to small and medium entities.
Assuming the relief is permanent
Students overlook that the classification is tested on facts that change.
Fix: Add that when the entity stops meeting the criteria it must apply the full standards.
Writing the conclusion without reasoning
Students rely on memory of the list and skip the facts.
Fix: Quote the figures or facts given (listed status, turnover, borrowings) before the conclusion.

Worked examples

Example 1

X Ltd is an unlisted company. It is not a bank or financial institution and meets the other conditions of a small and medium sized company under the Companies (Accounting Standards) Rules. The accountant asks whether X Ltd must prepare a cash flow statement, report segments and disclose related party information under the Accounting Standards. Advise.

Show the solution

Step 1: X Ltd is a company, so the SMC definition is the test. It is unlisted, is not a bank or financial institution and meets the other SMC conditions. As stated, it qualifies as an SMC, so it can use the relief.
Step 2: AS 3 (Cash Flow Statements) is one of the standards from which an SMC is exempt. X Ltd need not prepare a cash flow statement under AS 3.
Step 3: AS 17 (Segment Reporting) applies only where debt or equity securities are traded or being listed. X Ltd is unlisted, so it is outside AS 17 by scope. This is not a blanket SMC exemption.
Step 4: AS 18 (Related Party Disclosures) is not fully exempt for X Ltd. The Rules give an SMC limited disclosure relaxations, so X Ltd must still disclose related parties and its transactions with them, except for the relaxed parts. Check the ICAI/MCA table for the exact relaxation. Other laws, such as Schedule III or the Companies Act, may also require related-party information.
Step 5: X Ltd should state in its notes that it has complied with the Accounting Standards as applicable to a small and medium entity.

Answer: X Ltd is not required to prepare a cash flow statement (AS 3) because an SMC is exempt. It need not give segment information because, being unlisted, it is outside AS 17 by scope. AS 18 is not fully exempt: it must give related party disclosures, subject to the limited relaxations the Rules allow an SMC (check the ICAI/MCA table). It should also note that it follows the AS as applicable to small and medium entities.

Example 2

Y Ltd is an unlisted small and medium sized company. The finance head says: 'Since we are small, AS 20 does not apply to us at all, so we need not report any earnings per share.' Examine the statement.

Show the solution

Step 1: Check the class. Y Ltd is an unlisted company that qualifies as an SMC, so it is eligible for relief. An SMC cannot have listed shares.
Step 2: Test the scope of AS 20. It applies only to entities whose equity or potential equity shares are listed or in the process of listing. Y Ltd is unlisted, so it is outside AS 20 and has no EPS requirement under it.
Step 3: The reason is the scope of AS 20, not the small size of Y Ltd. Size alone is not the test.
Step 4: If Y Ltd chooses to present EPS voluntarily, it should follow AS 20 in computing it.
Step 5: Y Ltd should state in its notes that it follows the AS as applicable to a small and medium entity.

Answer: The conclusion is right but the reason is wrong. Y Ltd need not report EPS because it is unlisted and outside the scope of AS 20, not because it is small. If it chooses to present EPS voluntarily, it should follow AS 20 in computing it.

Exam tips

Begin every answer with the entity type, the class and the reason from the facts. It earns marks even if you forget a paragraph.
Use the exact words 'exempt', 'relaxed' and 'outside scope'. In MCQs, options that reverse them are common distractors.
For AS 17 and AS 20, test scope first: listed or in the process of listing. An unlisted small entity is outside them by scope, not by exemption.
For AS 18, say it is not fully exempt for an SMC, but the Rules give limited disclosure relaxations. Check the ICAI/MCA table for the exact relaxation.
Do not quote paragraph numbers or name a specific relaxed item unless you are sure of it. Name the standard and the type of relief instead.
In practical questions from RTPs, check the facts against the SMC conditions (company) or the Level I triggers (non-company) before applying the list.

Practice questions from Applicability of Accounting Standards

Exemptions and Relaxations for Level II and III Entities: frequently asked questions

Which standards are smaller entities exempt from?

The main full exemption is AS 3 (Cash Flow Statements). The Companies (Accounting Standards) Rules give it to small and medium companies, and ICAI's table gives it to Level II and Level III non-company entities; Level I entities must apply it. AS 17 and AS 20 apply to Level I non-company entities only, so Level II and Level III are both outside them, and an unlisted SMC is outside them by scope. Some other standards, such as AS 15, AS 18 and AS 29, carry partial relief, so check the ICAI table for the entity type in your question.

Is a small and medium company exempt from AS 3?

Yes. A small and medium company is exempt from preparing a cash flow statement under AS 3. It can still prepare one voluntarily, but the Accounting Standard does not require it.

Do small and medium entities have to compute EPS?

Only if AS 20 applies. AS 20 covers entities whose equity or potential equity shares are listed or in the process of listing, so an unlisted SMC is outside it and has no EPS requirement under it. If an SMC voluntarily presents EPS, it should follow AS 20 in computing it.

What must an entity say when it claims the relief?

It should disclose in its notes that it has complied with the Accounting Standards as applicable to a small and medium entity. This is not fixed statutory wording. If it stops qualifying, it must apply the full standards.