AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies

AS 5 is prescribed to bring a uniformity in presentation among all enterprises.

Introduction

AS 5 specifies the method of classification and disclosure for the following items:

a. Prior period items

b. Extraordinary items

c. Certain specific items w.r.t. profit and loss from ordinary activities

The standard also describes the treatment of changes in accounting estimates and disclosures to be made on account of such changes. The standard doesn’t deal with tax implication on account of such changes as mentioned above.

Application

Why apply – Applying this standard helps in comparison of financial statements among various enterprises. Also, the financial statements of different enterprises can be compared over time when the standard is applied properly.

Insight Into the Standard Guidelines

The standard particularly deals with following four specific items:

Net Profit or Loss for the Period

Two broad categories of net profit and loss for the period are Profit or loss from ordinary activities and Profit or loss from extraordinary activities. Profit or loss from ordinary activities is such which arise in the normal course of business. These activities are a part of business and related activities. Examples: Profit/loss on sale of goods, services. The transactions and results under this category are shown as usual items in the financial statements for the accounting period. Profit or loss from extraordinary activities is such which do not arise under the normal course of business. These activities do not occur regularly. Example: – Profit on sale of fixed assets, Loss due to theft. The transactions and results under this category are to be disclosed separately in financial statements. The disclosure should be in a manner which clearly shows the effect on overall profits/losses due to these activities. The standard also specifies that if the results of any activity are substantial on the overall performance of the enterprise, then it should be disclosed separately in financial statements as a separate head. Example: – Fixed assets disposal, Restructuring of activities, Settlement of litigations.

Prior Period Items

While preparing the financial statements, there are certain items which actually correspond to prior accounting periods. The income or losses due to these items are a result of error or omission in the financial statements of the prior period. By nature, these items are not frequent and can be easily identified. The current period’s financial statements should clearly show the effect of such prior period items.

Changes in Accounting Estimates

There are certain estimates which are used while preparing the financial statements for any period. For example estimate on the useful life of a machinery, estimate on the realizable value of an item in inventory. At times, these estimates are required to be revised due to any of the following reasons (inclusive list):

i. Change in circumstances

ii. New information

iii. Subsequent developments

iv. Experience

The effect of such change in estimates is to be taken into account while preparing financial statements. If the change in estimate affects ordinary activities, it is disclosed under ordinary activities other under extraordinary activities.

Changes in Accounting Policies

Accounting policies are the accounting principles and method of applying those principles while preparing the financial statements. A change in accounting policy should be undertaken only in two cases:

i. If the change is required by law or accounting standard; or

ii. If the change helps in better presentation of financial statements

Any change in an accounting policy which has a substantial/material effect has to be disclosed necessarily. The impact of such change should also be shown in financial statements. If the impact can’t be assessed, this fact should also be disclosed.

Illustration of AS 5

There was a theft of goods in the warehouse of ABC Pvt. Ltd. in the previous year (2016-17) amounting to Rs. 50 Lakhs. The same was detected in the current year (2017-18) at the time of physical verification of inventory. How do we account for this theft and its discovery in the financial statements of 2017-18? The theft is not expected to take place on a frequent or regular basis and is not in a normal course of business of ABC Pvt. Ltd. Thus, the same qualifies to be an extraordinary item. Also, the theft took place in the financial year 2016-17 but was discovered in 2017-18. This suggests that although the loss related to 2016-17, it was not shown and the profit was overstated by such amount i.e. Rs. 50 Lakhs. While taking the effect of such loss in the current year (2017-18), this is a prior period item. Thus, the disclosures for the same should be given in the financial statements that due to a theft in 2016-17, goods worth Rs. 50 Lakhs were lost and discovered only in the current year. The value of inventory should be adjusted for such loss (both opening and closing inventory).

Comparison with Ind AS (IAS)

The following points are of importance in comparing AS 5 with Ind-AS 8:

Case Study on Ind-AS 8 with regards to disclosure of prior period items

In September 2017, ABC Limited found that goods amounting to Rs. 42,000 which were included in the inventory as on 31 Mar 2017, were actually sold before 31 March 2017. The following figures for 2016-17 (reported) and 2017-18 (draft) are available.

Retained earnings on 1 Apr 2016 were Rs. 13,000. The cost of goods sold for 2017-18 includes Rs. 42,000 errors in opening inventory. The income tax rate was 30% for 2016-17 and 2017-18. No dividends have been declared or paid.

Required: Show the statement of profit or loss for 2017-18, with the 2016-17 comparative, and retained earnings.