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Statements of Accounting Standards
(AS 5) Revised
Net Profit or Loss for the Period,
Prior Period Items and Changes in Accounting Policies
(In this Accounting Standard, the
standard portions have been set in bold italic type. These
should be read in the context of the background material which
has been set in normal type, and in the context of the 'Preface
to the Statements of Accounting Standards'.)
The following is the text of the revised
Accounting Standard (AS) 5, 'Net Profit or Loss for the Period,
Prior Period Items and Changes in Accounting Policies', issued
by the Council of the Institute of Chartered Accountants of India.
This revised standard comes into effect
in respect of accounting periods commencing on or after 1.4.1996
and is mandatory in nature. It is clarified that in respect of
accounting periods commencing on a date prior to 1.4.1996, Accounting
Standard 5 as originally issued in November, 1982 (and subsequently
made mandatory) will apply.
Objective
The objective of this Statement is
to prescribe the classification and disclosure of certain items
in the statement of profit and loss so that all enterprises prepare
and present such a statement on a uniform basis. This enhances
the comparability of the financial statements of an enterprise
over time and with the financial statements of other enterprises.
Accordingly, this Statement requires the classification and disclosure
of extraordinary and prior period items, and the disclosure of
certain items within profit or loss from ordinary activities.
It also specifies the accounting treatment for changes in accounting
estimates and the disclosures to be made in the financial statements
regarding changes in accounting policies.
Scope
1. This Statement should be applied
by an enterprise in presenting profit or loss from ordinary activities,
extraordinary items and prior period items in the statement of
profit and loss, in accounting for changes in accounting estimates,
and in disclosure of changes in accounting policies.
2. This Statement deals with, among
other matters, the disclosure of certain items of net profit or
loss for the period. These disclosures are made in addition to
any other disclosures required by other Accounting Standards.
3. This Statement does not deal with
the tax implications of extraordinary items, prior period items,
changes in accounting estimates, and changes in accounting policies
for which appropriate adjustments will have to be made depending
on the circumstances.
Definitions
4. The following terms are used in
this Statement with the meanings specified:
Ordinary activities are any
activities which are undertaken by an enterprise as part of its
business and such related activities in which the enterprise engages
in furtherance of, incidental to, or arising from, these activities.
Extraordinary items are income
or expenses that arise from events or transactions that are clearly
distinct from the ordinary activities of the enterprise and, therefore,
are not expected to recur frequently or regularly.
Prior period items are income
or expenses which arise in the current period as a result of errors
or omissions in the preparation of the financial statements of
one or more prior periods.
Accounting policies are the
specific accounting principles and the methods of applying those
principles adopted by an enterprise in the preparation and presentation
of financial statements.
Net Profit or Loss for the Period
5. All items of income and expense
which are recognised in a period should be included in the determination
of net profit or loss for the period unless an Accounting Standard
requires or permits otherwise.
6. Normally, all items of income and
expense which are recognised in a period are included in the determination
of the net profit or loss for the period. This includes extraordinary
items and the effects of changes in accounting estimates.
7. The net profit or loss for the
period comprises the following components, each of which should
be disclosed on the face of the statement of profit and loss:
(a) profit or loss from ordinary activities;
and
(b) extraordinary items.
Extraordinary Items
8. Extraordinary items should be disclosed
in the statement of profit and loss as a part of net profit or
loss for the period. The nature and the amount of each extraordinary
item should be separately disclosed in the statement of profit
and loss in a manner that its impact on current profit or loss
can be perceived.
9. Virtually all items of income and
expense included in the determination of net profit or loss for
the period arise in the course of the ordinary activities of the
enterprise. Therefore, only on rare occasions does an event or
transaction give rise to an extraordinary item.
10. Whether an event or transaction
is clearly distinct from the ordinary activities of the enterprise
is determined by the nature of the event or transaction in relation
to the business ordinarily carried on by the enterprise rather
than by the frequency with which such events are expected to occur.
Therefore, an event or transaction may be extraordinary for one
enterprise but not so for another enterprise because of the differences
between their respective ordinary activities. For example, losses
sustained as a result of an earthquake may qualify as an extraordinary
item for many enterprises. However, claims from policyholders
arising from an earthquake do not qualify as an extraordinary
item for an insurance enterprise that insures against such risks.
11. Examples of events or transactions
that generally give rise to extraordinary items for most enterprises
are:
– attachment of property of the enterprise;
or
– an earthquake.
Profit or Loss from Ordinary Activities
12. When items of income and expense
within profit or loss from ordinary activities are of such size,
nature or incidence that their disclosure is relevant to explain
the performance of the enterprise for the period, the nature and
amount of such items should be disclosed separately.
13. Although the items of income and
expense described in paragraph 12 are not extraordinary items,
the nature and amount of such items may be relevant to users of
financial statements in understanding the financial position and
performance of an enterprise and in making projections about financial
position and performance. Disclosure of such information is sometimes
made in the notes to the financial statements.
14. Circumstances which may give rise
to the separate disclosure of items of income and expense in accordance
with paragraph 12 include:
(a) the write-down of inventories
to net realisable value as well as the reversal of such write-downs;
(b) a restructuring of the activities
of an enterprise and the reversal of any provisions for the costs
of restructuring;
(c) disposals of items of fixed assets;
(d) disposals of long-term investments;
(e) legislative changes having retrospective
application;
(f) litigation settlements; and
(g) other reversals of provisions.
Prior Period Items
15. The nature and amount of prior
period items should be separately disclosed in the statement of
profit and loss in a manner that their impact on the current profit
or loss can be perceived.
16. The term 'prior period items',
as defined in this Statement, refers only to income or expenses
which arise in the current period as a result of errors or omissions
in the preparation of the financial statements of one or more
prior periods. The term does not include other adjustments necessitated
by circumstances, which though related to prior periods, are determined
in the current period, e.g., arrears payable to workers as a result
of revision of wages with retrospective effect during the current
period.
17. Errors in the preparation of the
financial statements of one or more prior periods may be discovered
in the current period. Errors may occur as a result of mathematical
mistakes, mistakes in applying accounting policies, misinterpretation
of facts, or oversight.
18. Prior period items are generally
infrequent in nature and can be distinguished from changes in
accounting estimates. Accounting estimates by their nature are
approximations that may need revision as additional information
becomes known. For example, income or expense recognised on the
outcome of a contingency which previously could not be estimated
reliably does not constitute a prior period item.
19. Prior period items are normally
included in the determination of net profit or loss for the current
period. An alternative approach is to show such items in the statement
of profit and loss after determination of current net profit or
loss. In either case, the objective is to indicate the effect
of such items on the current profit or loss.
Changes in Accounting Estimates
20. As a result of the uncertainties
inherent in business activities, many financial statement items
cannot be measured with precision but can only be estimated. The
estimation process involves judgments based on the latest information
available. Estimates may be required, for example, of bad debts,
inventory obsolescence or the useful lives of depreciable assets.
The use of reasonable estimates is an essential part of the preparation
of financial statements and does not undermine their reliability.
21. An estimate may have to be revised
if changes occur regarding the circumstances on which the estimate
was based, or as a result of new information, more experience
or subsequent developments. The revision of the estimate, by its
nature, does not bring the adjustment within the definitions of
an extraordinary item or a prior period item.
22. Sometimes, it is difficult to
distinguish between a change in an accounting policy and a change
in an accounting estimate. In such cases, the change is treated
as a change in an accounting estimate, with appropriate disclosure.
23. The effect of a change in an accounting
estimate should be included in the determination of net profit
or loss in:
(a) the period of the change, if the
change affects the period only; or
(b) the period of the change and future
periods, if the change affects both.
24. A change in an accounting estimate
may affect the current period only or both the current period
and future periods. For example, a change in the estimate of the
amount of bad debts is recognised immediately and therefore affects
only the current period. However, a change in the estimated useful
life of a depreciable asset affects the depreciation in the current
period and in each period during the remaining useful life of
the asset. In both cases, the effect of the change relating to
the current period is recognised as income or expense in the current
period. The effect, if any, on future periods, is recognised in
future periods.
25. The effect of a change in an accounting
estimate should be classified using the same classification in
the statement of profit and loss as was used previously for the
estimate.
26. To ensure the comparability of
financial statements of different periods, the effect of a change
in an accounting estimate which was previously included in the
profit or loss from ordinary activities is included in that component
of net profit or loss. The effect of a change in an accounting
estimate that was previously included as an extraordinary item
is reported as an extraordinary item.
27. The nature and amount of a change
in an accounting estimate which has a material effect in the current
period, or which is expected to have a material effect in subsequent
periods, should be disclosed. If it is impracticable to quantify
the amount, this fact should be disclosed.
Changes in Accounting Policies
28. Users need to be able to compare
the financial statements of an enterprise over a period of time
in order to identify trends in its financial position, performance
and cash flows. Therefore, the same accounting policies are normally
adopted for similar events or transactions in each period.
29. A change in an accounting policy
should be made only if the adoption of a different accounting
policy is required by statute or for compliance with an accounting
standard or if it is considered that the change would result in
a more appropriate presentation of the financial statements of
the enterprise.
30. A more appropriate presentation
of events or transactions in the financial statements occurs when
the new accounting policy results in more relevant or reliable
information about the financial position, performance or cash
flows of the enterprise.
31. The following are not changes
in accounting policies :
(a) the adoption of an accounting
policy for events or transactions that differ in substance from
previously occurring events or transactions, e.g., introduction
of a formal retirement gratuity scheme by an employer in place
of ad hoc ex-gratia payments to employees on retirement; and
(b) the adoption of a new accounting
policy for events or transactions which did not occur previously
or that were immaterial.
32. Any change in an accounting policy
which has a material effect should be disclosed. The impact of,
and the adjustments resulting from, such change, if material,
should be shown in the financial statements of the period in which
such change is made, to reflect the effect of such change. Where
the effect of such change is not ascertainable, wholly or in part,
the fact should be indicated. If a change is made in the accounting
policies which has no material effect on the financial statements
for the current period but which is reasonably expected to have
a material effect in later periods, the fact of such change should
be appropriately disclosed in the period in which the change is
adopted.
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