NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND CHANGE IN ACCOUNTING POLICIES (AS-5)

Transcription

1 C H A P T E R 7 NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND CHANGE IN ACCOUNTING POLICIES (AS-5) Objective 7.1 The objective of this acconting standard is to prescribe the criteria for certain items in the statement of profit and loss so that comparability of the financial statement can be enhanced. Statement of profit and loss being a period statement covers the items of the income and expenditre of the particlar period. For example, if we are preparing the statement of profit and loss for the year ended this implies that all the items of the income and expenditre appearing in the statement of profit and loss pertain to the period to , however there may be a sitation where particlar income or expense appearing in the statement of profit and loss for the year ended may not relate to the period to , in that sitation, what shold be the acconting treatment and presentation of sch item in the statement of profit and loss is prescribed by this acconting standard. This acconting standard also deals with change in acconting policy, acconting estimates and extraordinary items. Components of net profit 7.2 Net profit or loss for the period consists of two components Profit or loss from ordinary activities Extraordinary items. These components shold be disclosed on the face of statement of profit and loss. 86

2 87 PRIOR PERIOD ITEM Para 7.3 Ordinary activities are defined as any activities, which are ndertaken by an enterprise as part of its bsiness and incidental to main bsiness Profit/loss from ordinary activities - Normally all items of income and expenses which are recognized in a period are inclded in the determination of the net profit or loss for the period. This incldes extraordinary items and change in acconting estimates. When items of income and expenditre from ordinary activities are of sch size and natre that their disclosre is relevant to explain the performance of the enterprises for the period. The natre and amont of sch items shold be separately disclosed. Althogh these items are not extraordinary items, examples of sch items are : The write down of inventories to net realisable vale or reversal of sch write down Restrctring cost or reversal of provision of restrctring cost Profit or loss on disposal of fixed assets Profit or loss on disposal of long term investment Litigation settlements Reversal of provisions Legislative changes having long term retrospective application Extraordinary items - Extraordinary items are income or expense that arise from transactions that are clearly distinct from ordinary activities. They are not expected to recr freqently or reglarly. The natre and amont of extraordinary items shold be separately disclosed in Profit and Loss Accont so that its impact on crrent profit or loss can be perceived. Example - Attachment of property of the enterprises or loss de to earthqake Examples of extraordinary items Loss de to earthqakes Attachment of property Government grants becoming refndable Government grants for giving immediate financial spport with no frther cost Governments grant receivable as compensation for expenses or losses incrred in previos acconting period. Prior Period item 7.3 Prior Period items are income or expenses, which arise, in crrent period as a reslt of error or omission in the preparation of financial statement of one or more prior periods.

3 Para 7.4 NET PROFIT OR LOSS FOR PRIOR PERIOD ITEMS 88 Example : Mr. Amit an employee of Indga Ltd. went on leave with pay for 9 months on pto His monthly pay was Rs. 15,000 while preparing the financial statement on for the year ended , the expense of salary of Mr. Amit for 3 months ( to ) was not provided de to omission. When Mr. Amit joined on the whole salary for 9 months ( to ) was paid to him. In this case three months salary ( to ) of Rs. 45,000 is prior period expense and following entry shold be passed : Salary A/c Dr. 90,000 (15,000 6) Prior period expense Dr. 45,000 (Salary) To Bank A/c 1,35,000 Sppose in above example Mr. Amit was terminated from service on and was re-instated in service by the Cort on with all back salary. On as per Cort order, Company paid the nine months salary to Mr. Amit, as the company accepted the Cort verdict. Then there is no prior period expense and the following entry to be passed : Salary A/c Dr. 1,35,000 To Bank A/c 1,35,000 In this case there is no error or omission while preparing the financial statement for the earlier year i.e. for the year ended As the company intentionally did not make the provision for salary for 3 months of Mr. Amit becase company terminated his service Disclosre of prior period items - The natre and amont of prior period items shold be separately disclosed in the statement of profit and loss in a manner that their impact on crrent profit or loss can be perceived Examples of prior period items Error in calclation in providing expenditre or income. Omission to accont for income or expenditre. Non-provision of travelling expenses for travel already ndertaken. Non-provision for salary already de in earlier year. Applying incorrect rate of depreciation. Treating operating lease as finance lease. Capitalisation of borrowing cost on working capital. Change in Acconting Estimate 7.4 It means that estimate is revised de to change in the circmstances/ conditions on which the estimates was based. For example: Estimation of provision of Sndry Debtors

4 89 CHANGES IN ACCOUNTING POLICIES Para 7.5 Estimation of provision for any liabilities Compting income-tax provision (crrent tax) Estimating the sefl life of fixed assets Effect of Change in Acconting Estimate - The effect of a change in acconting estimate shold be classified in following manner : If an estimate pertains to ordinary activities, then change in acconting estimate shold be classified as ordinary activities. If estimates pertain to extraordinary item, then change in acconting estimates shold be classified as extraordinary Disclosre of Acconting Estimate The effect of a change in acconting estimate disclosed in net profit or loss The period of change, if the change affects the period only Example: Estimation of provision of sndry debtor The period of change and ftre periods, if the change affects both Example: Estimation of the sefl life of the fixed assets Examples of change of Acconting Estimates Re-estimating the residal vale of fixed assets. Change in sefl life of fixed assets. Actal bad debts trning ot to be more or less than provisions. Changes in Acconting Policies 7.5 In the following circmstances changes in acconting policies are made : For the compliance of acconting standard For the compliance of the statte or law For better and appropriate presentation of the financial statement Disclosre of change in Acconting Policies Material effect shold be shown in financial statement to reflect the effect of sch change This effect shold be disclosed in the year of change If the effect of change is not ascertainable, the fact shold be disclosed If the effect of change is not material for crrent period, bt it is material effect for the later period, then fact shold be disclosed in the period of change.

5 NET PROFIT OR LOSS FOR PRIOR PERIOD ITEMS Examples of change in acconting policies : Change from cost model to Revalation model for measrement of carrying amont of PPE. Change in cost formla in measring the cost of inventories Change in acconting policy v. Change in acconting estimate Example : ABC Ltd. was making provision for non-moving stock based on no isse for the last 12 months pto The company wants to provide dring the year ending based on technical evalation: Total vale of Stock Rs. 1 crore Provision reqired based on 12 months isse Rs. 3,50,000 Provision reqired based on technical evalation Rs. 2,50,000 Does this amont to change in acconting policy? Can the company change the method of provision? Soltion : The change does not amont to change in acconting policy. The method is only a gideline and the better way of estimating the provision for non-moving stock. Frther the amont of difference is also not material. Hence, it is not a change in acconting policy. The acconting policy for valation of inventories is lower of cost and net realisable vale. Within this broad policy, some estimates are inherent, for example, in the making of provision for slow moving stocks. As a reslt of the ncertainties inherent in bsiness activities, any financial statement items cannot be measred with precision bt can only be estimated. The estimation process involves jdgments based on the latest information available. Estimates may be reqired, for example, of bad debts, inventory obsolescence or the sefl lives of depreciable assets. The se of reasonable estimates is an essential part of the preparation of financial statements and does not ndermine their reliability. An estimate may have to be revised if changes occr regarding the circmstances on which the estimate was based, or as a reslt of new information, more experience or sbseqent developments. In the given case the change is a change in an acconting estimate and not a change in an acconting policy. Frther the company shold be able to demonstrate satisfactorily that having regard to circmstances provision made on the basis of technical evalation provides more satisfactory reslts than provision based on 12 months isse. If that be the case, the company can change the method of provision. ILLUSTRATIONS Q1. At December 31, 2010, Matson Inc. was holding long-lived assets, which it intended to sell. The company appropriately recognized a loss in 2010 related to these assets. On Matson Inc. s income statement for the year ended December 31, 2010 this loss shold be reported as an (a) Extraordinary item. (b) Component of income from contining operations before income-taxes.

6 91 ILLUSTRATIONS (c) Separate component of selling or general and administrative expenses, disclosed net of tax benefit. (d) Component of the gain (loss) from sale of discontined operations, disclosed net of income-taxes. Soltion : As per AS-5 (refer point 6.2-1) losses associated with long-lived assets, which are to be disposed of, are to be reported as a component of income from contining operations before income-taxes for entities preparing income statements. Therefore, answer (b) is correct. Answer (a) is incorrect becase losses on long-lived assets to be disposed of are neither nsal nor infreqent occrrences. Answer (c) is incorrect becase these losses are not part of selling or general and administrative expenses and they are not disclosed net of tax, answer (d) is incorrect, becase discontined operations reslt from disposal of a bsiness, not the disposal of long-lived assets held for resale. Q2. The company has to pay delayed cotton clearing charges over and above the negotiated price for taking delayed delivery of cotton from the Spplier s Godown. Upto , the company has reglarly inclded sch charges in the valation of closing stock. This being in the natre of interest the company has decided to exclde it from closing stock valation for the year This wold reslt into decrease in profit by Rs lakhs. Comment. Soltion : AS-5 (refer point 6.5) states that a change in an acconting policy shold be made only if the adoption of a different acconting policy is reqired by statte or for compliance with an acconting standard or if it is considered that the change wold reslt in a more appropriate preparation or presentation of the financial statements of an enterprise. Therefore, the change in the method of stock valation is jstified in view of the fact that the change is in line with the recommendations of AS-2 and wold reslt in more appropriate preparation of the financial statements. As per AS-2, this acconting policy adopted for valation of inventories inclding the cost formlae sed shold be disclosed in the financial statements. Also, appropriate disclosre of the change and the amont by which any item in the financial statements is affected by sch change is necessary as per AS-1, AS-2 and AS-5. Therefore, the ndermentioned note shold be given in the Annal Acconts. In compliance with the Acconting Standard issed by the ICAI, delayed cotton clearing charges which are in the natre of interest have been exclded from the valation of closing stock nlike preceding years. Had the company contined the acconting practice followed earlier, the vale of closing stock as well as profit before tax for the year wold have been higher by Rs lakhs. Q3. Fel srcharge is billed by the State Electricity Board at provisional rate. Final bill for fel srcharges of Rs lakhs for the period October, 2005 to September, 2009 has been received and paid in Febrary, How this shold be dealt in acconts for year Soltion : It seems as a reslt of errors or omission in the preparation of financial statements of prior period i.e to This material charge has arisen in the crrent period i.e. year ended 31st March, 2010, therefore it shold be treated as prior period item as per para 16 of AS-5 (refer point 6.3) and as sch shold be separately disclosed as per para 15 of AS-5 (refer point 6.3-1) so that impact of this item on crrent profit can be known. It shold be frther noted that the item is not

7 NET PROFIT OR LOSS FOR PRIOR PERIOD ITEMS 92 an extraordinary item as per para 10 of AS-5 (refer point 6.2-2) as fel srcharge expense arises from ordinary corse of bsiness. Q4. U.P. Rajya Set Nigam Ltd. was awarded a contract of constrction of a bridge for Rs. 100 crores on Total contract cost estimated was Rs. 80 crores. The position of the contract on and was nder: As on As on Contract Price Contract Cost incrred p to date (100% complete) Estimate contract cost of completion 60 NIL While closing books of accont on , the chief accontant treated excess cost of Rs. 10 crores incrred as against estimated of Rs. (25+60) = 85 crores as on as mistakes in estimation of cost, hence categorized Rs. 10 crores (95-85) as prior period expenses. Comment. Soltion: Cost originally estimated by U.P. Rajya Set Nigam Ltd. Rs. 85 crores Excess Cost incrred Rs. 10 crores Treatment given by the company Prior period item As clearly provided in AS-5, a change in estimate is neither a prior period item nor an extraordinary item. Hence, the treatment given by the company is incorrect. Q5. State how yo will deal with the following matter in the acconts of U Ltd. for the year ended 31st March, 2010 with reference to Acconting Standard: The company finds that the stock sheets of did not inclde two pages containing details of inventory worth Rs lakhs. Soltion : As per AS-5 an item of expenses or income arises in crrent period as a reslt of omission or commission in the preparation of financial statements of one or more prior period is prior period item. In this case stock sheet of (prior year) did not inclde two pages containing details of inventory worth Rs lakhs which is the omission, and this omission was detected in crrent period i.e Therefore, it is a prior period item. Entry to be passed is as nder : Opening inventory A/c Dr. Rs lakhs To Prior Period Income Rs lakhs SIMPLE PROBLEMS P1. Whether the following items are (a) prior period items (b) change in acconting estimate (c) extraordinary items Arrears of salaries and wages of Rs.10 lakhs for the previos year will be paid dring the crrent year as per cort jdgment delivered in the crrent year.

8 93 SIMPLE PROBLEMS At the end of previos year, the company assessed that arrears of salaries and wages wold not be reqired to be paid. So no provision was made at the end of previos year. [Ans. : None of these] Expenses of Rs. 50,000 of the previos year, which were omitted from books of accont of the previos year de to an oversight. [Ans. : Prior period item] The amont of provision for dobtfl debts as at the end of the previos year was Rs. 5,00,000, of these debts of Rs. 3,00,000 were realized dring the year. [Ans. : Change in Acconting estimate] Sale of a significant part of the plot of land on which the footing is sitated. [Ans. : Extraordinary items] Write off a hge debt of a major cstomer de for more than a year. [Ans. : None of these] P2. Discss the acconting principle as having relevance to the aditors relating to Prior-period items Extraordinary items Change in acconting estimates P3. Distingish between changes in acconting policies and changes in acconting estimates. How change in acconting estimates is acconted for in the books of an enterprise? P4. The Company fond in that stock sheet as on had inclded twice an item of Rs. 2,00,000. [Ans. : Prior period item to be shown separately in profit and loss accont for ] P5. A claim was lodged with a transport company for loss of goods of Rs. 3 lakhs dring , the payment of which was received in No entry had been passed in acconts when claim was lodged. [Ans. : Amont to be credited to profit and loss accont in , if entry was not passed in de to ncertainty of ltimate receipt of claim (refer AS- 9) otherwise prior period item] P6. Dring the year , a medim size manfactring company wrote down its inventories to net realisable vale by Rs. 5,00,000. Is a separate disclosre necessary? [Ans. : Yes, considering the natre and amont of sch item] P7. A company signed an agreement with the Employees Union on for revision of wages with retrospective effect from This wold cost the company an additional liability of Rs. 5,00,000 per annm. Is a disclosre necessary for the amont paid in ? [Ans. : Yes, considering natre and amont of the item]