INDIGOLEARN

ACCOUNTING STANDARD 5

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AS 5 - NET PROFIT OR LOSS FOR THE PERIOD, PERIOD ITEMS AND
CHANGES IN ACCOUNTING POLICIES

1.1. Status and Applicability: AS-5 (Revised) is mandatory with effect from 1.4.1996 for
all enterprises a presenting profit or loss from ordinary activities, extraordinary item and
prior period item in the statement of profit and loss.

1.2. Objective And Scope: Quite often, the financial statements of one enterprise are to be
compared with the financial statements of other enterprises. What is required for this is
the common classification of different items of profit or loss, prior period items and
treatment of extra-ordinary items. The objective of this Standard is to bring uniformity
in preparation of income statements by different enterprises. This standard deals
with, among other matters, the disclosure of certain item of net profit or loss for the
period. These disclosures are made in addition to any other disclosures required by other
Accounting Standards. AS-5 also deals with change in accounting policy, accounting
estimates and extraordinary items. However, the AS-5 does not deal with the tax
implications of extraordinary items, prior period items and changes in accounting
estimates.

1.3. Definitions: The following terms have been used in these Standards as specified:

Ordinary activities are the 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. These are the basic activities of the firm.

Extraordinary items are income or expenses that arise from transactions other than from
the ordinary activities of the enterprise and, therefore, are not expected to occur 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 applied in the preparation and
presentation of financial statements.

1.4. Net Profit or Loss "For The Period": While preparing P 8z, L statement it is necessary
to disclose the following:

- Profit or Loss from ordinary activity.

- Profit and Loss from extraordinary activity.
- Prior Period items.
- Changes in Accounting estimate.
- Changes in Accounting Policies.

i. Ordinary activities: 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.

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 ii. Items of income or expenses falling under ordinary activities should be disclosed
separately in all cases, keeping materiality aspect in view i.e. where the (a) size (b)
nature or (c) its incidence warrants that a separate disclosure is relevant in order that
the performance for the period can be explained meaningfully.

Exceptional items: Although, some items of income and expenses are not extra ordinary items,
the nature & amount of such items may be relevant to users of financial statement in
understanding the financial position and performance of an enterprise. Examples of such items
which need to be disclosed separately, in the financial statements or in Notes to Accounts may
be

i. Writing down of inventories to N RV; reversals of such write down.

ii. Preliminary expenses written off.

iii. Disposal of items of fixed assets, or long term investments.

iv. Settlements in litigation's.

Note: Exceptional items emerge due to ordinary activities, but not n the ordinary course of the
business.

(b) Extra ordinary items (EIS) explained: In international accounting parlance, extra
ordinary items are material items, which arise from events or transactions falling outside
ordinary activities of a reporting entity. AS - 5 adds further clarity. The standard defines Els as
items of income or expense that arise from events or transactions that

iii. Are clearly distinct from ordinary activities, and therefore

iv. Are NOT expected to recur frequently or regularly.

Considerations governing identification of EIs: A single, universally applicable, principle

cannot be laid down. An event or transaction may be extraordinary for one entity. Yet the same
item may form a part of ordinary activity for another. For example, losses sustained as a result
of an earthquake may qualify as an extra ordinary item for many enterprises. However, claims
from policyholders arising from an earthquake do not qualify as an extraordinary item for an
insurance company that provides insurance against such risks.

One seeks an answer to a critical question -- does the El arise from a source or activity, which
is distinct from ordinary activity? If the answer is affirmative, then the items an El. Basis of
selection of an El is not the frequency or size. The definition of an El is highly restrictive.
Hence, in practice such items are rare.

Example: Losses due to natural disasters like floods or earthquakes.

Disclosure: Els should be disclosed in income statement in a manner that its impact on current
profit or loss can be perceived. Nevertheless, it should be remembered that such amounts are

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only part of the net profit or loss of the period.

(C) Prior Period Items Explained: Prior period items are income or expenses, which arise,
in the current period as a result of errors or omissions in the preparation of financial statements
of one or more prior periods.

Consideration governing identification of prior period items:

i. Here again, one seeks an answer to a critical question does the item arise from an error
or omission in prior period, and relate to income or expense?

ii. If the answer is affirmative, then the item is a prior period item. We should bear in mind
that, errors or omissions may occur as a result of mathematical mistakes in applying
accounting policies, misinterpretation of facts or oversight.

i. Prior period items do not include normal or recurring adjustments (e.g. arrears paid to
workers in current year on account of revision of wages with retrospective effect)

ii. Coverage under prior period items does not also include corrections of accounting
estimates made in prior years. Accounting estimates by their very nature are
approximations that may need revision, as additional information becomes known.

Disclosure of Prior period items- Disclose separately in a manner that the impact of item on
current year profit is perceived.

Disclosure of prior period items

First alternative Second Alternative

Normally included in NP or Loss for current Can also be reflected as a separate

period (in common parlance above the line) independent item, after determination of net
profit (in common parlance, below the line)

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 For Insightful Learning...!

Changes in accounting estimates result from new information or new developments and,
accordingly, are not corrections of errors. Hence, they will never be considered as prior period
adjustments

(d) Change in Accounting Estimate:

A change in accounting estimate is an adjustment of the carrying amount of an asset or a

liability, or the amount of the periodic consumption of an asset, that results from the assessment
of the present status of, and expected future benefits and obligations associated with, assets and
liabilities. Changes in accounting estimates result from new information or new
developments and, accordingly, are not corrections of errors.

An estimate regarding provision for bad and doubtful debts, useful life of an asset, valuation
of inventories, provision for income tax, etc, may be revised due to change in circumstances or
subsequent developments. The effect of a change in an accounting estimate should be included
in the determination of net profit or loss in:

i. the period of the change, if the change affects the period only (e.g. provision for bad
debts); or

ii. the period of the change and future periods, if the change affects both(e.g. amount
of depreciation).

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. Examples
of change in accounting estimates are: (1) Change in life or residual value of an asset, (ii)
Change in tax liability resulting from change in interpretation, (iii) Change in period over
which deferred revenue expenditures to be written off (iv) In case of construction contracts,
change in percentage of completion to be recognized, (v) Change in estimation of warranty
liability etc

Material omissions or misstatements of items are material if they could, individually or

collectively, influence the economic decisions that users make on the basis of the financial
statements. Materiality depends on the size and nature of the omission or misstatement judged
in the surrounding circumstances. The size or nature of the item, or a combination of both,
could be the determining factor.

For Insightful Learning...!

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 In the year which an entity changes its accounting system from manual to computerized, it
may be required to switch from first-in, first-out (FIFO) method (which it used while valuing
inventory manually) to the weighted average method. This change may be essential because
the computerized system, which is tailor-made for the industry to which the entity belongs,is
capable of valuing inventories under the weighted average method only and is not equipped
to value inventories under the FIFO method, because industry best practice dictates that only
FIFO is appropriate for the industry to which the entity belongs. Under these circumstances,
this change in method of valuing inventories from the FIFO to the weighted average method
is probably justified because it results in financial statements providing reliable and more
relevant information (and comparable to other entities within the industry to which the entity
belongs)

(e) Change in Accounting Policy:

A change in accounting policy should be made only in the following cases:

i. Such a changed accounting policy is necessitated by provisions of the statute or for

compliance with an Accounting Standard. (Including pronouncements of ICAI)

ii. Such a changed accounting policy would result in a more appropriate presentation of
the financial statement of the enterprise in order that relevance and reliability of
information presented, is enhanced

f) Change in accounting policy Disclosure: The standard prescribes the following

parameters

i. Any change that materially on the financial position, performance or cash flow, should
be so disclosed that the adjustments resulting from such a change (both for current and
later periods) is clearly brought out.

ii. A change may not have a material impact on the current period financial position,
performance and cash flows. Yet, if such a change is reasonably expected to have a
material effect in alter periods, the fact of such change should be appropriately
disclosed in the period in which the change is adopted.

iii. The customary practice of disclosing appropriately that it is impracticable to quantify

the effect of a change should also be followed.

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1.5. Some Noteworthy Points:

1. Change in method of depreciation say, from SLM to WDV or vice versa is a change in
accounting policy. But change in rate of depreciation or life of asset is only a change in
accounting estimate.

2. Similarly, change in inventory valuation method, say from FIFO to weight average method
is a change in accounting policy.

3. Wrong calculation of depreciation or wrong grouping of an asset for depreciation purpose

is a prior period item.

4. Attachment of a property by a court or loss of an asset in a natural calamity is an

extraordinary items.

5. Wrong counting of closing stock for previous year i.e. opening stock for current year, is a
prior period item.

6. Change in provision for doubtful debt is a change in accounting estimate. However, if the
firm wants to create a provision which was not a practice in the past, it is a change in
accounting policy.

7. Profit or loss on sale of asset/ investment. Non-admission of a claim by a tax authority or

writing off goodwill or preliminary expense is not extraordinary items. However, these may
be shown as exceptional items.

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