AS 5 Net Profit or Loss For the Period, Prior Period Items

AS 5 Net Profit or Loss For the Period, Prior Period Items and Changes in Accounting Policies. In the previous article, we have given AS 4 Contingencies & Events Occurring after the Balance Sheet Date and AS 6 Depreciation. Today we are providing the complete details of accounting standard – 5 net profit or loss for the period, prior period items and changes in accounting policies. You can also download AS 5 revised summary notes by ICAI in PDF at the end of this article. This summary notes is also useful for IPCC students.

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

Net Profit or Loss for the Period :

All items of income and expense which are recognized 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.  Normally, all items of income and expense which are recognized 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.

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:

• profit or loss from ordinary activities; and
• extraordinary items

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.

When items of income and expenses within profit or loss from ordinary activities are of such size, nature 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 properly. Examples of such circumstances are: (Exceptional Items)

• disposal of items of fixed assets
• litigation settlements
• legislative changes having retrospective application
• disposal of long term investments
• reversal of provisions

Extraordinary items are income or expense 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.

Examples of events or transactions that generally give rise to extraordinary items for most enterprises are:

• attachment of property of the enterprise;
• an earthquake

However, claims from policyholders arising from an earthquake do not qualify as an extraordinary item for an insurance enterprise that insures against such risks.

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.

Definitions

The following terms are used in this Standard with the meanings specified:

1) 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.

2) 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.

3) 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.

4) 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.

Prior Period Items:

Prior period items are income or expenses that arise in the current period as a result of ERROR or OMMISSIONS in the preparation of the financial statements of one or more prior periods.

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.

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 recognized on the outcome of a contingency which previously could not be estimated reliably does not constitute a prior period item. 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 Policy :

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.

A change in an accounting policy should be made only if the adoption of a different accounting policy is required:

• by statute
• for compliance with an accounting standard
• if it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise.

Any change in accounting policy which has a material effect, should be disclosed. Such changes should be disclosed in the statement of profit and loss in a manner that their impact on profit or loss can be perceived.

Where the effect of such change is not ascertainable, 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 material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.

Changes in Accounting Estimates

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.

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.

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.

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.

Clarifications:

(a) Change in accounting estimate does not bring the adjustment within the definitions of an extraordinary item or a prior period item.

(b) Sometimes, it is difficult to distinguish between a change in an accounting policy and a change in accounting estimate. In such cases, the change is treated as a change in an accounting estimate, with appropriate disclosures.

Click Here to download AS 5 notes by ICAI in PDF.

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