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AS 5:- NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD

ITEMS AND CHANGES IN ACCOUNTING POLICIES
1. Objective

1. Presentation & Disclosure of

• Certain ordinary activities;
• Extra ordinary activities;
• Prior period items;
2. Accounting Treatment & Presentation and disclosure of
• Changes in Accounting Estimates
• Changes in Accounting policies

This standard doesn’t deal with tax effect of the above items.

2. Net Profit or Loss for the period

All items of income and expense which are recognised in a financial year should be part of P &
La/c for the period. If any AS suggests or permits a different treatment, it should be accounted as
guided by that AS.

Net profit or loss for the period includes

• Profit or loss from ordinary activities; and

• Profit or loss from extra ordinary items;

3. Ordinary Activities
Ordinary activities are:

1. Entity’s business activities &

2. Related & incidental to such business activities

Note

✓ These activities arise in the normal course of business , so the frequency of the activities
is high;
✓ These activities are excepted to occur as part of business;

E.g. Sale of goods, providing services, sale of scrap, interest income/expense, salary expenses,
provisions, profit or loss on sale of fixed assets, etc.

Extraordinary items are

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• Activities which are clearly distinct from the ordinary activities of the entity ;
• These are not expected to occur as part of business;
• Generally frequency of such transaction is low. But frequency is not the only
criteria to determine;
• Classification of items is based on the NATURE of the but NOT on frequency;

Classification requires some degree of professional judgment.

E.g. An earthquake, attachment of property, refund of government grant (as per AS 12), seizure
of assets by the government, etc. These are not expected to occur as a part of business.

4. Presentation and Disclosure requirements

Extraordinary activities: Extraordinary activities should be separately disclosed in P&L a/c so as
to show the impact on profit and loss.

Exceptional items: (Certain items of ordinary activities)

The following items are ordinary activities as they are expected to occur as part of a business.
But based on size, nature, or incidence of transaction those activities require separate disclosure.
These items are generally termed as exceptional items.

❖ The writing down of inventories to net realizable value (NRV) as well as the
reversal of the same;
❖ A restructuring of the activities of an entity and the reversal of any provision
for the costs of restructuring;
❖ Profit or loss on disposal of long –term investments
❖ Profit or loss on disposal of fixed assets;
❖ Legislative changes having retrospective application;
❖ Litigation settlements; and
❖ Other reversals of provisions;

Note:

✓ Separate disclosure helps the users to understand the performance & position of the
company and it helps them in making projections of performance & financial position.
✓ Disclose the nature & amount of the transactions separately in P&L a/c and relevant
information in notes on accounts.

5. Prior Period Items

Prior period items are income or expense which arise in the current period as a result of errors
or omissions in the preparation of the financial statements of one or more be prior periods.

6. Presentation and Disclosure requirements

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Prior period items should be disclosed separately in the profit and loss a/c so as to show the
impact of prior period items in the current year.

Errors may occur as a result of

• Mathematical mistakes in calculations;

• Mistakes in application of accounting policies;
• Misinterpretation of facts; or
• Oversight (Failure to notice);

Omission means reliable information was available at the time of preparation of previous year
financial statements but the information was NOT considered.

7. Changes in Accounting Estimates

Estimation means an approximate calculation. Many items in the financials cannot be measured
accurately or exactly. The use of reasonable estimates is an essential part for the preparation of
financial statements. Usage of estimates doesn’t reduce the reliability of financial statements.

Following are general estimations used in preparation of financial statements.

• Useful life of assets ;

• Allowance for doubtful debts
• Inventory obsolescence ;
• Provisions for taxation, warranty, etc.

Estimations are made based on the latest information available and the circumstances on the
date of preparation of financial statements. Professional judgement is required while estimating.
As we discussed above, estimation is approximation, hence it requires revision as and when
a) There is any change in the circumstances and information available;
b) New information is available;
c) More experience or subsequent developments.

Revision in estimation is expected to occur, hence it is an ordinary activity and it CANNOT be

treated as an extraordinary item. Estimations are revised in the above circumstances but not
because of errors or omissions. Hence revision of estimation is NOT a prior period item. Changes
in accounting estimate should be accounted prospectively.

If the effect of change in estimation is significant - the entity should disclose the nature of
change and amount of change. Any change in an accounting estimate which is expected to have
a material effect in later periods should also be disclosed.

8. Changes in Accounting Policy

As per AS 1, Entity should follow the accounting policies consistently i.e. accounting policies
followed in PY should be continued in the current year also.

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It doesn't mean that the entity should not change its accounting policies. The entity can change
accounting policies in the following circumstances:

1. When it is a requirement of a statute;

2. Requirement of Accounting standard; or
3. Change in policy reflects better presentation of financial statements; (This should be justified
by the entity)

Accounting for change in accounting policy:

There is NO guidance in AS 5 on accounting for change in policy.

As a practice & IND AS- change in accounting policy is accounted RETROSPECTIVELY.
Retrospective recomputation means the entity should recompute the carrying amount as if the
new policy is followed from the beginning. The surplus or deficiency in carrying amount should
be taken to P&L a/c in the year of change in policy.

When the entity is not able to distinguish the change in estimate and change in accounting policy
– It should treat the change as change in accounting estimate only.

The following are NOT changes in accounting policy:

(a) Adoption of new accounting policy; and

(b) The adoption of an accounting policy for events or transactions that differ in substance from
previously occurring events or transactions.

9. Disclosure requirement
✓ If change in accounting policy has material effect it should be disclosed in the year of
change.
✓ If the impact is not ascertainable, the entity should disclose the fact in financial
statements.
✓ If there is no impact in the year of change but there is material impact in the future years,
the fact of such impact should be disclosed in the year of change in policy.
✓ As part of better practice, entity should disclose the reason for change in policy.

10.Try to understand various terminologies used with respect to fixed assets

Change in depreciation method e.g. from WDV Change in accounting policies

to SLM
Change in useful life of the asset Change in accounting estimate
Mathematical error in calculation of Prior period item
Depreciation in PY
Fixed assets destroyed in an earthquake Extraordinary item
Major disposal of fixed assets Ordinary activity (Exceptional items)
Example for disclosure of Ordinary, Extraordinary and Prior Period Items:

Statement of profit and loss account of XYZ Ltd for the year ended 31 st March, 2019

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Income: Rs. Rs.

Revenue from operation XXX
Other income XX
Total Revenue (A) XXX
Expenses:
Cost of goods sold XXX
Employee benefits expense XXX
Finance costs XXX
Depreciation and amortization expense XXX
Other expenses XXX
Total expenses(B) XXX
Profit before exceptional and extraordinary items and XXX
tax C= A-B
Exceptional items (D) XXX
Profit before extraordinary items and tax E= C-D XXX
Extraordinary Items XXX
Prior period items XXX
Profit before tax XXX
Tax expense XXX
Net profit after tax XXX

Examples
Examples of Changes in Accounting Policy:

a. Change of depreciation method from WDV to SLM and vice-versa.

b. Change in cost formula in measuring the cost of inventories.

Examples of Changes in Accounting Estimates:

a. Change in estimate of provision for doubtful debts on sundry debtors.

b. Change in estimate of useful life of fixed assets.

Examples of Extraordinary items:

a. Loss due to earthquakes / fire / strike

b. Attachment of property of the enterprise by government

Examples of Prior period items:

a. Applying incorrect rate of depreciation in one or more prior periods.

b. Omission to account for income or expenditure in one or more prior periods

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Questions
Q1

A limited company created a provision for bad and doubtful debts at 2.5% on debtors in
preparing the financial statements for the year 2010-2011.
Subsequently on a review of the credit period allowed and financial capacity of the
customers, the company decided to increase the provision to 8% on debtors as on 31.3.2011.
The accounts were not approved by the Board of Directors till the date of decision. While
applying the relevant accounting standard can this revision be considered as an extraordinary
item or prior period item?

Q2

X Co. Ltd. signed an agreement with its employees union for revision of wages in June, 2012. The
wage revision is with retrospective effect from 1.4.2008. The arrear wages upto 31.3.2012
amounts to 80 lakhs. Arrear wages for the period from 1.4.2012 to 30.06.2012 (being the date of
agreement) amounts to 7 lakhs.
Decide whether a separate disclosure of arrear wages is required.

Q3

Fuel surcharge is billed by the State Electricity Board at provisional rates. Final bill for fuel
surcharge of Rs 5.30 lakhs for the period October, 2008 to September, 2015 has been received
and paid in February, 2016. However, the same was accounted in the year 2016-17. Comment on
the accounting treatment done in the said case.

Q4

i. During the year 2016-2017, a medium size manufacturing company wrote down its
inventories to net realisable value by Rs 5,00,000. Is a separate disclosure necessary?
ii. A company signed an agreement with the Employees Union on 1.9.2016 for revision of
wages with retrospective effect from 30.9.2015. This would cost the company an
additional liability of Rs 5,00,000 per annum. Is a disclosure necessary for the amount
paid in 2016-17?

Q5

The company finds that the inventory sheets of 31.3.2016 did not include two pages containing
details of inventory worth Rs 14.5 lakhs. State, how you will deal with the following matters in
the accounts of Omega Ltd. for the year ended 31st March, 2017.

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Q6

Explain whether the following will constitute a change in accounting policy or not as par AS 5.
(1) Introduction of a formal retirement gratuity scheme by an employer in place of ad hoc
ex-gratia payments to employees on retirement.
(2) Management decided to pay pension to those employees who have retired after
completing 5 years of service in the organisation. Such employees will get pension of Rs
20,000 per month. Earlier there was no such scheme of pension in the organisation.

Q7

S.T.B. Ltd. makes provision for expenses worth Rs 7,00,000 for the year ending March 31, 2011,
but the actual expenses during the year ending March 31, 2012 comes to Rs 9,00,000 against
provision made during the last year. State with reasons whether difference of Rs 2,00,000 is to
be treated as prior period item as per AS-5.

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Answers
Q1

As per AS 5 'Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting
Policies', the preparation of financial statements involves making estimates which are based on
the circumstances existing at the time when the financial statements are prepared. It may be
necessary to revise an estimate in a subsequent period if there is a change in the circumstances
on which the estimate was based. Revision of an estimate, by its nature, does not bring the
adjustment within the definitions of a prior period item or an extraordinary item.
In the given case, a limited company created 2.5% provision for doubtful debts for the
year 2010-2011. Subsequently in 2011 the company revised the estimates based on the changed
circumstances and wants to create 8% provision. As per AS-5, this change in estimate is neither a
prior period item nor an extraordinary item.
However, as per AS 5, a change in accounting estimate which has material effect in the
current period, should be disclosed and quantified. Any change in the accounting estimate which
is expected to have a material effect in later periods should also be disclosed and quantified

Q2

It is given that revision of wages took place in June, 2012 with retrospective effect from
1.4.2008. The arrear wages payable for the period from 1.4.2008 to 31.3.2012 cannot be taken
as an error or omission in the preparation of financial statements of earlier years and hence this
expenditure cannot be taken as a prior period item.
Additional wages liability of 87 lakhs (from 1.4.2008 to 3062012 should be included in
current year wages.
It may be mentioned that additional wages is an expense arising from the ordinary
activities of the company. Although abnormal in amount, such an expense does not qualify as an
extraordinary item.
However, as per AS 5,' Net Profit or loss for the Period, Prior Period Items and Changes in
the Accounting Policies', when items of income and expense within profit or loss from ordinary
activities are of such size, nature or incident 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.

However, wages payable for the current year (from 1.4.2012 to 30.6.2012) amounting Rs
7 lakhs is not a prior period item hence need not be disclosed separately. This may be shown as
current year wages.

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Q3

The final bill having been paid in February, 2016 should have been accounted for in the annual
accounts of the company for the year ended 31st March, 2016. However, it seems that as a
result of error or omission in the preparation of the financial statements of prior period i.e., for
the year ended 31st March 2016, this material charge has arisen in the current period i.e., year
ended 31st March, 2017. Therefore it should be treated as 'Prior period item' as per AS 5. As per
AS 5, 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.
It may be mentioned that it is an expense arising from the ordinary course of business.
Although abnormal in amount or infrequent in occurrence, such an expense does not qualify an
extraordinary item as per AS 5. For better understanding, the fact that power bill is accounted
for at provisional rates billed by the state electricity board and final adjustment thereof is made
as and when final bill is received may be mentioned as an accounting policy.

Q4

i. Although the case under consideration does not relate to extraordinary item, but the
nature and amount of such item 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. AS 5 on 'Net Profit or Loss for the
Period, Prior Period Items and Changes in Accounting Policies' states that

"When items of income and expense within profit or loss from ordinary activities are of
such size, nature or incident 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."
Circumstances which may give to separate disclosure of items of income and expense in
accordance with AS 5 include the write-down of inventories to net realisable value as well
as the reversal of such write-downs.

ii. It is given that revision of wages took place on 1st September, 2016 with retrospective
effect from 30.9.2015. Therefore wages payable for the half year from 1.10.2016 to
31.3.2017 cannot be taken as an error or omission in the preparation of financial
statements and hence this expenditure cannot be taken as a prior period item.

Additional wages liability of Rs 7,50,000 (for 1.5 years @ 5,00,000 per annum) should be
included in current year wages. It may be mentioned that additional wages is an expense
arising from the ordinary activities of the company. Such an expense does not qualify as

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an extraordinary item. However, as per AS 5, 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

Q5

AS 5 on 'Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies',
defines Prior Period items as "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".

Rectification of error in inventory valuation is a prior period item vide AS 5. Separate disclosure
of this item as a prior period item is required as per AS 5.

Q6

As per AS 5 'Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting
Policies', the adoption of an accounting policy for events or transactions that differ in substance
from previously occurring events or transactions, will not be considered as a change in
accounting policy.
(1) Accordingly, introduction of a formal retirement gratuity scheme by an employer in place
of ad hoc ex-gratia payments to employees on retirement is not a change in an
accounting policy.
(2) Similarly, the adoption of a new accounting policy for events or transactions which did
not occur previously or that were immaterial will not be treated as a change in an
accounting policy.

Q7

As per AS 5 'Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting
Policies', 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. The use of reasonable estimates is
an essential part of the preparation of financial statements and does not undermine their
reliability.

Estimates 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.

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As per the standard, 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. 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. Thus, revision of an estimate by its nature i.e. the difference of 2 lakhs, is not a prior
period item.
Therefore, in the given case expenses amounting 2,00,000 (i.e. Rs 9,00,000- Rs 7,00,000) relating
to the previous year recorded in the current year, should not be regarded as prior period item.

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