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

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

1. As usual Let's start with the Objective

The objective of this Standard 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 Standard 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.
AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies 39
2. We need to know also the application of this standard :
This Standard 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.
This Standard 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.Take care that standard Does not Applies to
This Standard 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.
4. Let's now have a look over some significant terms
4.1 Net profit or loss for the period
It comprise of – profits from ordinary activities and Extra- ordinary activities
4.2 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 its activities or such activities which are incidental to such
activities or activities which arises due to ordinary or normal business activities. CA Trix limited is an
educational company and if they start and venture into related activities such as computer training or
management consultancy then these shall be treated as ordinary activities
4.3Exceptional items
Although these items of income and expense are not extra-ordinary 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. Therefore such items should be presented in the financial statements in
such a manner so that their impact on Net Profit for the year could be clearly perceived. Some of the
items which are exceptional are – presenting inventories at net realizable value, disposal of fixed assets or
inventories.
Circumstances which may give rise to the separate disclosure of items of income and expense 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
4.4 Extra-ordinary activities
Items are those which arise from abnormal or unusual events lying outside the ordinary range of firm’s
activities and which are both material and expected not to occur frequently or regularly.
Extra-ordinary items should be disclosed in the statement of profit and loss as a part of net profit and loss
for the period. The nature and the amount of such extra-ordinary item should be separately disclosed
in the statement of profit and loss in such a manner that its impact, on current year profits, could be
clearly observed.
Examples of events or transactions that generally give rise to extraordinary items for most enterprises are:
- attachment of property of the enterprise
- an earthquake
- Refund of Capital Grant
- VRS Payments
4.5 Prior period items
There may be several items of income and expense which arise in the current period as a result of some
error in one or more prior periods. The errors may occur as a result of mathematical error, wrong
accounting policy or misrepresentation of fats. These are called as Prior Period Items and, are infrequent in
nature. The nature and amount of prior period items should disclosed in the income statements in
such a manner so that impact on the current year’s profit could be perceived clearly.
40 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies AS 5
4.6 Changes in Accounting Estimates.
1.As a result of the uncertainties inherent in business activities, many financial statement items cannot be
measured with precision but can only be estimated.
2.The estimation process involves judgments based on the latest information available
3.Estimates may be required, for example, of bad debts, inventory obsolescence or the useful lives of
depreciable assets.
4.The use of reasonable estimates is an essential part of the preparation of financial statements and does not
undermine their reliability.
5.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.
6.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.
7.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.
8.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.
9.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.
10.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.
4.7 Changes in Accounting Policies
1. 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.
2. 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.
3. A more appropriate presentation of events or transactions in the financial statements occurs when the
new accounting policy results in more relevant Net Profit or Loss for the Periodor reliable information
about the financial position, performance or cash flows of the enterprise.
4. 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.
5. 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.
6. 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
7. A change in accounting policy consequent upon the adoption of an Accounting Standard should be
accounted for in accordance with the specific transitional provisions, if any, contained in that Accounting
AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies 41
Standard. However, disclosures required by paragraph 32 of this Standard should be made unless the
transitional provisions of any other Accounting Standard require alternative disclosures in this regard

5. Disclosure
AS-5 requires that the effect of
 Prior period items
 Extra ordinary items
 Change in accounting estimates
 Change in accounting policies
should be disclosed in the income statement of the current period. However, if it is impractical to quantify
the amount, this fact should be disclosed in Notes to Accounts.

Illustrative Case Studies

1. 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.
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.
2. 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?
Response:
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 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."
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.
3. 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?
Response:
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
42 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies AS 5
be taken as a prior period item.
Additional wages liability of Rs. 7,50,000 (for 1% years @ Rs. 5,00,000 per annum) should be
included in current year's 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 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.
4. 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.
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.
5. Explain whether the following will constitute a change in accounting policy or not as per AS 5.
(i) Introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex-gratia
payments to employees on retirement.
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.
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.
6. Explain whether the following will constitute a change in accounting policy or not as per AS 5.
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.
Response:
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.
7. M-4 purchased a new machine costing Rs. 10 lacs. Useful life was taken to be for 10 years,
therefore, depreciation was charged at 10% on original cost each year. After 5 years when carrying
amount was Rs. 5 lacs for the machine, management realises that machine can work for another 2
years only and they decide to write off Rs. 2.5 lacs each year. Comment.
Response:
This is not a case of prior period item but change in accounting estimate.
8. Continuing the facts of previous Case Study suppose management by mistake calculates the
depreciation in the fifth year as 10% of Rs. 6,00,000 i.e. Rs. 60,000 instead of Rs. 1,00,000 and in
the next year decides to write off Rs. 1,40,000. Comment.
Response:
In such a case, Rs. 1,00,000 current year's depreciation and Rs. 40,000 will be considered as prior
period item.
As per AS 10 (Revised), Property, Plant and Equipment, residual value and the useful life of an
asset should be reviewed at least at each financial year-end and, if expectations differ from
previous estimates, the change should be accounted for as a change in an accounting estimate in
AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies 43
accordance with AS 5 'Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies'.
9. Sale value of scrap items adjusted against Miscellaneous Expenditure. Comment
Ans- As- 5 states that 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 then nature and amount of such items should be
presented separately. Thus in the present case sale of scrap should be shown on the credit side of
profit and loss account while Misc. exp. Should be shown on the debit side of the said account
instead of intra- adjustment.
10. Insurance claim of Rs. five lakhs received stands included under Miscellaneous Income. Comment.
Answer-A business house generally insures itself against various sorts of losses which might arise
during the course or life of the business. As such losses such as loss of goods due to fire or say
theft, destruction of machinery or buildings etc. are part and parcel of business related activities
and consequently receipt of insurance claim against such losses are also very much part of business
activity.
Therefore, being an item of normal ordinary activity, it should be disclosed separately on the credit
side of P&L a/c.
11. A sum of Rs.15 lacs is received from Insurance Company in respect of claim for the loss of goods
in transit costing Rs.10 lacs. The amount is credited to the purchases account. Is the accounting
treatment correct?
Answer-
Same as above- but add further that loss of goods should be shown on the credit side of trading a/c
and then again on the debit side of the profit and loss account and receipt of insurance claim
should be shown on the credit side of profit and loss account and also on the assets side of the
Balance Sheet.
12. A loss of Rs.2 lakhs on account of embezzlement of cash was suffered by the company and it was
debited to salaries account.
Answer- AS-5 on Net Profit or loss for the period, prior period items and changes in accounting
policies requires that all items of income and expenses which are recognized in a period should be
included in the determination of net profit or loss for the period. It further states that when items
are of such size and nature that their separate reflection is relevant for understanding the
performance of the organization then such items must be presented separately. In the given case
embezzlement of cash is a business loss and as such should be disclosed separately.
13. The surplus arising from a change in the basis of accounting was set off by X limited against a
non-recurring loss.
Answer-Keeping the guidelines of AS-5 in mind one say in this case it would be prudent to
disclose the surplus separately instead of setting it off against the non- recurring loss.
14. Explain the provisions of AS- 5 regarding accounting treatment of prior period items.
Hint -The nature and amount of prior period items should disclosed in the income statements
in such a manner so that impact on the current year’s profit could be perceived clearly.
15. During the year 2007-08, a medium size manufacturing company wrote down its inventories to net
realizable value by Rs. 5,00,000. Is a separate disclosure necessary?
Hint- although it is an ordinary item, yet due to size should be treated an exceptional item and
disclosed separately.
16. A company signed an agreement with Employees Union on 1.09.2011 for revision of wages with
retrospective effect from 30.09.2010. This would cost the company an additional liability of Rs.
5,00,000 per annum. Is a disclosure necessary for the amount paid in 2011-2012?
44 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies AS 5
Hint - Not a prior-period item. Should be included in current year’s wages, as it arises from
ordinary activities of the organisation. However, due to nature and size of the amount it is better to
disclose it separately also.
17. A company signed an agreement with employees union for revision of wages in June 2004. The
wage revision is with retrospective effect from 1.4.2000. The arrears of wages up to 31.3.2004
amount to Rs. 80 lakhs. Arrears of wages for the period from 1.4.2004 to 30.6.2004 [being the date
of agreement] amount to Rs. 7 lakhs. Decide whether a separate disclosure 0f arrear is required.
Hint – same as in previous question.
18. While preparing its final accounts for the year ended 31.3.2009, Clear-sky Limited created a
provision for bad and doubtful debts at 2 % on trade debtors. A few weeks later, the company
found that the payments from some of the major debtors were not forthcoming. Consequently, the
company decided to increase the provision to 10% on the debtors as on 31.3.2009 as the accounts
were still open awaiting approval of the Board of Directors. Is this to be considered as an extra-
ordinary item or prior period item?
Hint - It is a case of change in accounting estimate. Any change in the accounting estimate which
is expected to have a material effect in the current period should be disclosed and quantified and
further if change in estimate is expected to have a material effect in the later periods should also be
disclosed and quantified.
19. The company finds that the stock sheets of 31.3.2007 did not include two pages containing details
of inventory worth Rs. 20 lakhs. State, how will you deal with this matter in the accounts of A
Ltd. for the year ended 31st March, 2008 with reference to AS 5.
Answer
As per Para 16 of AS 5 on ‘Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies’, omission of two pages containing details of inventory worth Rs.20 lakhs in
31.3.2007 is a prior period item. As per Para 19 of the standard, prior period items are normally
included in the determination of net profit or loss for the current period. Accordingly, Rs.20 lakhs
must be added to opening stock of 1.4.2007. 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.
20. A company entered into a wage in May 2015 whereby the Employees Union has accepted a
revision of wages from June 2014. The agreement provides that the hike till May 2015 will not be
paid to the employees but will be settled to them at the time of retirement. The company agrees to
deposit the arrears in Government Bonds by September 2015.
Answer:
It is a case of an event taking place after the balance sheet date but before approval of accounts.
The arrears of wages for the wage revision period should be provided for in the accounts of the
company for the Reporting Period 2014-15
1.4.14 June 14 31.3.15 May 15 30.9.15

Wage revision agreed

Wage revision made