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ccounting as a “Language of Business” communicates the financial results of an enterprise to various users. It is pertinent that in order to evaluate the financial results of the enterprise one has to compare the financial status of an entity with either its financial results of the industry or the past results of the same entity. To ensure that the users of the general purpose financial statements understand and evaluate the same, a need is felt for some uniform accounting policies to be followed by the entities in the same industry. In furtherance to this an entity also has to follow the accounting policies consistently in every accounting period. The ICAI has made sure that the transparency, consistency, comparability, adequacy and reliability in the preparation of financial statements is guaranteed by taking initiatives in formulating various Accounting Standards.
The Growth of the Company, performance at the Stock market, Individual and the Corporate Wealth all depend on one line “The Net Profit And Loss of the Company”. The Income Statement or Statement of Profit or Loss showing the end result of operations during an accounting period consists of income/gains and expenses/losses that have financial implications. To enhance the comparability of such statements the ICAI has introduced Accounting Standard - 5, which lays down the guidelines pertaining to the classification and disclosure of such items of income/gains and expenses/losses recognized in Income Statement. Accounting Standard - 5 was first issued in November 1982 and was titled ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’. Later the standard was revised which came into effect in respect of accounting periods commencing on or after April 1996.
An Income statement of an entity should invariably include the expenses and incomes that are incurred or accrued during the financial year. The net result is in what the user is interested in. The statement should clearly disclose the extra – ordinary items, the expenditures charged to the profit or loss account which pertains to the previous financial year. Further the user should also be made aware of accounting policies adopted for the preparation of the financial statements which are a deviation from the policies adopted in the previous years. All such things govern the decision making of the user. This is what is covered in the accounting standard 5. So, let’s go for it now!!!!!!
SCOPE
AS-5 is mandatory and should be applied by all enterprises in presenting income or expense from ordinary activities, extraordinary items and prior period items in the statement of profit or loss, in accounting for changes in accounting estimates, and in disclosure of changes in accounting policies. But it does not cover the tax implications of the aforesaid items for which appropriate adjustments have to be made depending on the circumstances.
OBJECTIVE
Profit and Loss account being a period statement covers the Items of Income and Expenditure of a particular period. In order to identify the trends in the financial position, its performance and cash flows, the users will have to compare the financial statements of an enterprise over a period of time.
The objective of this standard is to prescribe the classification, disclosure and presentation of certain items in the statement of profit and loss so that all enterprises prepare and present such a statement on a uniform basis.
AS-5 classifies the items recognized in Profit & Loss Statement into five broad groups:
· Ordinary Items.
· Extraordinary Items.
· Prior Period Items.
· Changes in Accounting Estimates.
· Changes in Accounting Policies.
The importance of AS-5 in making the financial statements speak about the company is discussed below.
Let us now take you through each item
All items of income/expense recognized in the statement of profit/loss are made up of two components:
ü Ordinary Activities.
ü Extraordinary Activities.
§ Ordinary Activities: Ordinary activities are any activities that are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages in furtherance or incidental to, or arising from these activities.
Examples: a)
b)
Disclosure:
The items of income/expense falling under ordinary activity should be disclosed considering the materiality concept i.e. if they arise out of ordinary activities but are of exceptional size, nature or incidence, separate disclosure is required.
§ Extraordinary Activities: Extraordinary activities are income or expense arising from events or transactions that are clearly distinct from ordinary activities of the enterprise and are infrequent and irregular in nature. It may be noted that the same event/transaction can be an ordinary activity for one entity and extraordinary for another.
Example: Losses due to natural disaster like flood or earthquake will be an extraordinary item for many enterprises whereas an insurance company will treat claims from policyholders arising from such natural disasters as an ordinary item.
Disclosure:
The nature and amount of each extraordinary item should be separately disclosed in the statement of profit or loss in a manner that its impact on the current profit or loss can be perceived.
Example: Due to unusual heavy rains and floods in Mumbai city in the FY 2005-06 a textile company’s fixed assets got seriously damaged. Therefore the company can write off the loss and disclose it as an extraordinary item in the debit side of P & L A/c, since the event was clearly distinct from the ordinary activities of the company and cannot be expected to recur frequently/regularly. Now, if in the FY 2006-07 the company receives insurance claim against the aforesaid damaged fixed assets, the amount received should be disclosed as extraordinary item in the credit side of P & L A/c.
Ø PRIOR PERIOD ITEMS:
Prior period items are income or expense, which arise, in the current period as a result of errors or omission in the preparation of the financial statements of the previous years. They are infrequent in nature and do not include normal or recurring adjustments and also does not include corrections of accounting estimates made in prior years.
Disclosure:
There are two ways of disclosing prior period items:
ü It can be included in the determination of current year’s net profit or loss.
ü It can be added or deducted as the case may be to the current profit as a separate independent item.
Examples: a) Omission to account for income or expenditure
b) Non provision for expenses already due in earlier years.
Ø ACCOUNTING ESTIMATES:
As a result of uncertainties inherent in business activities the preparation of financial statements requires the management to make estimates & assumptions that affect the reported balances of Assets & Liabilities on the date of financial statements and reported amounts of revenue and expenses during the period reported. The estimation process involves judgement based on latest information available.
Disclosure:
Any revision to Accounting Estimates must be recognized prospectively in the current and future periods. In other words, change in Accounting Estimates should be included in the determination of Net Profit or Loss in :
ü The period of change, if the change affects the current period only.
ü The period of change and future periods, if the change affects both the periods.
Examples: a) Estimation of provision of doubtful debts.
b) Estimation of provision of income tax.
Ø CHANGES IN ACCOUNTING POLICIES:
As per AS-1 Accounting Policies refer to:
§ Specific accounting principles &
§ Methods adopted by enterprises in applying these principles in the preparation and presentation of financial statements.
As a general rule, enterprises are not required to alter the Accounting Policies normally adopted by them for similar events or transactions from period to period. But AS-5 deals with the exception to this rule and permits changes in accounting policy in the following cases:
ü For compliance of AS.
ü For compliance of statute or law.
ü For better presentation of financial statements.
Disclosure:
· The impact of and the adjustments due to such change if it has any material implications should be shown in the Financial Statements of the period in which such a change is made.
· If such change is reasonably expected to have a material effect in future periods, the fact must be disclosed in the period of change.
· If for any reasons it is impracticable to quantify the amount of change the fact must be clearly disclosed in the notes to accounts.
Examples: a) Change in method of depreciation from WDV to Straight Line
b) Change in Cost formula in measuring the cost inventories
The Disclosures made are in addition to any other disclosures made by other accounting standards.
To illustrate the above, a comprehensive example can be looked into:
In preparing the financial statements of ABC Ltd. for the year ended 31/03/07, the following were observed:
1) It was found that an item of stock costing Rs.60000 had been included twice in the stock sheet as on 31.3.07.
2) There was a sale of a sizeable part of existing machinery, which had low productive use.
3) The Income tax provision as on 31/03/06 was made for Rs.45000, however the actual tax liability was Rs.42500.
4) The method of depreciation for a machinery costing Rs.1,00,000 was changed from WDV to SLM. (@ 10%)
5) Revision in the Salary, effective from 1.4.06 would cost the Company additional liability of Rs.2,00,000/ p.a.
An analysis on the above can be drawn as follows:
1. In view of the above, the Opening Stock as on 1.4.07 includes an amount of Rs.60000/-, which is an error in the Stock valuation .As per AS-5, it is a Prior Period Item and should be disclosed separately in Profit and loss statement in a manner to show its impact on current year’s profit or loss account.
2. The sale is treated as an ordinary activity of the company. The disclosure however is made on the basis of materiality.
3. As the provision for Rs.2500 over estimated Income tax, the same must be included in the determination of Net profit or loss on prospective basis in the current & future periods.
4. This would lead to the change of accounting policy for which appropriate disclosure has to be made in the notes to accounts and a retrospective change must be stated in the P & L account.
5. As per AS-5, the additional liability of Rs.200000/- p.a is neither an extraordinary item nor a Prior period item. It is an expense arising from Ordinary activity. It does not arise from change in accounting estimates or change in accounting policy.
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