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Prior Period Items (Income Tax)

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( Author )
30 December 2008

Are prior period expenses and incomes disallowed for the current year computation of income under the head PGBP (excluding the ones subjected to TDS like purchase of materials)? If yes please give the reference of the section that disallowes it?


CA RAMESH KUMAR AHUJA

( Expert )
30 December 2008

Section 145 of the Income Tax Act deals with the accounting system. Accounting Standards have also been notified for the assessees to follow them to maintain their accounts under the mercantile system of accounting. Accounting Standard on Prior Period Items has also been notified. The accounts which are not prepared on those basis may be rejected or the expenses may be disallowed. The following detailed provisions of section 145 will through a light on the issue.


Section 145

Method of accounting

Annuity received by film artistes - In case of a film artiste who follows the cash system of accounting for professional income and who is paid remuneration either wholly or partly through an annuity policy (policies) as per the agreement/contract, only the particular amount of the annuity instalment(s) as is paid in a year is to be included in the total income of the said year provided the annuity policy incorporates all the features mentioned in this instruction.—Instruction : No. 1310, dated 26-2-1980 [Source : 91st Report of PAC (1981-82) (Seventh Lok Sabha)(pp. 13-15)].

State Financial Corporations - State Financial Corporations are governed by the directives of the Reserve Bank of India and IDBI. If these authorities are satisfied that the change in the system of accounting of interest from mercantile to cash basis by the concerned State Financial Corporation is legal, valid and bona fide, the Income-tax Department may accept the cash system of accounting of interest.—Circular: No. 491 [F. No. 201/60/867-IT(A-II)], dated 30-6-1987.

Notified accounting standards - The following accounting standards are notified, to be followed by all assessees following mercantile system of accounting, namely:—

A. Accounting Standard I relating to disclosure of accounting policies :

1. All significant accounting policies adopted in the preparation and presentation of financial statements shall be disclosed.

2. The disclosure of the significant accounting policies shall form part of the financial statements and the significant accounting policies shall normally be disclosed in one place.

3. Any change in an accounting policy which has a material effect in the previous year or in the years subsequent to the previous years shall be disclosed. The impact of, and the adjustments resulting, from, such change, if material, shall be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact shall be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the previous year but which is reasonably expected to have a material effect in any year subsequent to previous year, the fact of such change shall be appropriately disclosed in the previous year in which the change is adopted.

4. Accounting policies adopted by an assessee should be such so as to represent a true and fair view of the state of affairs of the business, profession or vocation in the financial statements prepared and presented on the basis of such accounting policies. For this purpose, the major considerations governing the selection and application of accounting policies are following, namely:—

(i) Prudence : Provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information;

(ii) Substance over form : The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form;

(iii) Materiality : Financial statements should disclose all material items, the knowledge of which might influence the decisions of the user of the financial statements.

5. If the fundamental accounting assumptions relating to Going Concern, Consistency and Accrual are followed in financial statements, specific disclosure in respect of such assumptions is not required. If a fundamental accounting assumption is not followed, such fact shall be disclosed.

6. For the purposes of the paragraphs (1) to (5), the expressions,—

(a) “Accounting policies” means the specific accounting principles and the methods of applying those principles adopted by the assessee in the preparation and presentation of financial statements;

(b) “Accrual” refers to the assumption that revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate ;

(c) “Consistency” refers to the assumption that accounting policies are consistent from one period to another;

(d) “Financial Statements” means any statement to provide information about the financial position, performance and changes in the financial position of an assessee and includes balance sheet, profit and loss account and other statements and explanatory notes forming part thereof;

(e) “Going concern” refers to the assumption that the assessee has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the business, profession or vocation and intends to continue his business, profession or vocation for the foreseeable future.

B. Accounting Standard II relating to disclosure of prior period and Extraordinary items and changes in accounting policies :

7. Prior period items shall be separately disclosed in the profit and loss account in the previous year together with their nature and amount in a manner so that their impact on profit or loss in the previous year can be perceived.

8. Extraordinary items of the enterprise during the previous year shall be disclosed in the profit and loss account as part of taxable income. The nature and amount of each such item shall be separately disclosed in a manner so that their relative significance and effect on the operating results of the previous year can be perceived.

9. A change in an accounting policy shall be made only if the adoption of a different accounting policy is required by statute or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements by an assessee.

10. Any change in an accounting policy which has a material effect shall be disclosed. The impact of, and the adjustments resulting from such change, if material, shall be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact shall be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the previous year but which is reasonably expected to have a material effect in years subsequent to the previous years, the fact of such change shall be appropriately disclosed in the previous year in which the change is adopted.

11. A change in an accounting estimate that has a material effect in previous year shall be disclosed and quantified. Any change in an accounting estimate which is reasonably expected to have a material effect in years subsequent to previous year shall also be disclosed.

12. If a question arises as to whether a change is a change in accounting policy or a change in an accounting estimate, such a question shall be referred to the Board for decision.

13. For the purposes of paragraphs (7) to (12), the expressions,—

(a) “Accounting estimate” means an estimate made for the purpose of preparation of financial statements which is based on the circumstances existing at the time when the financial statements are prepared;

(b) “Accounting policies” means the specific accounting principles and the method of applying those principles adopted by the assessee in the preparation and presentation of financial statements;

(c) “Extraordinary items” means gains or losses which arise from events or transactions which are distinct from the ordinary activities of the business and which are both material and expected not to recur frequently or regularly. Extraordinary items includes material adjustments necessitated by circumstances which though related to years preceding to the previous years are determined in the previous year:

Provided that income or expenses arising from the ordinary activities of the business or profession or vocation of an assessee, though abnormal in amount or infrequent in occurrence, shall not qualify as extraordinary item;

(d) “Financial Statements” means any statement to provide information about the financial position, performance and changes in the financial position of an assessee and includes balance sheet, profit and loss account and other statements and explanatory notes forming part thereof;

(e) “Prior period items” means material charges or credits which arise in the previous year as a result of errors or omissions in the preparation of the financial statements of one or more previous years:

Provided that the charge or credit arising on the outcome of a contingency, which at the time of occurrence could not be estimated accurately shall not constitute the correction of an error but a change in estimate and such an item shall not be treated as a prior period item.

This notification shall come into force with effect from 1st day of April, 1996 and shall, accordingly, apply to the assessment year 1997-98 and subsequent assessment years.

Notification : No. SO 69(E), dated 25-1-1996.


CA. Dashrath Maheshwari

( Expert )
30 December 2008

1. Prior period expenses are not allowable deductions for Income tax computation.

2. TDS is not applicable on purchase of materials.

3. reference: http://www.taxindiaonline.com/RC2/dailymailer/dm2008/2008-TIOL-NEWS-273-11-19.htm

4. Accounting standard


Aakhri Pasta

( Author )
03 January 2009

Section 145 of the Income Tax Act clarifies on the seperate disclosure of prior period items but doesnot specifically disallow it. Is there no section that specially disallow prior period item? Please clarify on this matter!!


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