Net Profit & loss For The Prior Period Item & Changes In Accounting Policies

INTRODUCTION OF ACCOUNTING STANDARD V

This revised standard comes into effect in respect of accounting periods commencing on or after 1.4.1996 and is mandatory in nature.2 It is clarified that in respect of accounting periods commencing on a date prior to 1.4.1996, Accounting Standard 5 as originally issued in November, 1982 (and subsequently made mandatory) will apply.

In India there is no specific accounting standard dealing with the presentation of profit and loss account. Generally all the items of income and expenses are included in determination of net profit or loss. Earlier in India every item of income and expenses except those that are directly taken to equity in the balance sheet (e.g. Revaluation reserve) are routed through profit and loss account. However they are explained in following manner are as follows:-

OBJECTIVES: The objective of this Standard is to classify and disclose of certain items in the statement of profit and loss so that all enterprises prepare and present such a statement on a uniform basis. Accordingly, this Standard requires the classification and disclosure of extraordinary and prior period items 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.

Net Profit /Loss

Prior Period

comparision

Changing in Accounting Policy

Fundamental Errors

scope Conclusio n

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Meaning of accounting standards

Accounting is the art of recording transactions in the best possible manner, so as to enable to know about judgments/and also to know about conclusions, and in this regard it is utmost necessary that there are setting a guidelines. It also has a wider concept than book keeping. Accounting Standards are written statements of accounting rules and guidelines to prepare financial statements. Accounting Standards consists of detailed rules to be adopted for the treatment of various items in accounting process so as to attain uniformity and consistency in internal and external reporting process. The main role in the preparation of Accounting Standards is to achieve global uniformity and comparability and thereby bridging the gap that exists in numerous and diverse accounting practices. Whereas it also makes easy to take decision relating to business.

DEFINITION:
According to Robert Anthony accounting is being defined as every business enterprise has accounting system which means to collect, summarize, analyzed and report in monetary terms and also information about the business transaction. The institute of charted accountants of India (ICAI) has so far issued 32 accounting standards in that we are giving details about accounting standard AS-5 NET PROFIT OR LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND CHANGES IN ACCOUTING POLICY.

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NET PROFIT AND LOSS

Normally 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. It has two types of items A) Extra ordinary item B) Ordinary item

Extraordinary Item

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. Therefore, only on rare occasions does an event or transaction give rise to an extraordinary item. Therefore, an event or transaction may be extraordinary for one enterprise but not so for another enterprise because of the differences between their respective ordinary activities. For example, losses sustained as a result of an earthquake may qualify as an extraordinary item for many enterprises. However, claims from policyholders arising from an earthquake do not qualify as an extraordinary item for an insurance enterprise that insures against risk.

Definition of Extraordinary Activities:

According to FRS 3, extraordinary items are material items possessing a high degree of Abnormality which arise from events or transactions that fall outside the ordinary activities of the reporting entity and which are not expected to recur. They do not include exceptional items nor do they include prior period items merely because they relate to a prior period.

DISCLOSURE OF EXTAORDINARY ITEM

An enterprise has to disclose such extraordinary items in the notes to the financial statements together with its total amount .Occasionally an enterprise sells a major line of business which is distinguishable from other business activities, for example, a segment as reported under IAS 14. The following disclosures should be made for each discontinued operation:

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Net Profit & loss For The Prior Period Item & Changes In Accounting Policies Disclosure requirements of discontinued operations: (a) The nature of the discontinued operation; (b) The industry and geographical segments in which it is reported (c) The effective date of discontinuance; (d) The manner of discontinuance (sale or abandonment) (e) The gain or loss on discontinuance and the accounting policy used to measure that gain or loss

Example: Moon Food Industries Limited Profit and Loss Account For the year ended on December 31, 2007

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ORDINARY ITEM
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. Are not extraordinary 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 and in making projections about financial position and performance.

Definition of Ordinary Activities: According to FRS 3, ordinary activities are the activities which are undertaken by a reporting entity as part of its business. Ordinary activities include the effects on the reporting entity

of any event in the various environments in which it operates including the political, regulatory, economic and geographic environments, irrespective of the frequency or unusual nature of the events.

Disclosure requirements of profit or loss from ordinary activities: Circumstances which may give rise to the separate disclosure of such items of income and expense include: (a) The write-down of inventories to net realisable value or vice versa, (b) The write-down of property, plant and equipment to recoverable amount or viceversa. (c) Organisations restructuring, (d) Disposals of items of property, plant and equipment, (e) Disposals of long-term investment (f) Litigation settlements, and (g) Other reversals of provisions.

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Net Profit & loss For The Prior Period Item & Changes In Accounting Policies INFOSYSTECHNOLIGIES LTD. MAR 2011

During the year, the company of USA has transferred the product for a gross consideration of Rs 8,93,40,000 (US$ 2 Million ), received as equity preferred voting and preferred nonvoting securities on mobile system Inc. the income arising out of the transfer of Rs 5,49,44,000 ( net of tax) is disclosed has an extraordinary item.

PRIOR PERIOD The term prior period items, as defined in this Standard, refers only to 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. E.g. arrears payable to workers as a result of revision of wages with retrospective effect during the current period. These are generally infrequent in nature and can be distinguished from changes in accounting estimates. For example, income or expense recognized on the outcome of a contingency which previously could not be estimated reliably does not constitute. They 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.

Prior Period Adjustments: Prior period adjustments are material adjustments applicable to prior periods arising from changes in accounting policies or from the correction of fundamental errors. They do not include recurring adjustments or corrections of accounting estimates made in prior periods. 1) Change from FIFO to average method: XYZ company used FIFO method for valuing inventories. In the year 2004, they decide use weighted average method for the current year and for further year also. Here the change can be recognized and even AS-2 recognized both the formulas. An error is being distinguished. So error is omission or misstatement facts available at the time of preparation of financial statements.

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Net Profit & loss For The Prior Period Item & Changes In Accounting Policies SHORT SUPPLY OF COMPONENTS Sudarshan limited (SL) is engaged in manufacturing and selling electrical equipment regularly. At the end of year it estimates the short supply of components for the goods. It also receives from the customers after the goods reach them. In the year 2004, it discovers that its estimates for the year 2003 was wrong, because they had no information of various consignments due to certain special circumstances, which resulted in loss of certain items, which are usually not lost during transit. The additional liability should be accounted for as a change in estimate.

CHANGE FROM DIRECT COSTING TO ABSORPTION COSTING METHOD

ABC Company used direct costing method for their inventories. But later on they started to use absorption costing method for the current year and also for the subsequent year .however as in the case of a change in accounting policy the effect of the change can be calculated for all the past years. Therefore it is represented in the profit and loss account for the current period as a prior period item.

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FUNDAMENTAL ERRORS:
Errors in the preparation of financial statements of one or more prior periods may be discovered in the current period. Errors may be occurred as a result of Mathematical mistakes, mistakes in applying accounting policies, misinterpretation of facts, fraud or oversights. The correction of these errors is normally included in the determination of net profit or loss for the current period.

Fundamental Errors: On rare occasions, an error has such a significant effect on the financial statements of one or more prior periods that those financial statements can no longer be considered as reliable as on the date of their issuance.

Methods of Correcting Fundamental Errors: There are two suggested methods for correcting fundamental errors: 1. Benchmark treatment, 2. Allowed alternative treatment.

1. Benchmark Treatment: The amount of the correction of a fundamental error that relates to prior periods should be reported by adjusting the opening balance of retained earnings. Comparative information should be restated, unless it is impracticable to do so. However, national laws may require the amendment of such financial statements.

Disclosure requirements of correcting fundamental errors under benchmark Treatment: In this regard, an enterprise should disclose in its financial statements the following: (a) The nature of the fundamental error and the amount of the correction for the current period. (b) The amount of the correction relating to periods prior to those included in the comparative information.

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Net Profit & loss For The Prior Period Item & Changes In Accounting Policies CHANGES IN ACCCOUNTING 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.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.

What are changing in accounting estimates means? There are certain examples to know and generally a change in estimate is applied prospectively .i.e. 1) Useful life of the asset was originally estimated as ten years. In the sixth year estimate is revised to fifteen years. At the beginning of the sixth year should be allocated over the remaining useful life of ten years. Thus effect of change in accounting estimates should be include in the net profit or loss in the period of changes and future periods. 2) a change in the estimates of item previously reported under ordinary activity. Similarly a change in the in the estimate of an item previously reported under extraordinary item should be classified as extraordinary item .

AS-5 requires that the nature and the amount of a change in accounting estimate which has a material effect in the current period or which is expected to have a material effect in further periods should be disclosed

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EFFECTS
The effect of a change in accounting estimate should be included in the determination of net profit or loss in: (a) The period of the change, or (b) The period of the change and future periods.

(a) The period of change: A change in an accounting estimate may affect the current period only. No future periods are affected. For example, a change in the estimate of the amount of bad debts affects only the current period and therefore is recognised immediately.

(b) The period of the change and the future periods: A change in an accounting estimate may affect the current period and the coming future periods also. For example, a change in the estimated useful life of a depreciable fixed asset affects the depreciation expense both in the current period and in the future periods.

Disclosure requirements of changes in accounting estimates: The nature and amount of a change in an accounting estimate should be disclosed. If it is impracticable to quantify the amount, this fact should also be disclosed.

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Net Profit & loss For The Prior Period Item & Changes In Accounting Policies CHANGES IN ACCOUNTING POLICY Accounting Policies: Are specific principles, bases, conventions, rules and practices adopted by an enterprise in preparing and presenting financial statements? Users of financial statements needed the sustainability of the accounting policies in order to compare the financial statements over a period of time. Therefore, the same accounting policies are normally adopted in each period.A more appropriate presentation of events or transactions in the financial statements occurs when the new accounting policy results in more relevant or reliable information about the financial position, performance or cash flows of the enterprise A change in accounting policy is applied either: (i) Retrospectively (ii) Prospectively.

(i)

Retrospectively Application:

Retrospective application results in the new accounting policy being applied to events and transactions as if the new accounting policy had always been in use. Therefore, the accounting policy is applied to events and transactions from the date of origin of such items.

(ii)

Prospective Application:

Prospective application means that the new accounting policy is applied to the events and transactions occurring after the date of the change. No adjustments relating to prior periods are made either to the opening balance of retained earnings or in reporting the net profit or loss for the current period because existing balances are not recalculated. However, the new accounting policy is applied to existing balances as from the date of the change.

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Methods of Changing Accounting Policies

Before going into further depth, it should be understood that there are two types of changes in accounting policies: 1. Adoption of an IAS, and 2. Other changes.

1. Adoption of an International Accounting Standard: If there is a change in accounting policy by way of an adoption of an IAS, it should be treated in accordance with transitional provisions. In the absence of transitional provisions, such a change should be applied in accordance with the benchmark treatment or allowed alternative treatment.

2. Other changes: There are two methods for treating other changes in accounting policies:

(a) Benchmark treatment, and (b) Allowed alternative treatment.

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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. 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. 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 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 Standard.

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Advantage of Setting Accounting Standards:

The setting of accounting standards has following advantages.

1-Reduction in variations standards reduced to a reasonable extent or eliminate all

together confusing variation in the accounting treatment use to prepare financial statement.

2- Disclosure beyond that required by law there are certain areas where important
information is not statutorily required to be disclosed .standards may call for discloser beyond that require by law.

3- Facilitates comparison the application accounting standards would to a limited

extent facilitates comparison of financial statements of companies situated of different part of the world and also of different companies situated in same country .however, it should be noted in this respect that difference in the institution, tradition and legal system from one country to another give rise to differ3nce in accounting standards practiced in different countries.

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RATIONALE OF ACCOUNTING STANDARDS

Accounting Standards are formulated with a view to harmonies different accounting policies and practices in use in a country. The objective of Accounting Standards is, therefore, to reduce the accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises with a view to provide meaningful information to various users of financial statements to enable them to make informed economic decisions. The Companies Act, 1956, as well as many other statutes in India requires that the financial statements of an enterprise should give a true and fair view of its financial position and working results. This requirement is implicit even in the absence of a specific statutory provision to this effect. The Accounting Standards are issued with a view to describe the accounting principles and the methods of applying these principles in the preparation and presentation of financial statements so that they give a true and fair view. The Accounting Standards not only prescribe appropriate accounting treatment of complex business transactions but also

promote greater transparency and market discipline. Accounting Standards also helps the regulatory agencies in benchmarking the accounting accuracy.

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CONCLUSION:
The Indian practice of preparing and presenting profit and loss is different from the others viz US, GAAP. Earlier in India every item of income and expenses except those that are directly taken to equity in the balance sheet (e.g. Revaluation reserve) are routed through profit and loss account. However Indian enterprise are required to make adequate disclosure to enable analyses to determine the results of the business operations separately Thus the net profit is determined after taking into account all expenses and income, which might not directly relate to the operations of the entity. the Indian GAAP requires that any deficit or surplus should be adjusted against the profit or loss for the current period .IAS has withdrawn the concept of extraordinary items while the Indian GAAP and US GAAP requires separate disclosure of extraordinary item

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