CHAPTER AS-5 (Revised): Net Profit or

3
Loss for the Period, Prior
Period Items & Changes in
Accounting Policies
1 Requirements of AS-5
 Profit or loss for the period should comprise profit or loss from ordinary activities, extraordinary
items and changes in accounting estimates.
 Extraordinary items to be disclosed distinctly.
 Exceptional items of profit or loss from ordinary activities to be disclosed distinctly
 Prior period items to be distinctly disclosed in financial statements.
 Accounting policy is permitted to be changed only if any of the following three conditions are
satisfied.
- Required by law
- Required by Accounting Standards
- More appropriate presentation
 Change in Accounting policies to be disclosed alongwith financial impact

2 Net Profit or Loss for the Period

 All items of income and expense (including extraordinary items and the effects of changes in
accounting estimates) which are recognised 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.
 The net profit or loss for the period comprises the following components, each of which should be
disclosed on the face of the statement of profit and loss:
 profit or loss from ordinary activities; and
 extraordinary items.

2.1 Profit or loss from ordinary activities

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, incidental to, or arising
from, these activities.
When items of income and expense 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.
Following are items of income/expense which require separate disclosure:
 the write-down of inventories to net realisable value as well as the reversal of such write-downs;
 a restructuring of the activities of an enterprise and the reversal of any provisions for the costs of
restructuring;
 profit/loss on disposals of items of fixed assets;
 profit/loss on disposals of long-term investments;
 legislative changes having retrospective application;
 litigation settlements; and
 other reversals of provisions.
The above items are not extraordinary items. They are part of profit/ loss from ordinary activities,
which require separate disclosure.

Illustration 1 (May 2001): State briefly the duty of an auditor with regard to each of the following:
(i) A sum of Rs. 10,00,000 is received from an insurance company in respect of a claim for loss of
goods in transit costing Rs. 8,00,000. The amount is credited to the Purchases Account.
Solution: The claim for loss of goods in transit is arising out of ordinary activities of the enterprise.
However, the cost of goods lost in transit is only Rs. 8,00,000 while the insurance money received is
Rs. 10,00,000. Purchase Account need not be credited since it would distort the purchases during the
year and the gross profit. Therefore, entire amount of Rs. 10 lacs needs to be taken to profit and loss
account under an appropriate head. This is an income arising from an ordinary activities of the
enterprise. But in view of the amount involved and exceptional nature, a separate disclosure be made
in the profit and account to enable the users to understand the performance of enterprise for the
period.
(ii) A loss of Rs. 2,00,000 on account of embezzlement of cash was suffered by the company and it
was debited to Salary Account.
Solution: According to AS-5 (Revised) if “when items of income and expense within profit or loss
from ordinary activities are of such size, nature of 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. In view of the above requirement. It cannot be merged with salary or any other
head. Being material item, it should be disclosed under a distinct head in the profit and loss account.

Illustration 2(Nov. 2002): As a Company Auditor how would you react to the following situations?
(i) Sale value of scrap items adjusted against miscellaneous expenditure.
Solution: Sale value of scrap is an item of miscellaneous income and adjusting such income against
miscellaneous expenditure is not proper. AS-5 and also, Part II of Schedule III to the Companies Act,
2013 requires that in the profit and loss account of a company, it should disclose clearly credits or
receipts and debits or expenses in respect of non-recurring transactions or transactions of an
exceptional nature. The auditor should see that the revenue has been disclosed properly in the
financial statement since such an adjustment would fail to explain the performance of the company.
(ii) Insurance claim of Rs. 2 lakhs received stands included under miscellaneous income.
Solution: Money received from the insurance company is against a specific loss. It has to be
adjusted against that loss. The auditor should check the adjustment of the amount received if short
of the value of actual loss as per the insurance policy. In respect of claim against an asset, the profit
and loss account should be debited with the shortfall of the claim against the book value. If the claim
was lodged in the previous year but no entries were passed, entries in the profit and loss account
should be appropriately described.

2.2 Extraordinary Activities (Extraordinary Items)

 Extraordinary items are income or expenses that arise from events or transactions that are clearly
distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur
frequently or regularly.
 The nature and 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.
 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 such risks.
However, if the insurance companies uninsured building is destroyed in earthquake, the loss
would be from extraordinary activities and not ordinary.
 Examples of events or transactions that generally give rise to extraordinary items for most
enterprises are:
o attachment of property of the enterprise; or
o an earthquake.

2.2.1 Examples of extraordinary items

1. Loss due to earthquake
2. Attachment of property
3. Government grant becoming refundable
4. Government grant for giving immediate financial support with no further related
costs.
 5. Government grant receivable as compensation for expenses or losses incurred in
previous accounting period.
2.3 Prior period items
When can an item qualify to be a prior period item? [May 1998] [May 2008]
Explain the provisions of AS-5 regarding accounting treatment of prior period items. [May 2009]
 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.
 Errors in the preparation of the financial statements of one or more prior periods may be
discovered in the current period. Errors may occur as a result of
 mathematical mistakes,
 mistakes in applying accounting policies,
 misinterpretation of facts, or
 oversight.
The nature and amount of prior period items should be separately disclosed in the
statement of profit and loss in a manner that their impact on the current profit or loss
can be perceived.

The term ‘prior period items’, does not include

 other adjustments necessitated by circumstances, which though related to prior periods, are
determined in the current period, e.g., arrears payable to workers as a result of revision of wages
with retrospective effect during the current period.
 changes in accounting estimates. Accounting estimates are approximations that may need
revision as additional information becomes known.

2.3.1 Examples of prior period items

1. Error in calculation of depreciation
2. Use of incorrect rates of depreciation
3. Omission to provide for depreciation
4. Non-provision of gratuity payable under law or retirement benefit scheme.
5. Non-provision of a bad/ doubtful debt.
6. Accounting for a finance lease as an operating lease.
7. Capital expenditure treated as revenue expenditure
8. Non-provision for taxation

Illustration 3 (CA Final Nov. 1996): Sagar Limited belongs to the engineering industry. The Chief
Accountant has prepared the draft accounts for the year ended 31.03.96. You are required to advise
the company on the following items from the viewpoint of finalisation of accounts, taking note of the
mandatory accounting standards.
An audit stock verification during the year revealed that the opening stock of the year was
understated by Rs. 3 lakhs due to wrong counting.
Solution. This is an error, which has occurred in prior period and now rectified. Hence, this should
be treated as a prior period item.

Illustration 4 (CA Final May 1998) In preparing the financial statements of R Ltd. for the year
ended 31st March, 1998 you come across the following information. State with reasons, how you
would deal with them in the financial statements –
There was a major theft of stores valued at Rs. 10 lakhs in the preceding year, which was detected
only during the current financial year (1997-98).
Solution. Adjustment should be made for this in accounts of 97-98 if the theft was detected before
Board of Directors approved accounts. If deducted after Board of Directors approved accounts then it
should be treated as prior period items in accounts of 1998-99.

2.4 Change in Accounting Estimate

What is meant by Accounting estimate? Give two examples for accounting estimate. [Nov. 2007]
 As a result of the uncertainties inherent in business activities, many financial statement items
cannot be measured with precision but can only be estimated based on the latest information
available.
 Estimates may be required, for example, of bad debts, inventory obsolescence or the useful lives
of depreciable assets.
 The use of reasonable estimates does not make the financial statements unreliable.
 An estimate may have to be revised if –
o changes occur regarding the circumstances on which the estimate was based, or
o as a result of new information, more experience or subsequent developments.
 The revision of the estimate is not an extraordinary item or a prior period item.
 If sometimes, it is difficult to distinguish between a change in an accounting policy and a change
in an accounting estimate. The change should be treated as a change in an accounting estimate,
with appropriate disclosures.
 Effect of a change in an accounting estimate should be included in the determination of net profit
or loss in:
o the period of the change, if the change affects the period only; or
o the period of the change and future periods, if the change affects both.
 A change in an accounting estimate may affect the current period only or both the current period
and future periods.
o For example, a change in the estimate of the amount of bad debts is recognised
immediately and therefore affects only the current period.
o 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.

2.4.1 Examples of changes in accounting estimates

1. Change in useful life of fixed assets
2. Actual bad debts turning out to be more or less than the provision
3. Actual liability turning out to be more than or less than the provision.
4. Actual gratuity liability/ retirement benefits turns out to be more than the provision.

Illustration 5.5 (CA Final May 2000) As an auditor state your views on the following situations:
Y Ltd. provided Rs. 25 lakhs for inventory obsolescence in 1998-1999. In the subsequent year, it was
determined that 50% of such stock was usable. The company wants to adjust the same through prior
period adjustment account as the provision was made in the earlier year.
Solution. The write-back of provision made in respect of inventories in the earlier year does not
constitute prior period adjustment since it neither constitutes error nor omission. It merely involves
making estimates based on prevailing circumstances when financial statements were being prepared.
T Ltd. provided Rs. 25 lakhs for inventory obsolescence in 1998-99. In the subsequent year due to
changes circumstances, it was determined that 50% of such stock was usable. Revision of such an
estimate does make the resulting amount of Rs. 12.5 lakhs either a prior period item or an extra-
ordinary item. The amount, however, involved is material and requires separate disclosure to
understand the financial position and performance of an enterprise. Accordingly, the accounting
treatment followed by the company is not proper.

Illustration 6 (CA Final Nov 2002) In the context of relevant Accounting Standards, give your
comments on the following matters for the financial year ending on 31.3.2002.
While preparing its final accounts for the year ended 31 st March, 2002 Rainbow Limited created a
provision for Bad and Doubtful debts at 2% on trade debtors. A few weeks later the company found
that payments from some of the major debtors were not forthcoming. Consequently the company
decided to increase the provision by 10% on the debtors as on 31 st March, 2002 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?
Solution. In the given case, Rainbow Limited created a provision for bad and doubtful debts at 2%
on trade debtors while preparing its final accounts for the year ended 31 st March, 2002. Subsequently,
the company decided to increase the provision by 10%. As per AS 5 (Revised), this is a change in
estimate and is not a prior period item or an extraordinary item.
However, the change is being made in the same year as the accounts are not yet approved, thus it is
an event occurring after the balancesheet date requiring adjustments.
2.5 Changes in Accounting Policies
Under what circumstances can an enterprise change its accounting policy? [Nov. 2005] [May 2007]
When can a company change its accounting policy? [May 2007]
A change in an accounting policy should be made only if
 the change 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. (more relevant or reliable information about the financial position,
performance or cash flows of the enterprise.)
The following are not changes in accounting policies :
 the adoption of an accounting policy for events or transactions that differ in substance from
previously occurring events or transactions,
 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 effect of such change (i.e. 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.
 If the effect of such change is not ascertainable, wholly or in part, the fact should be indicated.
 If a change in the accounting policies 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 be appropriately disclosed in the period in which the change is adopted.

2.5.1 Examples of change in accounting policy

1. Change in actuarial assumptions for calculation of provision for retirement benefits.
2. Making provision for doubtful debts on the basis of age analysis rather than adhoc
provision.
3. Change from LIFO method to FIFO method to value inventory to comply with AS-2
(Revised)
4. Change from completed of contract method to percentage of completed method to
account for construction to comply with AS-7 (Revised)
5. Changes in the method of measurement of percentage of completion as at balance
sheet date.
 NET PROFIT OR LOSS
will comprise of

Net profit or loss for the current Prior period items, there are the
period which includes all items of results of errors or omission
income and expenses committed in any earlier periods
recognised in a period accounts

From Ordinary Activity From Extraordinary Activity It should be shown after

Including effect of change in
- Accounting estimate
- Accounting policy
If significant, effect & nature
of change should be
disclosed
the current period profit
It should be separately
shown in the P&L, each
significant item be shown
separately
 EXAM QUESTIONS

Problem No. 1: (Nov. 2012, Nov. 2014) Give two examples on each of the following items:
(i) Change in Accounting Policy
(ii) Change in Accounting Estimate
(iii) Extra Ordinary Items
(iv) Prior Period Items.
Solution:
(i) Examples of Changes in Accounting Policy:
a. Change from completed of contract method to percentage of completed method to
account for construction to comply with AS-7 (Revised)
b. Change in cost formula in measuring the cost of inventories.
(ii) 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.
(iii) Examples of Extraordinary items:
a. Loss due to earthquakes
b. Attachment of property of the enterprise by government
(iv) 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.

Problem No. 2: (Nov. 2009) Goods worth Rs. 5,00,000 were destroyed due to flood in September,
2006. A claim was lodged with insurance company. But no entry was passed in the books for
insurance claim in the financial year 2006-07.
In March, 2008, the claim was passed and the company received a payment of Rs. 3,50,000 against
the claim. Explain the treatment of such receipt in final accounts for the year ended 31 st March, 2008.
Solution: Not a prior period item, since company was right in not recognising the amount in the
previous years, because against the claim of 5,00,000 made in Sept 2006 actual received is only
3,50,000 that too in March 2008. However, it should be recognized the current year and disclosed
distinctly as part of profit or loss from ordinary activities.

Problem No. 3: [May 1998] The difference between actual expense or income and the estimated
expense or income as accounted for in earlier year’s accounts, does not necessarily constitute the
item to be a “prior period” item. – Comment.
Solution: The statement given in the question is correct and is in reference with the
Accounting Standard AS-5 (Revised):
The use of estimates is an important part of the preparation of financial statement and does not
undermine their reliability. 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 or subsequent
developments. The revision, of the estimate, by its nature, does not bring the adjustment within the
definition of an extraordinary item or prior period item.

Problem No. 4: (May 2012) Tiger Motor Car Limited signed an agreement with its employees
union for revision of wages on 01.07.2011. The revision of wages is with retrospective effect from
01.04.2008. The arrear wages up to 31.03.2011 amounts to Rs. 40,00,000 and that for the period
from 01.04.2011 to 01.07.2011 amount to Rs. 3,50,000. In view of the provisions of AS 5 “Net Profit
or Loss for the period, Prior Period Items and Changes in Accounting Policies”, decide whether a
separate disclosure of arrear wages is required while preparing financial statements for the year
ending 31.03.2012.
Solution: As per AS-5, “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.”
Thus, as Per AS-5, a separate disclosure of the amount of revision in wages is required such that its
impact on the current year profits can be perceived. It is neither a Prior period item nor an Extra-
ordinary item.
Problem No. 5: [Nov. 2005] X Co. Ltd. signed an agreement with its employees union for revision
of wages in June, 2004. The wage revision is with retrospective effect from 1.4.2000. The arrear
wages upto 31.3.2004 amounts to Rs. 80 lakhs. Arrear wages for the period from 1.4.2004 to
30.6.2004 (being the date of agreement) amounts to Rs. 7 lakhs.
Decide whether a separate disclosure of arrear wages is required.
Solution: As per the said problem, revision of wages took place in June 2004 with retrospective
effect from 1.4.2000. Therefore, wage payable for from 1.4.2000. to 30.6.2004 cannot be taken as an
error or omission in the preparation of financial statement and hence this expenditure cannot be
taken as a prior period item
An enhanced wage liability of Rs. 87 Lakhs (80 lakhs + 7 lakhs) should be included in the wages of
the current year, because this enhanced wage is an expense arising from the ordinary activities of the
company.
The amount and nature of such items should be disclosed separately.

Problem No. 6: (May 2011) A company signed an agreement with the employee’s union on 01-09-
2010 for revision of wages with retrospective effect from 01-04-2009. This would cost the company
an additional liability of Rs.10 lakhs per annum. Is a disclosure necessary for the amount paid in
2010-11.
Solution: Payment for wages revision Rs.10lakh related to year 2009-10, paid in the year 2010-11
because these liability has arisen in the current year, hence it is neither a prior period item nor an
extra-ordinary item. But being of a significant amount and a special nature, disclosure should be
made.

Problem No. 7: [Nov. 2008] 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 31 st March, 2008 with reference to AS 5.
Solution: As per AS-5, this is a Prior Period Item. In the above case, 2 pages of stock sheet were
missing in financial statements of 2007. Due to this the closing stock of 2007 was shown short by Rs.
20 lakhs as a result of which the opening stock of 2008 was understated resulting into an
overvaluation of profit in 2008.
In the current year 2008, the prior period item will be adjusted as follows:
Opening stock account Dr.
To, Prior period adjustment.
As per AS-5 a separate disclosure of prior period items should be shown separately in the statement
of trading and Profit & Loss A/c in a manner that the impact on the current profit or loss can be
perceived.

Problem No. 8: (May 2013) Closing Stock for the year ending on 31 st March, 2013 is Rs. 1,50,000
which includes stock damaged in a fire in 2011-12. On 31 st March, 2012, the estimated net realizable
value of the damaged stock was Rs. 12,000. The revised estimate of net realizable value of damaged
stock included in closing stock at 2012-13 is Rs. 4,000. Find the value of closing stock to be shown in
Profit and Loss Account for the year 2012-13, using provisions of Accounting Standard 5.
Solution: The fall in estimated net realisable value of damaged stock Rs.8,000 is the effect of
change in accounting estimate. As per AS-5, the effect of a change in accounting estimate should be
classified using the same classification in the statement of profit and loss as was used previously for
the estimate. It is presumed that the loss by fire in the year ended 31.3.2012, i.e. difference of cost
and NRV was shown in the profit and loss account as an extra-ordinary item. Therefore, in the year
2012-13, revision in accounting estimate should also be classified as extra-ordinary item in the profit
and loss account and closing stock should be shown excluding the value of damaged stock.

Value of closing stock for the year 2012-13 will be as follows:

Rs.
Closing Stock (including damaged goods) 1,50,000
Less: Revised value of damaged goods (4,000)
Closing stock (excluding damaged goods) 1,46,000
Problem No. 9: [May 2010] Closing stock for the year ending on 31.3.2010 is Rs. 50,000 which
includes stock damaged in a fire in 2008-09. On 31.3.2009 the estimated net realizable value of the
damaged stock was Rs. 12,000. The revised estimated net realizable value of the damaged stock is
Rs. 4,000 at which it is included in the stock on 31.03.2010.
Find the value of Closing stock to be shown in Profit and Loss account for the year 2009-10.
Solution: Closing stock to be shown is Rs.50,000 which includes damaged material included at
revised value of Rs.4,000. It is a change in accounting estimate.

Problem No. 10: (Nov 2004) A Limited company created a provision for bad and doubtful debts at
2.5% on debtors in preparing the financial statements for the year 2003-2004.
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 31.3.2004. 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?
Solution: In the given case, a limited company created 2.5% provision for doubtful debts for the
year 2003-2004. Subsequently in 2004 they revised the estimates based on the changed
circumstances and wants to create 8% provision. As per AS-5 (Revised), this change in estimate is
neither a prior period item nor an extraordinary item.
However, 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.

Problem No. 11: (May 2011) A Limited company created a provision for bad and doubtful debts at
5% on debtors in preparing the financial statements for the year 2009-10. Subsequently on a review
of the credit period allowed and financial capacity of the customers, the company decided to increase
the provision to 10% on debtors as on 31-03-2010. The accounts are 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?
Solution: It is neither an Extra-ordinary item nor a prior period item, it is only change in estimate
and as the accounts are not yet approved, the change should be recognized in that year itself.
(Note: Had the account been approved, this would have been recognized in the next year as a
change in estimate.)

Problem No. 12: (May 2013) Cost of a machine acquired on 01.04.2009 was Rs. 5,00.000. The
machine is expected to realize Rs.50,000 at the end of its working life of 10 years. Straight-line
depreciation of Rs. 45,000 for the year has been charged upto 2011-12. For and from 2012-13, the
company switched over to 15% p.a. reducing balance method of depreciation in respect of the
machine. The new rate of depreciation is based on revised useful life of 15 years. The new rate shall
apply with retrospective effect from 01.04.2009. State how would you deal with the above in the
annual accounts of the Company for the year ended 31stMarch. 2013 in the light of AS-5.
Solution: Company is changing method of Depreciation from Straight Line Method (SLM) to Written
Down Value Method (WDV) which amounts to change in accounting estimate as per AS-10 PPE &
should be given prospective effect. Company has also re-estimated the useful life from 10 year to 15
years which is a change in estimate & should be given prospective effect.
Both together is being given prospective effect as per AS-10 PPE (although question has
asked to give retrospective effect as per old provisions of that time as per AS-6):
Depreciation already Charged by Straight Line Method (SLM)
For the 3 year 2009-10 to 2011-12 = 45,000 × 3 = 1,35,000

Depreciation for the year 2012-13 by WDV

3,65,000 × 15% = 54,750

Depreciation A/c Dr. 54,750

To Machine A/c 54,750
Problem No. 13: (May 2016) The company has entered into a wage agreement in May 2015
whereby the labour union has accepted a revision in wage 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.
Solution: The amount of wage revision related to period upto March 2015 be provided for in the
year ended on 31.3.2015 and be treated as non-current liability.