ICAI Notes- Unit 2: Accounting Standards Based on Items Impacting Financial Statements | Advanced Accounting for CA Intermediate PDF Download

 Page 1


a
 
ADVANCED ACCOUNTING 
7.14 
 
LEARNING OUTCOMES 
UNIT 2: ACCOUNTING STANDARD 5 NET PROFIT OR 
LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND 
CHANGES IN ACCOUNTING POLICIES
 
 
After studying this unit, you will be able to comprehend the meaning 
and accounting treatment for 
? Net Profit or Loss for the Period  
? Extraordinary Items  
? Profit or Loss from Ordinary Activities  
? Prior Period Items  
? Changes in Accounting Estimates  
? Changes in Accounting Policies. 
2.1 INTRODUCTION 
The objective of AS 5 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, AS 5 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.  
This Statement 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. 
© The Institute of Chartered Accountants of India
Page 2


a
 
ADVANCED ACCOUNTING 
7.14 
 
LEARNING OUTCOMES 
UNIT 2: ACCOUNTING STANDARD 5 NET PROFIT OR 
LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND 
CHANGES IN ACCOUNTING POLICIES
 
 
After studying this unit, you will be able to comprehend the meaning 
and accounting treatment for 
? Net Profit or Loss for the Period  
? Extraordinary Items  
? Profit or Loss from Ordinary Activities  
? Prior Period Items  
? Changes in Accounting Estimates  
? Changes in Accounting Policies. 
2.1 INTRODUCTION 
The objective of AS 5 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, AS 5 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.  
This Statement 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. 
© The Institute of Chartered Accountants of India
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
a
7.15 
 
 
 2.2 NET PROFIT OR LOSS FOR THE PERIOD 
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. 
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:  
(a) Profit or loss from ordinary activities  
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. For example, profit on sale of 
merchandise, loss on sale of unsold inventory at the end of the season. 
(b) Extraordinary items  
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.  
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 or in notes to accounts in a manner 
that its impact on current profit or loss can be perceived. Whether an event or 
transaction is clearly distinct from the ordinary activities of the enterprise is 
determined by the nature of the event or transaction in relation to the business 
ordinarily carried on by the enterprise rather than by the frequency with which 
such events are expected to occur. 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 such risks.
© The Institute of Chartered Accountants of India
Page 3


a
 
ADVANCED ACCOUNTING 
7.14 
 
LEARNING OUTCOMES 
UNIT 2: ACCOUNTING STANDARD 5 NET PROFIT OR 
LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND 
CHANGES IN ACCOUNTING POLICIES
 
 
After studying this unit, you will be able to comprehend the meaning 
and accounting treatment for 
? Net Profit or Loss for the Period  
? Extraordinary Items  
? Profit or Loss from Ordinary Activities  
? Prior Period Items  
? Changes in Accounting Estimates  
? Changes in Accounting Policies. 
2.1 INTRODUCTION 
The objective of AS 5 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, AS 5 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.  
This Statement 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. 
© The Institute of Chartered Accountants of India
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
a
7.15 
 
 
 2.2 NET PROFIT OR LOSS FOR THE PERIOD 
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. 
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:  
(a) Profit or loss from ordinary activities  
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. For example, profit on sale of 
merchandise, loss on sale of unsold inventory at the end of the season. 
(b) Extraordinary items  
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.  
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 or in notes to accounts in a manner 
that its impact on current profit or loss can be perceived. Whether an event or 
transaction is clearly distinct from the ordinary activities of the enterprise is 
determined by the nature of the event or transaction in relation to the business 
ordinarily carried on by the enterprise rather than by the frequency with which 
such events are expected to occur. 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 such risks.
© The Institute of Chartered Accountants of India
a
 
ADVANCED ACCOUNTING 
7.16 
 
Examples of events or transactions that generally give rise to extraordinary items 
for most enterprises are: 
–  attachment of property of the enterprise 
–  an earthquake 
(c) Exceptional items
1
  
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 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 property, plant and equipment 
(d) Disposals of long-term investments 
(e) Legislative changes having retrospective application 
(f) Litigation settlements 
(g) Other reversals of provisions 
1
 There is no such term as ‘exceptional item’ under AS 5 and Schedule III to the Companies Act, 
2013, however, the same has been used for better understanding of the requirement. Students 
may provide a suitable note in this regard in the examination. 
© The Institute of Chartered Accountants of India
Page 4


a
 
ADVANCED ACCOUNTING 
7.14 
 
LEARNING OUTCOMES 
UNIT 2: ACCOUNTING STANDARD 5 NET PROFIT OR 
LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND 
CHANGES IN ACCOUNTING POLICIES
 
 
After studying this unit, you will be able to comprehend the meaning 
and accounting treatment for 
? Net Profit or Loss for the Period  
? Extraordinary Items  
? Profit or Loss from Ordinary Activities  
? Prior Period Items  
? Changes in Accounting Estimates  
? Changes in Accounting Policies. 
2.1 INTRODUCTION 
The objective of AS 5 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, AS 5 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.  
This Statement 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. 
© The Institute of Chartered Accountants of India
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
a
7.15 
 
 
 2.2 NET PROFIT OR LOSS FOR THE PERIOD 
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. 
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:  
(a) Profit or loss from ordinary activities  
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. For example, profit on sale of 
merchandise, loss on sale of unsold inventory at the end of the season. 
(b) Extraordinary items  
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.  
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 or in notes to accounts in a manner 
that its impact on current profit or loss can be perceived. Whether an event or 
transaction is clearly distinct from the ordinary activities of the enterprise is 
determined by the nature of the event or transaction in relation to the business 
ordinarily carried on by the enterprise rather than by the frequency with which 
such events are expected to occur. 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 such risks.
© The Institute of Chartered Accountants of India
a
 
ADVANCED ACCOUNTING 
7.16 
 
Examples of events or transactions that generally give rise to extraordinary items 
for most enterprises are: 
–  attachment of property of the enterprise 
–  an earthquake 
(c) Exceptional items
1
  
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 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 property, plant and equipment 
(d) Disposals of long-term investments 
(e) Legislative changes having retrospective application 
(f) Litigation settlements 
(g) Other reversals of provisions 
1
 There is no such term as ‘exceptional item’ under AS 5 and Schedule III to the Companies Act, 
2013, however, the same has been used for better understanding of the requirement. Students 
may provide a suitable note in this regard in the examination. 
© The Institute of Chartered Accountants of India
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
a
7.17 
 
 
  2.3 PRIOR PERIOD ITEMS 
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 may occur as a result of mathematical mistakes, mistakes in applying 
accounting policies, mis-interpretation 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. 
Prior period items are generally infrequent in nature and can be distinguished 
from changes in accounting estimates. Accounting estimates by their nature are 
approximations that may need revision as additional information becomes known. 
For example, income or expense recognised on the outcome of a contingency 
which previously could not be estimated reliably does not constitute a prior 
period item. 
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. 
Net Profit or Loss for the Period
Ordinary Items
Extra Ordinary Items
Prior Period Items
Changes in Accounting 
Estimates
Changes in Accounting 
Polices
© The Institute of Chartered Accountants of India
Page 5


a
 
ADVANCED ACCOUNTING 
7.14 
 
LEARNING OUTCOMES 
UNIT 2: ACCOUNTING STANDARD 5 NET PROFIT OR 
LOSS FOR THE PERIOD, PRIOR PERIOD ITEMS AND 
CHANGES IN ACCOUNTING POLICIES
 
 
After studying this unit, you will be able to comprehend the meaning 
and accounting treatment for 
? Net Profit or Loss for the Period  
? Extraordinary Items  
? Profit or Loss from Ordinary Activities  
? Prior Period Items  
? Changes in Accounting Estimates  
? Changes in Accounting Policies. 
2.1 INTRODUCTION 
The objective of AS 5 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, AS 5 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.  
This Statement 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. 
© The Institute of Chartered Accountants of India
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
a
7.15 
 
 
 2.2 NET PROFIT OR LOSS FOR THE PERIOD 
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. 
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:  
(a) Profit or loss from ordinary activities  
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. For example, profit on sale of 
merchandise, loss on sale of unsold inventory at the end of the season. 
(b) Extraordinary items  
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.  
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 or in notes to accounts in a manner 
that its impact on current profit or loss can be perceived. Whether an event or 
transaction is clearly distinct from the ordinary activities of the enterprise is 
determined by the nature of the event or transaction in relation to the business 
ordinarily carried on by the enterprise rather than by the frequency with which 
such events are expected to occur. 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 such risks.
© The Institute of Chartered Accountants of India
a
 
ADVANCED ACCOUNTING 
7.16 
 
Examples of events or transactions that generally give rise to extraordinary items 
for most enterprises are: 
–  attachment of property of the enterprise 
–  an earthquake 
(c) Exceptional items
1
  
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 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 property, plant and equipment 
(d) Disposals of long-term investments 
(e) Legislative changes having retrospective application 
(f) Litigation settlements 
(g) Other reversals of provisions 
1
 There is no such term as ‘exceptional item’ under AS 5 and Schedule III to the Companies Act, 
2013, however, the same has been used for better understanding of the requirement. Students 
may provide a suitable note in this regard in the examination. 
© The Institute of Chartered Accountants of India
 
AS BASED ON ITEMS IMPACTING FINANCIAL 
STATEMENTS 
a
7.17 
 
 
  2.3 PRIOR PERIOD ITEMS 
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 may occur as a result of mathematical mistakes, mistakes in applying 
accounting policies, mis-interpretation 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. 
Prior period items are generally infrequent in nature and can be distinguished 
from changes in accounting estimates. Accounting estimates by their nature are 
approximations that may need revision as additional information becomes known. 
For example, income or expense recognised on the outcome of a contingency 
which previously could not be estimated reliably does not constitute a prior 
period item. 
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. 
Net Profit or Loss for the Period
Ordinary Items
Extra Ordinary Items
Prior Period Items
Changes in Accounting 
Estimates
Changes in Accounting 
Polices
© The Institute of Chartered Accountants of India
a
 
ADVANCED ACCOUNTING 
7.18 
 
Illustration 
From the past 5 financial years, an old outstanding balance of `50,000 was still 
appearing as sundry creditor in the current year balance sheet of People Ltd. The 
company is certain that this amount is not payable due to one or more reasons. 
Therefore, it decided to write off the said amount in its current year’s books of 
accounts and recognize it as income. The company treated the amount of ` 50,000 
written off as a prior period item and made the adjustments accordingly.  
The company is of the view that since sundry balances were recognized in the prior 
period(s), its related written-off amount should be treated as a prior period item. 
Solution 
No, the company is not correct in treating the amount written off as a prior 
period item. As per AS 5, prior period items are income or expenses which arise in 
a current year due to errors or omissions in the preparation of the financial 
statements of one or more prior period(s). 
Writing off an old outstanding balance in the current year which is appearing in 
its books of accounts from the past 5 financial years does not mean that there has 
been an error or omission in the preparation of financial statements of prior 
period(s). It is just a practice adopted by the company to write off the old 
outstanding balances of more than 5 years in its current year books of accounts. 
Therefore, the amount written off is not  treated as a prior period item. 
Hence, adjusting the amount `50,000 written off as a prior period item on the 
basis that sundry balances were recognized in prior period(s) is not in line with  
AS 5. 
 2.4 CHANGES IN ACCOUNTING ESTIMATES  
An estimate may have to be revised if changes occur in the circumstances based 
on which the estimate was made, 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. 
© The Institute of Chartered Accountants of India