Introduction
Accounting Policies discusses presentation and disclosure of Certain Ordinary activities, Extraordinary activities, Prior Period items and Accounting Treatment and Presentation and Disclosure of Changes in Accounting estimates and Accounting Policies. This standard does not deal with tax effect of the above items. All items of income and expense which are recognized in a financial year should be part of P&L a/c for the period. If any Accounting Standard suggests or permits a different treatment, it should be accounted as preferred by that respective AS.
Net profit or Loss for the period includes Profit or loss from Ordinary activities and Profit or loss from extraordinary items.
Ordinary Activities are Entity’s business activities and related and incidental to such business activities. These activities arise in the normal course of business, so the frequency of the activities is high and these activities are expected to occur as a part of business like sale of goods, providing services etc.
Extraordinary activities are clearly different from the ordinary activities of the entity and not expected to occur as part of business. Generally the frequency of such transactions is low but it is not the only criteria to determine. Classification of items is based on the Nature of the item but not on frequency. Here classification requires some degree of professional judgment. Loss when an earthquake occurs, refund of government grants, etc are examples. These are not expected to occur as a part of business.
Extraordinary activities should be separately disclosed in P&L a/c so as to show the impact on profit and loss. But there are some certain ordinary activities as they are expected to occur as part of a business, though they require a separate disclosure. These are called Exceptional items. These are disclosed based on the size, nature or incidence. Writing down of inventories to NRV as well as the reversal of that, Profit or loss on disposal of fixed assets and long term investments, Litigation Settlements and other reversals of provisions, Cash theft, etc, are some examples of these Exceptional items. This separate disclosure helps the users to understand the performance and position of the company and it helps them in making projections of performance and financial position. The nature and amount of the transactions separately in P&L a/c and relevant information in notes on accounts should be disclosed.
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. Actually those are related to previous years but recorded in the current year P&L a/c and not recorded in the respective previous years. These items should be disclosed separately in the profit and Loss a/c so as to show the impact of prior period items in the current year.
Many items in the financials cannot be measured accurately or exactly, so the use of reasonable estimates is an essential part for the preparation of financial estimates. Usage of estimates does not reduce the reliability of financial statements. Estimations are approximate Calculations. Useful life of assets, Allowance for doubtful debts that is Provisions, Inventory obsolescence, etc are some of the general estimations that are used. Estimations are made based on the latest information available and the situations on the date of preparation of financial statements. Professional judgment is required while estimating. As these are approximations it requires revision as and when there is any change in the situation or information or if any new information is available. These changes should be accounted prospectively. If the change is significant, the entity should disclose the nature of change and amount of change and if it is expected to have a material effect in later periods should be disclosed.
Revision in estimation is expected to occur, hence it is an ordinary activity and it cannot be treated as an extraordinary item. Estimations are revised not because of errors or omissions so the revision of estimation is not a prior period item.
As per AS 1, Entity should follow the accounting policies consistently that is accounting policies followed in previous year should be continued in the current year also. But it does not mean that the entity should not change its accounting policies. The entity can change accounting policies when it is a requirement of a Statute or Accounting Standard or if there is change in policy reflects better presentation of financial statements. There is no guidance in AS 5 on accounting for change in policy but as a practice and as per Ind AS change in accounting policy is accounted retrospectively. The surplus or deficit that arises with this effect should be taken to P&L a/c in the year of change of policy. When an entity is not able to differentiate the change in estimate and change in accounting policy then it should be treated as change in accounting estimate only. Adoption of new accounting policy is not a change in accounting policy.
Disclosure:
If change in accounting policy has material effect it should be disclosed in the year of change.
If the impact is not ascertainable, the entity should disclose the fact in financial statements.
If there is no impact in the year of change but there is material impact in the future years, the fact of such impact should be disclosed in the year of change in policy.
As part of better practice, entity should disclose the reason for change in policy.
Accounting Standard 5 vs. Ind AS 8 – Accounting Policies, Change in Accounting estimates and Errors vs. IAS 8 – Accounting Policies, Change in Accounting estimates and Errors.
As per AS 5 there was no guidance on accounting when there is a change in accounting policy but it should be accounted retrospectively as per Ind AS 8 and IAS 8.
As per AS 5 Prior period items are included in determination of net profit or loss of the period in which the error related to prior period is discovered and disclosed separately. As per Ind AS 8 and IAS 8 Material prior period errors are corrected retrospectively by restating the comparative amounts for prior periods presented in which the error occurred.
As per Ind AS 8 and IAS 8 non application of new accounting pronouncements that have been issued but are not yet effective as at the end of the reporting period is disclosed. But as per AS 5 there is no requirement of disclose.