Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 1

Subject:     

Rectification of errors committed in prior periods.1

 

A. Facts of the Case

 

1. A private limited company is engaged in the business of investment and property development.  The query relates to the annual accounts of the company for the financial years ended on:

 

        (i)  31st December, 1987;

 

        (ii)   31st March, 1989 (15 months); and

 

        (iii)   31st March, 1990.

 

2.  During the financial year ended 31st December, 1987, a payment of Rs. 9,000 was made to a consultant, being the ‘soil testing fee’ of a property.  This property belonged to Mr. X, who had provided an unsecured loan to the company and had a credit balance of Rs. 20,000 at the year end.  The payment was made under the instructions of Mr. X.  In the annual accounts of the company for the period ended 31st December, 1987, the sum of Rs. 9,000 was shown as ‘purchase’ and as ‘closing stock’ in a schedule to the balance sheet, under the sub-heading ‘Premises at Calcutta’.

 

3.  During the period ended 31st March, 1989, a payment of Rs.1,74,613 was made by the company to the municipal authorities under the instructions of Mr. X, being the building plan sanction fee payable by Mr. X as the owner of the aforesaid property.  In the annual accounts of the company for the period, the aforesaid sum of Rs.9,000 continued to appear as balance brought forward and the sum of Rs.1,74,613 paid to municipal authorities during the year was recorded as purchase and therefore the ‘closing stock’ appeared as Rs.1,83,613 in a schedule to the balance sheet, under the sub-heading ‘Premises at Calcutta’.  Mr. X’s unsecured loan to the company continued and the balance due as at the end of the period was Rs.3,00,000.

 

4. The querist has stated that both the transactions as stated in paragraphs 2 and 3 above should have been debited to the ‘unsecured loan account’ of Mr. X, since these payments were made by the company under his instructions.  Accordingly, in the year ended 31st March, 1990, an adjustment was made by debiting the ‘Unsecured Loan Account of Mr. X' and disclosing the closing stock in the relevant schedule to the balance sheet under the sub-heading ‘Premises at Calcutta’ as: ‘Opening Balance Rs.1,83,613 less: Refund of Development Expenses against Premises at Calcutta Rs.1,83,613', thereby making the net balance of closing stock ‘nil’ in the balance sheet.

 

5. The following disclosure was made by way of a note to the accounts:

 

“Development expenses relating to premises at Calcutta amounting to Rs.1,83,613 were previously incorporated inadvertently in valuation of inventories on 31.3.1989 whereas the same should have been reduced from Unsecured Loan Account of Mr. X.  This year the same has been transferred to proper account head of Mr. X.”

 

6. In all the three years, the auditors did not make any specific reference to the aforesaid transactions in their report.  The annual accounts were duly adopted at the annual general meetings (AGM) of the company.

 

B. Queries  

 

7. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether the manner adopted by the company in the year 1989-90 to rectify the errors made in accounting for the said payments of Rs. 9,000 and Rs. 1,74,613 was in accordance with the generally accepted accounting practices.

 

(b) Once an audited balance sheet is adopted by the members of a company at its annual general meeting, whether any subsequent rectification is just and proper under law, and if not, how else can the rectification of the mistake be given effect to.

 

C. Points Considered by the Committee

 

8. The Committee notes that during the period to which the query relates, the pre-revised Accounting Standard (AS) 5, ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’ (issued in November, 1982 and hereinafter referred to as ‘the Standard’) was applicable.  Paragraph 3.1 of the Standard defined ‘prior period items’ as below:

“3.1“Prior period items” are material charges or credits 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.”

9. Paragraph 9 of the Standard provided for disclosure of prior period items as below:

“9.Prior period items should be separately disclosed in the current statement of profit and loss together with their nature and amount in a manner that their impact on current profit or loss can be perceived.”

10. From the above, the Committee notes that the Standard requires separate disclosure in the profit and loss account of those charges or credits that result from rectification of errors or omissions in the preparation of the financial statements of one or more prior periods.  The Committee notes that the Standard does not specify any particular manner of disclosure of the nature and amount of prior period items in the profit and loss account; it merely requires that the disclosure should be such that the impact of the prior period items on current profit or loss can be perceived.  In the absence of a clear stipulation in the Standard regarding the manner of disclosure of prior period items, the Committee is of the view that the requirements of the Standard can be considered to have been complied with if the following conditions are satisfied:

(a)The disclosure of prior period item is made in the profit and loss account.  This would include schedules/notes forming part of the profit and loss account.

 

(b)The nature and amount of prior period items are presented in such a manner that a reader of financial statements can perceive their impact on various figures of the profit and loss account.

11.The Committee is of the view that the above conditions should also be fulfilled, mutatis mutandis, in disclosure of adjustments resulting from correction of errors affecting one or more balance sheet items.  Thus, the nature and amount of adjustments to balance sheet items should be disclosed in such a manner that the effect of the adjustments on the financial position can be clearly perceived.  The disclosure can be made either on the face of the balance sheet or in the schedules/notes forming part of the balance sheet.

 

12. Based on the foregoing, the Committee is of the view that the manner of disclosure of rectification of errors in the instant case is appropriate.

 

13. Rectification of errors of prior years is well-accepted in accounting.  The Committee is of the view that there is also no bar in the Companies Act, 1956, on such rectification.

 

14.The Committee wishes to emphasise that its opinion is based on the presumption that the manner of recording and disclosure of the relevant transactions in the accounts for the periods ended 31st December, 1987 and 31st March, 1989 was in fact erroneous as stated by the querist.

 

D. Opinion

 

15. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7:

(a) The rectification of the errors and the manner of carrying out the rectification in the instant case are in accordance with the generally accepted accounting principles.

 

(b) Rectification of the errors of prior years is well-accepted in accounting.  There is also no bar in the Companies Act, 1956, on such rectification.

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1Opinion finalised by the Committee on 22.4.2000.