Query No. 8

Subject:

Disclosure of income/expenditure

pertaining to prior years.¹

A. Facts of the Case

1. A public sector company, registered under the Companies Act, 1956, under the Ministry of Telecommunication, Government of India, maintains its accounts on the basis of mercantile system. The main business of the company is to provide telecommunication related services to the public.

2. The querist has informed that the company has adopted the following accounting policy in respect of the prior period items:

“Income from services pertaining to prior years is not disclosed as prior period item. In respect of other income/expenditure, only cases involving sums exceeding Rs. 0.10 million are disclosed as prior period items”.

3. The Comptroller and Auditor General of India (C&AG) has raised the following objection in respect of the above policy:

 

“As per Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India (ICAI), the income or expenditure that arises in the current period as a result of errors or omissions in the preparation of the financial statements of previous periods are to be accounted for as prior period income or expenditure. In view of the above, the accounting policy followed by the company is in contravention of AS 5”.

4. The querist has informed that the company is consistently following the above policy relating to prior period items for the last several years. As per the querist, this is in line with the accounting policy in this regard followed by some other major public sector undertakings.

5. The querist has further informed that the company is having an annual turnover of Rs. 58,065 million. Keeping in view the size of its business, number of transactions and the nature of business which is spread over at least 50 sub-accounting units, it was decided by the company that all the transactions of income/expenditure exceeding the specified limit will be disclosed separately under prior period items. As per the querist, this has been done keeping in view the materiality concept of accounting.

B. Query

6. The querist has sought the opinion of the Expert Advisory Committee as to whether the company is justified in not including the transactions of income and expenditure below Rs. 0.10 million separately as prior period items keeping in view the size of the company, volume of transactions and the materiality aspect, and whether the accounting policy of the company in this respect is in accordance with AS 5.

C. Points considered by the Committee

7. The Committee notes that the query basically relates to whether certain errors or omissions pertaining to items of income or expenditure relating to prior years, should be disclosed separately as prior period items keeping in view the materiality concept. The Committee has, therefore, considered only this issue and has not touched upon any other issue arising from the Facts of the Case.

8. The Committee notes that paragraph 15 of AS 5 requires as below:

“15. 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.”

9. The Committee also notes that paragraph 4.3 of the Preface to the Statements of Accounting Standards, issued by the Institute of Chartered Accountants of India states, inter alia, that “The Accounting Standards are intended to apply only to items which are material”.

10. The Committee further notes that paragraph 17(c) of Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’, explains ‘materiality’ as below:

 “c. Materiality

Financial statements should disclose all “material” items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements.”

11. The Committee also notes that paragraph 3 of Auditing and Assurance Standard (AAS) 13, ‘Audit Materiality’, issued by the Institute of Chartered Accountants of India, explains, inter alia, that, “Materiality depends on the size and nature of the item, judged in the particular circumstances of its misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which the information must have if it is to be useful”. It further states, inter alia, in paragraphs 4 and 5, respectively that

“the assessment of what is material is a matter of professional judgement” and “the concept of materiality recognises that some matters, either individually or in the aggregate, are relatively important for true and fair presentation of financial information in conformity with recognised accounting policies and practices”.

12. On the basis of the above, the Committee is of the view that threshold of materiality is applicable to all items of financial statements. If an information is immaterial, on the consideration of materiality as mentioned in the paragraphs above, its accounting would not have any effect on the decisions of the users of the financial statements. Accordingly, it needs to be determined under the specific facts and circumstances of the company concerned as to whether the prior period items, either individually or in aggregate, which are not disclosed as separate items, can influence the decisions of the users of the financial statements. For this purpose, apart from the volume of transactions and quantum of turnover, other factors such as nature of the item, impact on profit/loss etc., should also be considered. If the nature of an item is such that its disclosure can influence the decisions of the users of the financial statements, it should be disclosed as a separate item irrespective of its amount. Similarly, in case a prior period item materially affects the profit/loss for the period, a separate disclosure thereof would be necessary.

D. Opinion

13. On the basis of the above, the Committee is of the opinion that justification of the company of not disclosing errors or omissions pertaining to items of income and expenditure below Rs. 0.10 million separately as prior period items would depend upon the considerations of materiality determined on the basis described in paragraph 12 above. Thus, if on such considerations, the prior period items are not material, the accounting policy followed by the company in this regard would be appropriate.

¹ Opinion finalised by the Committee on 28.4.2005