1.21 Query
Treatment of adjustments regarding prior period items, changes in accounting policies bonus provision etc. for the purpose of Section 349 of the Companies Act, 1956
1 The Institute of Chartered Accountants of India has notified that the Accounting Standard – 5 (AS-5) on ‘Prior Period and Extra-ordinary Items and Changes in Accounting Policies’ issued by the Institute shall become mandatory in respect of accounts for periods commencing on or after 1st January, 1987.
2. ‘Prior Period Items’ are defined in Para 3.1 of AS-5 as “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”.
3.In this context, the querist has drawn the attention of the Expert Advisory Committee to an extract from the Expert Advisory Committee’s reply to Query No. 1.49 (Compendium of Opinions, Volume I, 2nd Edition) regarding treatment of expenses of previous year in the Profit and Loss Account “……. the treatment given by the company to the expenditure relating to the prior years as stated in the query is the correct treatment as the disclosure of prior period expenditure would imply that certain adjustments like managerial remuneration, bonus provision and provision for taxation are also treated likewise which is not the practice usually followed” (emphasis by the querist).
4.The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from the above:
(i) Whether prior period items are to be excluded for the purposes of the computation of profits in terms of Section 349 of the Companies Act, 1956, bonus provision and taxation.
(ii) Should similar treatment be given to debits or credits arising due to a change in accounting policy of the company having a retrospective effect.
(iii) If answers to (i) and (ii) are in the affirmative:
(a) Then whether computations for the respective purposes (i.e. managerial remuneration, bonus etc.) made in earlier years have to be recomputed and appropriate entries passed in the books of account in respect of excess or short provision of directors’ remuneration, bonus and taxation etc., in the year in which the items are disclosed as prior period adjustments;
(b) Whether adjustments of prior period items/debits or credits arising due to changes in accounting policy having retrospective effect can be adjusted against general reserve instead of routing these through the profit and loss account. Whether this treatment can be considered to be in accordance with generally accepted accounting principles and in compliance with the requirements in Part II, Schedule VI to the Companies Act, 1956, and would not be deemed to be in non-compliance of (Companies Transfer of Profits to Reserve) Rules, 1975 and (Companies Declaration of Dividend out of Reserve) Rules, 1975.
Opinion August 10, 1987
1.The Committee notes that Section 349 of the Companies Act, 1956, dealing with determination of net profits for the purpose of computation of managerial remuneration, the relevant provisions of the Payments of Bonus Act, 1965 and the Income-tax Act, 1961 are silent about the treatment of prior period items and charges/credits arising on account of changes in accounting policies. The Committee is therefore of the view that the net profits for the aforesaid purposes should be determined on the basis of the accepted accounting principles and practices.
2.The Committee notes that AS-5 referred to by the querist in paras 1 and 2 above also states in para 5.1 that “Prior period items are generally infrequent in nature”. Para 9 of the Accounting Standard further states that “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”. The Committee is of the view that it is not necessary to redetermine the managerial remuneration, bonus provision etc. of the year(s) to which the prior period items relate. These should however be considered for the aforesaid computations pertaining to the current year. The Committee is of the view that this is what the earlier opinion of the Committee referred to by the querist in para 3, meant.
3. With regard to changes in accounting policies, the Committee notes that para 11 of AS-5 provides as below:
“A change in an accounting policy should be made only if the adoption of a different accounting policy 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 preparation or presentation of the financial statements of an enterprise”.
4. On the basis of the above considerations, the opinion of the Expert Advisory Committee on the issues raised by the querist in para 4 of the query is as below:
(i) No.
(ii) The changes in accounting policies having a retrospective effect, of the types covered by para 11 of AS-5 (reproduced in para 3 above) should be taken into account for computing profits for the current year for the purposes of managerial remuneration and bonus provision. As far as the question of tax provision is concerned, that matter will have to be determined with reference to the specific circumstances of the case.
(iii) Recomputation of managerial remuneration and bonus provision of the earlier period(s) to which prior period items and changes in accounting policies relate, is not warranted.
(iv) Adjustments arising from prior-period items and retrospective changes in accounting polices should be made through the current statement of profit and loss. ________________________ |