In this article we will discuss about the General Instructions for Preparation of Statement of Profit And Loss Account.
I. The provisions of this part shall apply to the income and expenditure account referred to in sub-section (2) of section 210 of the Act, in like manner as they apply to a statement of profit and loss.
II. In respect of a company other than finance company revenue from operations shall disclose separately in the notes revenue from:
(i) Sale of products;
(ii) Sale of services;
(iii) Other operating revenues;
(a) Excise duty.
(b) In respect of a finance company, revenue from operations shall include revenue from
(c) Interest; and
(d) Other financial services
Revenue under each of the above heads shall be disclosed separately by way of notes to accounts to the extent applicable.
III. Finance costs:
Finance costs shall be classified as:
(i) Interest expense;
(ii) Other borrowing costs;
(iii) Applicable net gain/loss on foreign currency transactions and translation.
IV. Other income:
Other income shall be classified as:
(i) Interest Income (in case of a company other than a finance company);
(ii) Dividend Income:
(iii) Net gain/loss on sale of investments
(iv) Other non-operating income (net of expenses directly attributable to such income).
V. Additional Information:
A company shall disclose by way of notes additional information regarding aggregate expenditure and income on the following items:
(i) (a) Employees Benefits Expense [showing separately (i) salaries and wages, (ii) contribution to provident and other funds, (iii) expense on Employee Stock Option Scheme (ESOP) and Employee Stock Purchase Plan (ESPP), (iv) staff welfare expense];
(b) Depreciation and amortization expense
(c) Any item of income or expenditure which exceeds one per cent of the revenue from operations or Rs.1,00,000, whichever is higher;
(d) Interest Income;
(e) Interest Expense;
(f) Dividend Income
(g) Net gain/loss on sale of investments;
(h) Adjustments to the carrying amount of investments;
(i) Net gain or loss on foreign currency transaction and transition (other than considered as finance cost);
(j) Payments to the auditor as:
(b) For taxation matters,
(c) For company law matters,
(d) For management services,
(e) For other services,
(f) For reimbursement of expenses;
(k) Details of items of exceptional and extraordinary nature;
(i) Prior period items.
(ii) (a) In the case of manufacturing companies:
(1) Raw materials under broad heads.
(2) Goods purchased under broad heads
(b) In the case of trading companies, purchase in respect of goods traded in by the company under broad heads.
(c) In the case of companies rendering or supplying services, gross income derived from services rendered or supplied under broad heads.
(d) In the case of a company, which falls under more than one of the categories mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the requirements herein if purchases, sales and consumption of raw material and the gross income from services rendered is shown under broad heads.
(e) In the case of other companies, gross income derived under broad heads.
(iii) In the case of all concerns having works-in-progress, works -in-progress under broad heads.
(iv) (a) The aggregate, if material, of any amounts set aside or proposed to be set aside, to reserve, but not including provisions made to meet any specific liability, contingency or commitment known to exist at the date as to which the balance-sheet is made up.
(b) The aggregate, if material, of any amounts withdrawn from such reserves.
(v) (a) The aggregate, if material, of the amounts set aside to provisions made for meeting specific liabilities, contingencies or commitments. (b) The aggregate, if material, of the amounts withdrawn from such provisions, as no longer required.
(vi) Expenditure incurred on each of the following items, separately for each item:
(a) Consumption of stores and spare parts.
(b) Power and fuel.
(d) Repairs to buildings.
(e) Repairs to machinery.
(g) Rates and taxes, excluding, taxes on income.
(vii) (a) Dividends from subsidiary companies.
(b) Provisions for losses of subsidiary companies,
(i) Miscellaneous expenses.
(viii) The statement if profit and loss shall also contain by way of a note, the following information, namely:
(a) Value of imports calculated on C.I.F basis by the company during the financial year in respect of –
1. Raw materials
2. Components and spare parts
3. Capital goods;
(b) Expenditure in foreign currency during the financial year on account of royalty, know- how, professional and consultation fees, interest, and other matters;
(c) Total value of all imported raw materials, spare parts and components consumed during the financial year and the total value of all indigenous raw materials, spare parts and components similarly consumed and the percentage of each to the total consumption.
(d) The amount remitted during the year in foreign currencies on account of dividends with a specific mention of the total number of non-resident shareholders, the total number of shares held by them on which the dividends were due and the year to which the dividends related:
(e) Earnings in foreign exchange classified under the following heads, namely;
1. Export of goods calculated on F.O.B. basis;
2. Royalty, know-how, professional and consultation fees;
3. Interest and dividend;
4. Other income, indicating the nature thereof.
Broad heads shall be decided taking into account the concept of materiality and presentation of true and fair view of financial statements.
The following is the trial balance of Nafees Ltd as on 31st March, 2012:-
Prepare statement of Profit and Loss for the year ended 31st March, 2012 and Balance Sheet as at that date after taking into consideration the following adjustments also:-
(i) Stock on 31st March, 2012 was valued at Rs.79,24 thousand.
(ii) Make a provision for income -tax @ 31 %
(iii) Depreciate plant and machinery @ 15%, furniture’s and fittings @ 10% and patents and trademarks @ 5%
(iv) On 31st March, 2012 outstanding rent was Rs.80 thousand while outstanding salaries totalled Rs.65 thousands.
(v) Provide for managerial remuneration @ 10% of net profits before tax but after such managerial remuneration.
(vi) Transfer 10% of net profits to general reserve.
(vii) The directions propose a dividend @ 15% per annum for the year end 31st March, 2012 and make a provision for dividend distribution tax @17%.
There is no fundamental difference between the preparation of the Trading and Profit and Loss Account for a sole proprietor or a partnership or for a company. The same principles hold good.
The following points have to be kept in mind in general:
(a) A point of importance is that of matching revenue and expenditure. All expenses incurred for the purpose of earning an income shown in the Profit and Loss Account should be debited to the account. Expenses incurred against which revenue has still to be earned should be carried forward to the period in which revenue will be credited to the Profit and Loss Account.
Revenue expenditure may be treated as deferred on this basis.
(b) Expenditure of revenue nature alone, and that relating to only the period concerned, should be debited. Capital expenditure or expenditure relating to the past period or the future should be excluded.
(c) Even if some expenditure relating to the period for which accounts are being prepared has not been actually paid for, it should be brought into books, and if it is of revenue nature should be debited to the Profit and Loss Account.
(d) The above three points, (a), (b) and (c), hold equally good for incomes of the company. This is to say, only the revenue income relating to the period concerned but all the incomes relating to the period, even if they have not been actually received in cash, should be credited to the Statement of Profit and Loss.
(e) Losses suffered by accident or otherwise should be debited to the Statement of Profit and Loss Diminution in the value of assets due to wear and tear and passage of time should be brought into account. But it is not advisable to bring into account appreciation in the value of assets
(f) Adjustments for prior years should be shown separately, unless they are immaterial.
The above principles hold good for a company also. But there are some differences in the accounts relating to say a partnership and those relating to a company.
The important differences are:
(a) The heading in case of a partnership is usually Trading and Profit and Loss Account; in case of a company the heading is Statement of Profit and Loss.
(b) There are certain items like Interest on Debentures, Directors’ Fees, etc., which appear in a company’s Statement of Profit and Loss but not in accounts of a partnership. Income-tax on profits is treated as an expenditure in the case of companies.
(c) The profit or loss disclosed by accounts of partnership is transferred to the capital accounts (or current accounts) of partners, but the profit or loss disclosed by the statement of profit and loss of a company is not transferred to the Share Capital Account; balance, after appropriations, if any, is shown as a separate item in the balance sheet as Surplus.
(d) There are special features relating to the division (or appropriation) of profits of a company.
The concept of materiality is vital to the preparation of final statements of account on a true and fair basis which means that those who study the profit and loss account and the balance sheet should be able to form a good idea of profit earned (or loss suffered) by the company during the year and of its financial position at the end of the year.
Materiality is a relative term – what is material for one company may not be material for another. An error of Rs 5,000 in stock-taking in the case of a company where the value of stock runs into crores of rupees is surely too small to deserve special treatment but not so if the value of the stock is, say only Rs 50,000.
The under mentioned general rules may help in this regard:
(i) As far as possible, figures relating to previous years, representing adjustments, should be reported separately. Suppose, a fairly big debt written off in the past is recovered.
The amount should be credited in the profit and loss account as a separate item and not credited to Bad Debts Account so as to reduce the figure of bad debts to be written off in the current year If on settlement of tax liability relating to past years, the actual amount differs from the provision already made, the difference should be separately debited or credited, as the case may be.
(ii) Whether an amount is material or not should be judged having regard to the size of the net profit as well as the size of the sub-group to which the item belongs. For example, an adjustment of purchase price results in an extra amount to be paid in respect of purchases made in the previous year.
This should be stated separately in the profit and loss account if the amount appears to be large having regard to current year’s purchases and also to the net profit. In case of a balance sheet, this rule will apply with reference to the total of assets and liabilities as well as the particular sub-group involved.
A contingent liability, for instance, should be reported separately if the amount is large enough in view of the total amount of contingent liabilities and total liabilities.
ii. Prior Period Items:
The Institute of Chartered Accountants of India defines Prior Period Items as 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.
Since the purpose of the profit and loss account is to reveal the profit or loss for the period under report, it is clearly necessary to distinguish amounts that pertain to the previous periods from those concerning the current period, if the former are material.
Adjustments for previous periods become necessary since it is not possible to reopen the accounts for a period once these have been adopted by the shareholders in the annual general meeting.
iii. Extraordinary Items:
These are defined by the Institute as “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”.
These losses which arise from events or transactions those are distinct from the ordinary activities of the business and which are both material and expected not to recur frequently or regularly. These would include material adjustments necessitated by circumstances which though related to previous periods are determined in the current period.
The following are a few examples of extraordinary items:—
a. Profit or loss on sale of raw materials, when this has not been the practice
b. Profit or loss on speculation, where this has not been resorted to regularly.
c. Loss due to earthquake.
d. Wages to be paid for the previous years where the higher wages are to take effect with retrospective effect.
The nature and amount of extraordinary or exceptional items should be separately disclosed so that the effect on current income is clearly discernible. It should be noted that incomes or expenses arising from the ordinary activities of the enterprise, though abnormal in amount are not extraordinary items, for example a very large debt from a regular trade customer written off.
As a result of uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. Estimates may be required, for example, of bad debts, inventory obsolescence, or the useful lives of depreciable assets.
An estimate may have to be revised if changes occur regarding the circumstances on which the estimate was based, 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 prior period item.
iv. Changes in Accounting Policies:
It is well known that any change in accounting policies (such as in the method of valuation of inventories or provision for depreciation) has to be disclosed along with the amount by which the profit or loss of the year under report is affected, if the amount is material. Such a change may cloud the profit or loss disclosed.
Therefore, the Institute of Chartered Accountants of India recommends, through its Accounting Standard 5 (Revised), that 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 presentation of the financial statements of the enterprise.
In this Accounting Standard, the standard portions have been set in bold type. These should be read in the context of the background material which has been set in normal type and in the context of the Preface to the Statements of Accounting Standards.