Accounting transactions that are accounted for through other profit or loss from prior years
Reporting entities traditionally report profit or loss for the current period in equity as a difference between income and expenses related on an accruals basis to the reporting period. Accounting for other profit or loss from prior years, as follows from the name of this line, takes place if the reporting entity records income or expense caused by the previous period that was, for some reason, not recognised in the previous period. The Regulation specifies three instances of such use, namely the moment of first-time recognition of deferred tax, correction of errors of prior years (as a result of incorrect recognition or failure to recognise income and expenses in previous reporting periods) and reporting of differences arising from changes in accounting policies. Let’s go through each of these situations in greater detail.

A. First-time recognition of deferred tax
When a company recognises deferred tax for the first time, it will certainly use other profit or loss from prior years to recognise the portion of a deferred tax liability or asset related to the pervious reporting period – i.e. caused by circumstances in the previous reporting period(s). It needs to be pointed out here that the first-time recognition of deferred tax is caused by the fact that the company is obliged for the first time to recognise deferred tax, not that the company did not account for deferred tax in previous years due to an error, although correction of errors related to previous reporting periods can ultimately have the same effect on accounting and the financial statements.

The reason for this approach is the origin of deferred tax, which is, in the first year of recognition, based on all temporary differences that have arisen throughout the existence of the reporting entity and continue to exist as of the balance sheet date. Whether it is necessary to recognise a deferred tax liability or deferred tax asset, the part of deferred tax that relates to the previous reporting period cannot affect the profit or loss of the current period and it will be recognised only in the balance sheet – i.e. Dr 426 “Other profit or loss from prior years“ / Cr 481 “Deferred tax liability“ for a deferred tax liability, or Dr 481 “Deferred tax asset”  / Cr 426 “Other profit or loss from prior years” for a deferred tax asset.

The portion of deferred tax that was caused by events of the current period will affect expenses via account 592 and it will be recognised as Dr 592 “Income tax – deferred”  / CR 481 “Deferred tax liability” for a deferred tax liability, or Dr 481 “Deferred tax asset”  / Cr “Income tax – deferred” for a deferred tax asset.

If the reporting entity interrupted the recognition of deferred tax (e.g. due to expected tax losses, the company decided not to account for a deferred tax asset on the grounds of prudence because it would not be able to recover it in the future) but after a certain time it started recognising the deferred tax asset again, the use of the item Other profit or loss from prior years is not applied and the entire impact of the recommencement of recognition of deferred tax affects the profit or loss of the current period. The reason for this approach is the fact that it is not a policy change or a correction of an error of prior years, but a change of an estimate, which is reflected prospectively. This can apply, for example, to a situation when a reporting entity recognises and reports deferred tax only on a portion of total accumulated tax losses that it anticipates to utilise in the future.

B. Corrections of errors of prior years.
The second case of accounting through other profit or loss from prior years is corrections of errors of prior years that were discovered after the closing of the books for the previous reporting period. The change therefore cannot be reflected in the related period but due to its materiality it has to be corrected. A material error is an error that can significantly impact the perspective and decision-making of an independent user of the financial statements. An professional judgement is necessary to assess materiality and the company’s management consults similar situations with the auditor.

Let’s have a look at such correction of errors of prior years using an example:
After the closing of the books, an omission is discovered in the form of a failure to recognise a received supplier invoice. This invoice relates to the supply of a service for the closed reporting period and the company’s management assessed the invoice amount as material. In the new reporting period, the invoice will be recognised only in the balance sheet as follows: Dr 426 “Other profit or loss from prior years” / Cr 321 “Trade payables”, since it should not affect the profit or loss of the current period.

However, it should be mentioned here that when preparing financial statements, it is necessary to adjust the data for the previous reporting period in order to maintain comparability of the information for the current and previous reporting periods. The information will therefore be included in the financial statements for the previous reporting period as if no error had occurred in the previous period.

This means that the supplier invoice will increase the amount of expenses for services at the level of the statements (line A.3. Services) and it will also increase trade payables (line C.II.4. Trade payables). Such an adjustment with an impact on profit or loss naturally indirectly affects the calculation of income tax for the previous reporting period via other tax base, and it requires filing an additional tax return. Simultaneously, the correction of tax liability for the previous reporting period would be taken into account with respect to the corrected error: in accounting records, this would concern accounting between account 426 – Other profit or loss from prior years, and account 341 – Corporate income tax (in our case, it would be a decrease in the total tax liability or the origination of or increase in the total tax asset); in the financial statements, the correction for the previous period would be reflected on the profit and loss account line L.1. Income tax payable, and in the balance sheet on line C.II.2.4.3. in assets, C.II.8.5., or B.2. in liabilities.

If the supplier invoice in our example concerned an immaterial amount, then the invoice would be recognised in the current period on the same expense account on which it would have been recognised in the previous period if the omission had not occurred, i.e. Dr 518 “Services” / Cr 321 “Trade payables”.

C. Differences arising from changes in accounting policies
Before the introduction of the item Other profit or loss, reporting entities recognised the impacts of changes in accounting policies as of the first day of the reporting period in extraordinary income expenses, which ultimately affected the profit or loss of the current periods. After 1 January 2013, these cases fall under other profit or loss and the recognition of differences arising from changes in accounting policies, such as a change in the method of inventory valuation, has to be made by a balance sheet entry via account 426. Similarly to the preceding situation regarding the correction of errors of prior years, data for the previous period presented in the financial statements have to be adjusted.

In the event of an increase in the valuation of internally produced inventory due to a change in valuation methods, the change will be reflected as Dr 12* “Internally produced inventory” / 426 “Other profit or loss from prior years”. The policy change should always be sufficiently commented on in the notes to the financial statements.

In practice, we can often encounter a thin line between correction of errors of prior years, policy change and change in accounting estimates (a dilemma most commonly arises in the area of estimated useful lives and depreciation of fixed assets). The accounting treatment of the change in accounting estimates is, however, different from the previous two categories. In the case of an estimate, the reporting entity predicts the amount and timing of an accounting event based on the information available at the time. If the circumstances under which the estimate was made change, the reporting entity should change and update the estimate at the moment when it becomes aware of the change, as of the balance sheet date or date of preparation of the financial statements at the latest. This does not affect the matter of disclosing so-called subsequent events or post balance sheet events, which may also concern accounting estimates and which we will address in one of our future articles.

Disclosure requirements
Other profit or loss from prior years is reported via a ledger account in group 42 and for the sake of clarity and later records of balances for the individual periods, it is suitable to divide it into sub-ledger accounts based on the nature of the transactions contained in them. When using the account of other profit or loss, the reporting entity is obliged to comment on this decision in the notes to the financial statements. Specifically, we emphasise the obligation to comment on the fact that incomparable information has been retained; this can concern e.g. situations where the errors relating to prior years or policy changes have been reflected on account 426 – Other profit or loss from prior years, but data for the previous period have not been restated in the financial statements.

What to do next about other profit or loss?
As with profit or loss for the current period, other profit or loss from prior years is also subject to the decision of the reporting entity’s highest body about its distribution, whether through transfer to accumulated losses/earnings of prior years or subsequent distribution in the form of profit shares.

Conclusion
Other profit or loss from prior years is not a line that should be used often, but it has an essential position and it is significant especially for compliance with the accruals principle and maintaining comparability of reporting periods.

The article is part od dReport – November 2018, Accounting news.