11 INCOME COMPUTATION AND DISCLOSURE STANDARDS. 22 Applies to “computation of income” under the head Profits and Gains of Business or Profession or

11

Presenter – CA Anil J. [email protected]

INCOME COMPUTATION AND DISCLOSURE STANDARDS

22

Applies to “computation of income” under the head Profits and Gains of Business or Profession or Income from Other Sources. Computation by whom – ‘Assessee’ or ‘Assessing

Officer’?

In case of conflict between Income Tax Act and ICDS, the Act shall prevail. Would the word “Act” include an interpretation thereof

by the Jurisdictional High Court or the Apex Court?

30th January, 2016 CA Anil J. Sathe

ICDS I – ACCOUNTING POLICIES

33CA Anil J. Sathe

Section 145 – Method of Accounting: (1) Income chargeable under the head "Profits and gains of

business or profession" or "Income from other sources" shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

(2) The Central Government may notify in the Official Gazette from time to time income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income.

(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) has not been regularly followed by the assessee, or income has not been computed in accordance with the standards notified under sub-section (2), the Assessing Officer may make an assessment in the manner provided in section 144.

30th January, 2016


44CA Anil J. Sathe

Computation according to “method regularly followed by assessee”

Computation according to notified ICDS If Assessing Officer –

Not satisfied about the correctness or completeness of accounts

Method of accounting not regularly followed by the assessee

Income not compute in accordance with ICDS

Assessing Officer to proceed to make an assessment under section 14430th January, 2016


55

ICDS I – ACCOUNTING POLICIES ICDS 1 is a disclosure Standard while the other standards are

computation standards. Scope – to deal with significant accounting policies Fundamental accounting assumptions:

Going Concern Consistency Accrual

Impact if assessee is not a Going Concern? Accounting Policies refer to specific accounting principles and

methods of applying those principles Accounting policies to be chosen to represent true & fair view of

state of affairs & income Substance over legal form (Issue – Finance Leases) Marked-to-market loss not to be recognised unless provided

by other ICDS30th January, 2016 CA Anil J. Sathe

66CA Anil J. Sathe

Prudence and Materiality not mentioned in the Standard All significant policies adopted by a person to be disclosed Disclosure:

Change in accounting policy having material effect shall be disclosed

The quantum of such change to be disclosed, if ascertainable If not ascertainable, such fact to be disclosed If change does not have material effect in year of change but will

affect in subsequent year, disclosure to be made in both the years. Changes in Accounting estimates not to be disclosed Disclosure of accounting policies cannot remedy a wrong /

inappropriate treatment of item Fundamental Accounting Assumptions of Going concern,

Consistency and Accrual If followed – no specific disclosures required If not followed – disclosure required

30th January, 2016


77CA Anil J. Sathe

Particulars ICDS AS Ind-AS

Relevant Standard ICDS 1 AS 1 & AS 5 Ind-AS 1 & Ind-AS 8

Fundamental Accounting Assumptions

Going ConcernConsistencyAccrual

Going ConcernConsistencyAccrual

Going ConcernAccrual

Consideration in the selection of Accounting Policies

Does not recognise the concepts of prudence and materiality for selection of accounting policies

Refers to prudence and materiality as a consideration for selection of accounting policies

If Ind-AS is applicable specifically to a transaction, other evernt or condition-refer to applicable Ind-AS

30th January, 2016


88CA Anil J. Sathe

Particulars ICDS AS Ind-ASChange in Accounting Policies

An accounting policy shall not be changed without “reasonable cause”

Change in Accounting Policy allowed if required by statute or for compliance with AS or if considered as resulting in more appropriate presentation

Change in Accounting Policy allowed if :a) Required by an Ind-

AS; orb) Results in the financial

statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flow.

30th January, 2016


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Explanatory Memorandum to Finance Act (No. 2) Bill, 2014 and Preamble to ICDS I : not for purpose of maintenance of books of accounts

ICDS I deals with accounting policies, fundamental accounting assumptions and considerations in selection of accounting policies If the provisions pertain to computation of income, how does

one ensure compliance? Will it mean that Memorandum Accounts need to be

maintained to prove compliance? The distinction between accounting which is a regular

exercise and computation of income which is a one time event appears not to have been appreciated.

Fundamental Accounting Assumption of “consistency” – in what context?

What if there is a conflict between principle of consistency and accrual?30th January, 2016 CA Anil J. Sathe

ICDS I – ACCOUNTING POLICIES - SIGNIFICANT ISSUES

1010CA Anil J. Sathe

ICDS I states that Accounting policies to be chosen to represent true & fair view of “state of affairs & income” What does “state of affairs” refer to with reference to

Computation and Disclosure of Income?

ICDS I requires that transactions and events be governed by their substance and not by legal form. Will this mean substance of a transaction shall prevail in

regard to transactions where there is a specific ICDS? Will this enable the Assessing Officer to re-compute the

income on the basis that substance of the transaction gives a different result (e.g., Real Estate Transactions and finance leases)

The concept of “materiality” has not been considered under ICDS I. This will require universal compliance of accrual irrespective

of quantum.30th January, 2016



In the absence of prudence and materiality, several situations resulting in earlier recognition of income or gains or later recognition of expenses may arise without any corresponding tax collection

Ambiguity would arise on deductibility of losses not specifically covered (e.g., MTM loss on derivatives)

The various judicial decisions allowing marked-to-market losses will be overruled?

Accounting Policies can be changed for any “reasonable cause”. However, the term “reasonable cause” has not been defined or explained. The subjectivity in interpretation of the term may lead to difference of opinions.

Implications when “Going Concern Assumption” fails30th January, 2016



It appears that ICDS I has to be read along with other Computation Standards

Will the principle of “substance over form” apply to computation even where the same is covered by another standard?

Disclosure: Where Disclosure to be made - Return of Income, tax audit

report, computation of income? If no tax audit, would e-returns permit such disclosures? If a person does not maintain books of accounts, is such

disclosure required? Do separate accounting policies have to be disclosed for

each source of income?30th January, 2016



Section 145A

Section 145A begins with a non obstantate clause . Does this override section 145 as far as Valuation of Inventory is concerned.

Section 145A requires inventory to be valued at: As per the accounting method regularly employed by the

assesse. Further adjusted to include the amount of tax, fees etc. paid

by the assesse to bring the goods to its present location and condition.

How does one reconcile this with the provisions of ICDS II?30th January, 2016

ICDS II – Valuation of Inventories


Applicability Determine the value at which inventories are carried in the

financials statements Cost ascertainment Treatment of carrying cost of inventories

Measurement Inventories to be valued at lower of cost or net realizable

value.

Assets Held for sale in ordinary course of business In process of Production for such sale Material or supplies to be consumed in the production

process or in the rendering of services30th January, 2016



Net Realizable Value Estimated Selling Price in ordinary course of business

reduced by estimated cost of completion necessary to make the sale.

Exclusions WIP under construction contract or other ICDS Securities held as stock-in-trade under ICDS VIII Inventories of Livestock Machine spares in connection with Tangible Assets

30th January, 2016



Cost of InventoriesIt is the cost incurred to bring inventories to their present location and condition.

Cost of Purchase Purchase price including duties & taxes, freight inwards and

other expenses directly attributable to acquisition excluding rebates.

Cost of Services Labour and other cost of personnel directly engaged in

producing service including supervisory and attributable overheads.

Cost of Conversion It is the systematic allocation of fixed and variable production

overheads30th January, 2016



Other Costs Costs incurred only to bring inventories to their present

location & condition, excluding interest & other borrowing cost unless covered under ICDS IX

Borrowing Costs If the inventory requires 12 months or more to bring it to a

saleable condition, then the borrowing cost is to be capitalized.

This is in conflict with Section 36(1)(iii)

30th January, 2016

ICDS II – Valuation of Inventories – Cost of Inventories


Exclusions Abnormal amounts of wasted materials & others Storage costs unless necessary Admin overheads not attributable to bring inventories to their

present location and conditions Selling & Distribution Overheads

Service Providers Definition of inventories does not include ‘Cost of services’ as

part of inventory. Words used are“materials or supplies to be consumed in the rendering services. However clause 6 includes, cost of labour, personnel and administrative overheads.

30th January, 2016

ICDS II – Valuation of Inventories – Cost of Inventories


Inventory Valuation methods include the following: Specific Identification Method First In First Out Weighted Average Standard Cost Retail Method ( For retail trader)

30th January, 2016



Specific Identification Cost Cost is not ordinarily interchangeable Specific identification of costs means costs attributed to

identified items of inventory Goods/ services produced and segregated fro specific

projects to be assigned to that project

First In First Out Most acceptable method if specified cost method is not

applicable Items of inventory purchased first are sold first Reflects the most fairest possible approximation to costs

incurred

30th January, 2016



Weighted Average Cost (WAC) WAC determines the cost on

Weighted average cost of similar items at the beginning &

Acquisition cost during the relevant period Average shall be calculated on periodic basis

Retail Method When it is impractical to use FIFO or WAC, in case of a retail

trader this method can be applied The inventory cost is determined by reducing the appropriate

Gross Profit margin from sales.

30th January, 2016



Net Realizable Value Method In this method the inventory is written down to NRV The most reliable evidence is taken into consideration for the

valuation of Net Realizable Value It also takes price fluctuation into consideration Material and supplies are not to be written down below cost.

Disclosure The accounting policy adopted in measuring , including the cost

formula should be disclosed along with The total carrying cost of inventories and its classification

30th January, 2016



Exclusion of Standard CostStandard cost which was included in AS 2 is not a part of ICDS II because:

Actual profit is higher if the standard cost method is not applied

ICDS proposes to tax income on actual profits basis No profit can arise from valuation of stock, hence standard

cost method is disputed Two fundamental principles of Tax law are applied:

Only the correct income for the year should be brought to tax for that year; and

Each year is an independent and self contained unit of assessment

30th January, 2016



Dissolution In situations of a firm, AOP or BOI inventory on Date of

dissolution shall be the NRV, whether or not the business is discontinued. No such provision exists in AS 2. AS 2 expects the business

continuation method for NRV No new rule has been prescribed for companies entailing

restructuring through amalgamation.Consequences of non compliance Non compliance of ICDS may result into best judgment

assessment

Method of valuation once adopted cannot be changed without reasonable cause

30th January, 2016

ICDS II – Valuation of Inventories – Other Aspects


Change in method of Valuation

The term reasonable cause has not been defined. Guidance may be obtained from some judicial precedence, and should be decided upon the facts of each case.

Change in Accounting Policy only if the adoption of a different accounting policy is required by the statute or for compliance of AS or if it results in a more appropriate presentation of financials

Different methods can be adopted for different businesses or sectors if needed

Consistent method followed by the taxpayer and not objected by the revenue should not result in any valuation adjustment of closing stock or change of method if the change is bonafide.

30th January, 2016

ICDS II – Valuation of Inventories – Reasonable Cause


Grandfathering Provisions

Value of the inventory at the beginning of the previous year is: For newly commenced business, cost of inventory on day of

commencement of business is the opening inventory Value of the inventory as on the close of the immediately

preceding previous year, in any other case

Transition provisions of inventory prescribes opening inventory to be carried out as per AS 2,including borrowing cost even though not compliant with ICDS IX

30th January, 2016



Scope of ICDS III ICDS III applies to determination of income of a contractor

arising from construction contract A construction contract is specifically negotiated for the

construction of an asset or a combination of assets that are closely interrelated in terms of their design, technology and function or their ultimate purpose or use and includes Contract for rendering of services which are directly related

to the construction of the asset, Contract of destruction or restoration of assets, and the

restoration of the environment following the demolition of assets

ICDS committee recommended a separate ICDS for: Real Estate Developer Service Concession Agreements (BOT Projects)

30th January, 2016

ICDS III – Construction Contracts


Fixed Price Contract It is a construction contract in which the contractor agrees to

a fixed contract price, or a fixed rate per unit of output, which may be subject to escalation clauses

Eg: Construction of Residential or commercial properties etc.

Cost Plus Contract It is a construction contract in witch the contractor is

reimbursed for allowable or otherwise defined costs, plus a mark up on these costs or a fixed fee

Such contracts are entered into where cost is not easily ascertainable.

30th January, 2016



Combining and Segregating Construction Contracts

ICDS III to be applied to each construction contract separately subject to the following parameters

When there are number of assets in a single contract, each asset to be treated as a separate construction contract when: Separate proposals, negotiations, acceptance are carried out

for each asset Cost and revenue is identifiable for each asset

Group contracts to be treated as single construction contracts when: It is negotiated as a single package with an interrelated

overall profit margin Contracts are performed concurrently or in a continuous

sequence30th January, 2016



Construction of additional asset to be treated as a separate construction contract when: Asset differs significantly in design, technology or function

from the assets covered by original contract Separate negotiation for the additional asset

Tests for combining and segmenting construction contracts are similar to those laid down in ICAI AS 7

30th January, 2016



Real Estate Developers

Presently revenue recognition from real estate development is governed by ICAI’s Guidance note on accounting for Real Estate Transactions

ICAI Guidance note borrows principles from AS 7 and AS 9 and recommends application of either of them based on substance of contract

ICAI AS 7 does not apply to real estate developers

Neither ICDS III nor ICDS IV on revenue recognition may aptly apply to revenue recognition from real estate development

30th January, 2016



ICDS committee has recommended notification of separate ICDS on real estate development activity in absence on mandatory AS

Exposure draft of Ind AS 11 includes within it’s scope ‘agreements of real estate development to provide services together with construction material in order to perform contractual obligation to deliver the real estate to the buyer.’

Taxation of real estate developers may continue to be governed by existing GAAP till ICDS III is modified.

30th January, 2016



Accounting Steps Step 1: Estimate total contract profit/ (loss)

The total projected revenue minus the total projected contract cost will give the estimated profit or loss

Step 2: Identify the stage of completion as at reporting dater with reference to: Costs incurred vis-à-vis total estimated costs (or) Survey of work performed (or) Completion of physical proportion of the contract work

Step 3: Recognize profit/ (loss) on contract as at reporting date w.r.t. stage of completion (minus) profit/ (loss) already recognized in the earlier years. For eg: If contract is at an early stage (<25%), do not

recognize any profits30th January, 2016



Contract Revenue Contract Cost

To be recognized when there is reasonable certainty of its ultimate collection

It includes direct cost, cost attributable from date of securing contract to final completion, costs specifically chargeable to customer, Borrowing costs as per ICDS IX

Retention money to be included as part of contract revenue

Identifiable costs for securing contract if there is probability of obtaining contract

Variations in contract work, claims and incentive payment, if cash flow is probable and capable of being reliably measured

Contract costs to be reduced by incidental income except interest, dividends or capital gains

ICDS IX does not permit reduction of income from temporary investments of borrowed funds for capitalizationContract costs relating to future activity to be recognized as an asset

30th January, 2016



Foreseeable Loss Recognition AS 7 permitted recognition of foreseeable loss at any stage of

contract

ICDS III provides that losses incurred shall also be allowed only in proportion to the stage of completion

Future or anticipated losses shall not be allowed unless such losses are actually incurred

ICDS I omits consideration of conservatism and prohibits recognition of expected losses (unless permitted by other ICDS)

30th January, 2016



Year Contract Unrelated

IncomeTotal Income Computation

Normal Income (ICDS)

Book Profit

1(<25

% work

)

Foreseeable loss (10,000) 8,000 8,000

-2000

2

Contract concludes on loss 8000 -2000 8000

30th January, 2016


Impact of MAT Therefore the tax payer

ends up paying tax in two years on income which is larger than his real income.

This militates against the objective of ICDS


Particulars AS 7/ Proposed Ind AS 11 ICDS III

Recognition of contract revenue

Contract revenue to be recognized on POCM

basis if it is possible to reliably measure the

outcome of a contract

Contract revenue to be recognized if there is

reasonable certainty of its ultimate collection

Recognition of incentive

payments/claims against

customers

Incentive payment/ claims to be recognized if

Incentives can be reliably measured and probability

exists that specified performance standards

would be met or exceeded, customer will

accept claim

Incentives payments/ claim to be recognized if:

Incentive/ claim is reliably measurable and it is probable that it will

result in revenue30th January, 2016



Particulars AS 7/ Proposed Ind AS 11

ICDS III

Impact of variation in scope of contract

Contemplates variation in revenue on account of increase or decrease in scope of work

Contemplates variation due to increase in scope of work and does not specifically refer to downward variation

Early stage of completion

There is no specific percentage

Early stage shall not extend beyond 25% of work completed

Parameters to determine stage of completion

It can be determined in a variety of ways including the methods in ICDS III

• Cost incurred vis-à-vis total cost

• Survey of work performed• Completion of physical

proportion

30th January, 2016



Particulars AS 7/ Proposed Ind AS 11

ICDS III

Recognition of contract WIP

Contract cost which relate to future activity shall be recognized as an asset if recovery is probable

To be recognized as an asset even if recovery not probable.If the cost is not realizable the loss is to be allowed under provisions of the act

Reversal of Revenue

Revenue already recognized can be reversed on account of uncertainty in the future

Reversal of revenue needs to be claimed separately as an expense and is not to be adjusted against the contract revenue

30th January, 2016



Disclosures Taxpayer needs to make the following disclosures:

Contract revenue recognized for the current period Method used to determine the stage of completion Total costs incurred and recognized profits (less recognized

losses) up to the reporting date Advances received Retention Money

No incremental disclosure as compared to AS 7 Whether disclosures made as part of financial statements

shall suffice?

30th January, 2016



Transitional Provisions ICDS committee recommended notification of transitional

provision along with ICDS to address the issue of double taxation or non taxation arising from ICDS becoming effective on a particular date

Transitional provision of ICDS III reads as follows“Contract revenue and contract costs associated with the construction contract, which commenced on or before 31st day of march, 2015 but not completed by the said date, shall be recognized as revenue and costs respectively in accordance with the provisions of the standard. The amount of contract revenue , contract cost or expected loss if any, recognized for the said contract for any previous year commencing on or before the 1st day of April, 2014 shall be taken into account for recognizing the revenue and costs of the said contract for the previous year commencing on the 1st day of April, 2015 and subsequent previous years.”30th January, 2016



Para 16 of ICDS III reads as follows:“Contract revenue and contract costs associated with the construction contract should be recognized as revenue and expenses respectively by the reference to the stage of completion of the contract activity at the reporting date.”

30th January, 2016



Issues with Construction Contracts Retention Money

There are a number of court decisions which have taken the view that retention monies accrue only when the conditions of retention are satisfied.

Will those decisions prevail or will ICDS prevail? Natural Calamities

If there are actual losses by natural calamities, can the recognition of such losses be ignored?

As per the “Substance over form” as prescribed by ICDS I, will it be ignored in the computation mechanism?

MAT Impact An assesse may have to pay tax on an amount that is more

than his real income.30th January, 2016



Challenges with service revenue recognition Mandatory for service sector following mercantile method of

accounting to recognize revenue on POCM basis mutatis mutandis ICDS III principles

Mandatory POCM may pose challenges for service sector activities like: Telecom/Software/Online Database- Royalty vs. service Hotel Industry (Eg. Time share plan) Banking Sector Other professional Long Term Contracts

POCM read with ICDS III on inventory valuation which requires valuation of service inventory poses administrative difficulties for short duration contracts which spillover two financial years.

30th January, 2016



THANKYOU!

30th January, 2016

Documents

11 INCOME COMPUTATION AND DISCLOSURE STANDARDS. 22 Applies to “computation of income” under the head Profits and Gains of Business or Profession or