PRACTICAL ISSUES IN INCOME COMPUTATION AND DISCLOSURE STANDARDS NO : I, II, IV, V, IX & X

APPLICABILITY OF ICDS The revised Income Computation and Disclosure Standards were notified by CBDT vide notification no. S.O 3078(E), dated 29th September 2016. The Central Board of Direct Taxes (CBDT) through its notification no. 87/2016, dated 29th September 2016 notified revised ICDS and repealed its earlier notification no. 32/2015, dated 31st March 2015.

The ICDS will be applicable from 1st April 2016 and will accordingly apply in relation to the Assessment year 2017-18 and subsequent years. The Income Computation and Disclosure Standards will apply to the following category of assessees who follow mercantile system of Accounting and have income chargeable to Income Tax under the heads: a) ‘Profits and gains of business or profession’ or b) ‘Income from other sources’

ICDS will apply to Non Residents also. The revised ICDS are applicable to all assessees other than individual or HUF who is not required to get his/her accounts of the previous year audited in accordance with the provisions of section 44AB of Income Tax Act, 1961.

ICDS is applicable to specified persons having income chargeable under the head ‘Profits and gains of business or profession’ or ‘Income from other sources’. Therefore the relevant provisions of ICDS shall also apply to the persons computing income under the relevant presumptive taxation scheme. For example, for computing presumptive income of a partnership firm under section 44AD of the Act, the provisions of ICDS on Construction Contract or Revenue recognition shall apply for determining the receipts or turnover, as the case may be.

As per notification no. S. O As per notification no.S.O. 3078(E) dated 29th September 2016, the following have been notified under Income Computation and Disclosure Standards: ICDS I Accounting Policies ICDS II Inventories ICDS III Construction Contracts ICDS IV Revenue Recognition ICDS V Tangible Fixed Assets ICDS VI Effects of changes in Foreign Exchange Rates ICDS VII Government Grants ICDS VIII Securities ICDS IX Borrowing Costs ICDS X Provisions, Contingent Liabilities and Contingent Assets

There are transitional provisions built-in for each of the ICDS except in the case of ICDS VIII relating to Securities. The objective of the transitional provisions is to ensure that ICDS will apply for those transactions which are existing on 1st day of April 2015 or entered into on or after 1st day of April 2015.

Section 145(1) of the Income Tax Act, 1961 provides an option to the assessee whose income is chargeable under the heads ‘Profits and gains of business or profession’ or ‘Income from other sources’ that income can be computed in accordance with either cash or mercantile system of accounting whichever is regularly employed by the assessee. Whereas ICDS applies only when mercantile system of accounting is followed. In other words, for those assessees following cash system of accounting, ICDS will not apply.

The method of Accounting followed by the assessee must be consistent The method of Accounting followed by the assessee must be consistent. Where the method of accounting is not consistent or the accounting standards as notified pursuant to S.145(2) have not been regularly followed by the assessee then in such circumstances, then the Assessing officer may make an assessment in the manner provided in S. 144 of the Income Tax Act, 1961. ICDS provides for change in the method of Accounting, there should be a reasonable cause. In the absence of reasonable cause, change in method of Accounting is not allowed. So reasonable cause is a substantive matter to prove for change in method of accounting.

The provisions of ICDS are applicable for computation of Income under the regular provisions of the Act, the provisions of ICDS shall not apply for computation of MAT. AMT under section 115JC of the Act, is computed on adjusted total income which is derived by making specified adjustments to total income computed as per the regular provisions of the Act. Hence the provisions of ICDS hall apply for computation of AMT.

The principle of presumptive taxation is that certain percentage of profit is offered to tax on certain presumptions which are governed by certain provisions. In such a case normally, the question of maintaining books of accounts will not apply. In the absence of maintenance of books of accounts, mercantile system of accounting will not apply. As such ICDS will not apply. In case of where there is a conflict between provisions of ICDS and provisions of the Income Tax Act 1961 then the provisions of the Act will prevail over ICDS.

ICDS-1 ACCOUNTING POLICIES

Fundamental Accounting Assumptions The following are fundamental accounting assumptions – a) Going Concern: “Going Concern” refers to the assumption that the person has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the business, profession or vocation and intends to continue his business, profession or vocation for the foreseeable future. b) Consistency: “Consistency” refers to the assumption that accounting policies are consistent from one period to another. c) Accrual: “Accrual” refers to the assumption that revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the previous year to which they relate.

Accounting Policies The accounting policies refer to the specific accounting principles and the methods of applying those principles adopted by a person.

Considerations in the Selection and Change of Accounting Principles a) Accounting policies adopted by a person shall be such as to represent a true and fair view of the state of affairs and income of the business, profession or vocation. For this purpose, i) the treatment and presentation of transactions and events shall be governed by their substance and not merely legal form, and ii) Market to Market (MTM) loss or an expected loss shall not be recognised unless the recognition is in accordance with the provisions of any other ICDS) as contained in ICDS-I relating to MTM losses or an expected loss shall apply mutatis mutandis to MTM gains or an expected profit. [Circular No. 10/217, dated 23-03-2017]

b) An accounting policy shall not be changed without reasonable cause. Disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item. If the fundamental accounting assumption of Going concern, Consistency and Accrual are followed, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact shall be disclosed.

All contract or transaction existing on the 1st day of April, 2016 or entered into on or after the 1st day of April, 2016 shall be dealt with in accordance with the provisions of this standard after taking into account the income, expense or loss, if any, recognised in respect of the said contract or transaction for the previous year ending on or before the 31st March, 2016.

Reporting Requirements under Form 3CD Clause 9 to Clause 13, Clause 21(b) to (i), Clause 26, Clause 27 (b) of the Form 3CD are relevant.

PRACTICAL ISSUES TO BE DISCUSSED RELATING TO ICDS- I ACCOUNTING POLICIES 1. Whether it is statutorily required to disclose when accounting assumptions were not followed? 2. What is the meaning of Accrual / Mercantile system of Accounting in ICDS – I? 3. How do you verify whether “Accrual/ Mercantile system of accounting is followed for ICDS –I? 4. What is the meaning of the expression “Significant Accounting Policies”? 5. What is meant by “True and fair view” of state of affairs under ICDS –I? In case of corporate assessees, is it the same as mentioned in Section 129 of Companies Act, 2013?

ICDS II VALUATION OF INVENTORIES

Scope of ICDS II ICDS II is applicable for valuation of inventories but is not applicable for: a) Work in progress arising from construction contracts. b) Work in progress dealt with in other ICDS c) Financial instruments held as stock in trade d) Product relating to agriculture, live stock, forest production, mineral, oils, ores and gases e) Machinery spares held as stock in trade

Cost of Inventories The cost of inventories includes all costs of purchase, costs of services, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Cost of Purchases The cost of purchase shall consist of the following: i) Duties and taxes ii) Freight inwards iii) Other expenditure directly attributable to the acquisition minus the following a) Trade discounts b) Rebates and other similar items.

Labour and other costs of personal directly engaged in providing the Cost of services The cost of service includes the following – Labour and other costs of personal directly engaged in providing the service including supervisory personnel and attributable overheads.  

Other costs Any other costs to the extent that they are incurred in bringing the inventories to their present location and condition shall be included. However, interest on other borrowing costs shall not be included unless the requirement specified in the ICDS on borrowing costs are met with.

Method of valuation i) Specific identification method ii) FIFO Following are the methods of valuation recognized in the ICDS II: i) Specific identification method ii) FIFO iii) Weighted average cost iv) Retail method v) Standard cost

Net realisable value “Net realisable value” is the estimated selling price in the ordinary course of business less the estimated costs, of completion and the estimated cost necessary to make the sale.

Basic principle of measurement of inventories As per Para 3 of ICDS II, inventories shall be valued at cost or net realisable value, whichever is lower.

Standard cost method Standard costs take into account normal levels of consumption of materials and supplies, labour, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of the current conditions.

Retail method The new technique for the measurement of cost Para 18(2) provides for the retail method. The retail method can be used in the retail trade for measuring inventories of large number of rapidly changing items that have similar margins and for which it is impracticable to use other costing methods. The cost of the inventory is determined by reducing from the sales value of the inventory, the appropriate percentage of gross margin. The percentage used takes into consideration inventory, which has been marked down to below its original selling price. An average percentage for each retail department is to be used.  

Valuation of opening inventory As per Para 22 of ICDS II, the value of the inventory as on the beginning of the previous year shall be i) The cost of inventory available, if any, on the date of the commencement of the business when the business has commenced during the previous year; and ii) The value of the inventory as on the close of the immediately preceding previous year, in any other case.

Change in the method of valuation of inventories As per Para 23, the method of valuation of inventories once adopted by a person in any previous year shall not be changed without reasonable cause

Valuation at the time of dissolution In case of dissolution of a partnership firm or association person or body of individuals, notwithstanding whether business is discontinued or not, the inventory on the date of dissolution shall be valued at the net realisable value

Reporting requirements under Tax audit Clause 14, Clause 15 and Clause 35 of Form 3CD are relevant.

PRACTICAL ISSUES RELATING TO ICDS II What Tax auditor has to do if incorrect method of inventory valuation is followed consistently for a long period by an assessee? What is the difference between the change in the method of valuation and deviation in the method of valuation? How to make adjustments under Section 145A in case of Inclusive and Exclusive method of accounting? What is the basis of valuing Work in progress in case of service provider?

ICDS IV REVENUE RECOGNITION

Scope of ICDS IV The Income Computation and Disclosure Standard IV deals with the basis for recognition of revenue arising in the course of the ordinary activities of a person from i) the sale of goods; ii) the Rendering of services; iii) the use by others of the person’s resources yielding interest, royalties or dividends. This Income Computation and Disclosure Standard does not deal with the aspects of Revenue recognition which are dealt with by other Income Computation and Disclosure Standards.

Revenue “Revenue” is the gross inflow of cash, receivables or other consideration arising in the course of ordinary activities of a person from the sale of goods, from the rendering of services, or from the use by others of the person’s resources yielding interest, royalties or dividends. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash , receivables or other consideration.

Rendering of Services Subject to Para 7, Revenue from service transactions shall be recognised by the percentage completion method. Under this method, revenue from service transaction is matched with the service transaction cost incurred in reaching the stage of completion, resulting in the determination of revenue, expenses and profit which can be attributed to the proportion of work completed. Income Computation and Disclosure Standard on Construction Contract also requires the recognition of revenue on this basis. The requirements of that Standard shall mutatis mutandis apply to the recognition of revenue and the associated expenses for a service transaction. However, when services are provided by an indeterminate number of acts over a specified period of time, revenue may be recognised on a straight line basis over the specific period. Revenue from Service contracts with duration of not more than ninety days may be recognised when the rendering of services under that contract is completed or substantially completed.

Recognition of Interest As per Para 8(1) and 8(2) of ICDS IV, “8(1) Subject to sub paragraph (2), Interest shall accrue on the time basis determined by the amount outstanding and the rate applicable. 8(2) Interest on refund of any tax, duty or cess shall be deemed to be the income of the previous year in which such interest is received.”

Recognition of Royalties As per Para 9 of ICDS IV, Royalties shall accrue in accordance with the terms of the relevant agreement and shall be recognised on that basis unless, having regard to the substance of the transaction, it is more appropriate to recognise revenue on some other systematic and rational basis.

Recognition of Dividends As per Para 10, Dividends should be recognised in accordance with the provisions of the Act.

Transitional Provisions The transitional provisions of Income Computation and Disclosure Standard on Construction Contract shall mutatis mutandis apply to the recognition of revenue and the associated costs for a service transaction undertaken on or before the 31 day of March, 2016 but not completed by the said date.

Transitional Provisions Revenue for a transaction, other than a service transaction in Para10, undertaken on or before the 31st day of March,2016 but not completed by the said date shall be recognised in accordance with provisions of this standard for the previous year commencing on the 1st day of April, 2016 and subsequent previous year. The amount of revenue, if any, recognised for the said transaction for any previous year commencing on or before the 1st day of April, 2015 shall be taken into account for recognising revenue for the said transaction for the previous year commencing on the 1st day of April, 2016 and the subsequent previous years.

Deferring the revenue recognition under ICDS, recognition of revenue can be deferred if there is an uncertainty in its ultimate collection.

Reporting requirements under Form 3CD Clause 16, 24, 25 and 27(b) of Form 3CD are relevant.

PRACTICAL ISSUES RELATING TO ICDS IV Treatment of Revenue recognition for different type of sales like a) Guaranteed sales b) Consignment sales c) Cash sales d) Instalment sale e) Conditional Delivery Treatment of advance received Treatment of different types of commission received like a) Advertising commission b) Insurance Agency Commission c) Commission on Financial Services Treatment of price revision, quantity claim, quality claim etc.

ICDS V TANGIBLE FIXED ASSETS

Tangible Fixed Asset “Tangible Fixed Asset” is an asset being land, building, machinery, plant or furniture held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business.

Stand-by equipment and servicing equipment Stand-by equipment and servicing equipment are to be capitalised. Machinery spares shall be charged to the revenue as and when consumed. When such spares can be used only in connection with an item of tangible fixed asset and their use is expected to be irregular, they shall be capitalised.

Components of actual cost The actual cost of an acquired tangible fixed asset shall comprise its purchase price, import duties and other taxes, excluding those subsequently recoverable, and any directly attributable expenditure on making the asset ready for its intended use. Any trade discounts and rebates shall be deducted in arriving at the actual cost.

Treatment of expenses incurred before commencement of commercial production As clarified in Para 8 of ICDS V, the expenditure incurred till the plant has begun commercial production, that is production intended for sale or captive consumption, shall be treated as capital expenditure.

Non monetary consideration When a tangible fixed asset is acquired in exchange for another asset, the fair value of the tangible fixed asset so acquired shall be its actual cost.

What is fair value? Fair value of an asset is the amount for which that asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.

Tangible asset acquired in exchange of shares and securities When a tangible fixed asset is acquired in exchange for shares or other securities, the fair value of the tangible fixed asset so acquired shall be its actual cost.

Improvements and repairs An expenditure that increases the future benefits from the existing assets beyond its previously assessed standard of performance is added to the actual cost.

Cost of an addition or extension to an existing tangible fixed asset The cost of an addition or extension to an existing tangible fixed asset which is of a capital nature and which becomes an integral part of an existing tangible fixed asset is to be added to its actual cost. Any addition or extension, which has a separate identity and is capable of being used after the existing tangible fixed asset is disposed of, shall be treated as separate asset.

Disclosures in Form 3CD Clause 13 and Clause 18

PRACTICAL ISSUES IN ICDS V Problems in criteria for Initial recognition. Capitalisation of subsequent expenditure - The old issue of replacement may again arise. Cost of dismantling or removing fixed asset and restoring the site.

ICDS IX BORROWING COST

Scope a) This Income Computation and Disclosure Standard deals with treatment of borrowing costs. b) This Income Computation and Disclosure Standard does not deal with the actual or imputed cost of owners’ equity and preference share capital.

Borrowing Costs “Borrowing costs” are interest and other costs incurred by a person in connection with the borrowing of funds and include: a) commitment charges on borrowings; b) amortised amount of discounts or premiums related to borrowings; c) amortised amount of ancillary costs incurred in connection with the arrangement of borrowings; d) finance charges in respect of assets acquired under finance leases or under other similar arrangements.

Qualifying asset “Qualifying asset” means – a) Land, Building, Machinery, Plant or Furniture, being tangible assets; b) Know-how, Patents, Copyrights, Trademarks, Licences, Franchises or any other business or commercial rights of similar nature, being intangible assets. c) Inventories that require a period of twelve months or more to bring them to a saleable condition.

Recognition Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset shall be capitalized as a part of the cost of that asset. The amount of borrowing costs eligible for capitalization shall be determined in accordance with this Income Computation and Disclosure Standard. Other borrowing costs shall be recognized in accordance with the provisions of the Act.

Borrowing costs eligible for capitalization a) To the extent the funds are borrowed specifically for the purposes of acquisition of a qualifying asset, the amount of borrowing costs to be capitalized on that asset shall be the actual borrowing cost incurred during the period on the funds so borrowed.

Borrowing costs eligible for capitalization b) To the extent the funds are borrowed generally and utilised for the purposes of acquisition of a qualifying asset, the amount of a borrowing costs to be capitalised shall be computed in accordance with the following formula namely – A x =B/C A = borrowing costs incurred during the previous year except on borrowings directly relatable to specific purposes; B = i) The average costs of qualifying assets as appearing in the Balance sheet of a person on the first day and the last day of the previous year ii) In case the qualifying asset does not appear in the balance sheet of a person on the first day or both on the first day and the last day of the previous year, half of the cost of qualifying asset; iii) In case the qualifying asset does not appear in the balance sheet of a person on the last day of the precious year, the average of the cost of the qualifying asset as appearing in the balance sheet of a person on the first day of a previous year and on the date of the completion, other than those qualifying assets which are directly funded out of specific borrowings; or C = The average of the amount of total assets as appearing in the balance sheet of a person on the first day and the last day of the previous year, other than those assets which are directly funded out of specific borrowings.

Commencement of Capitalisation The capitalisation of borrowing costs shall commence : a) In a case referred to in paragraph 5, from the date on which funds wee borrowed; b) In a case referred to in paragraph 6, from the date on which funds were utilized.

Cessation of Capitalisation Capitalisation of borrowing costs shall cease: a) In case of a qualifying asset referred to in item (i) and (ii) of clause (b) of sub-paragraph (1) of paragraph 2, when such asset is first put to use; b) In case of inventory referred to in item (iii) of clause (b) of sub-paragraph (1) of paragraph 2, when substantially all the activities necessary to prepare such inventory for its intended sale are complete.

Transitional provisions All the borrowing costs incurred on or after first day of April 2016 shall be capitalised for the previous year commencing on or after first day of April 2016 in accordance with the provisions of this standard after taking into account the amount of borrowing costs capitalised, if any, for the same borrowing for any previous year ending on or before 31st day of March 2016.

Disclosure The following disclosure shall be made in respect of borrowing costs, namely: a) The accounting policy adapted for borrowing costs; and b) The amount of borrowing costs capitalised during the previous year.

Reporting requirements under Form 3CD Clause 13 of Form 3CD.

PRACTICAL ISSUES IN ICDS IX What constitutes a substantial period of time? Treatment of interest of margin money paid out of cash credit. Treatment of interest cost incurred on acquisition of inventory

ICDS X PROVISONS CONTINGENT LIABILITES AND CONTINGENT ASSETS

Provision “Provision” is a liability which can be measured only by using a substantial degree of estimation.

Contingent liability i) A possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non- occurrence of one or more uncertain future events not wholly within the control of the person; or ii) A present obligation that arises from past events but is not recognised because: a) it is not reasonably certain that an outflow of resources embodying economic benefits will be required to settle the obligation; or b) a reliable estimate of the amount of the obligation cannot be made

Contingent asset “Contingent asset” is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or non- occurrence of one or more uncertain future events not wholly within the control of the person.

Recognition A) Provision a) A provision shall be recognised when: i) A person has a present obligation as a result of a past event; ii) It is reasonably certain that an outflow of resources embodying economic benefits will be required to settle the obligation; and iii) A reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision shall be recognised.

Recognition b) No provision shall be recognised for costs that need to be incurred to operate in the future. c) It is only those obligations arising from past events existing independently of a person’s future actions, that is the future conduct of its business, that are recognised as provisions. d) Where details of a proposed new law have yet to be finalised, an obligation arises only when the legislation is enacted.

Recognition B) Contingent liabilities A person shall not recognise a contingent liability. C) Contingent assets A person shall not recognise a contingent asset. Contingent assets are assessed continually and when it becomes reasonably certain that inflow of economic benefit will arise, the asset and related income are recognised in the previous year in which the change occurs.

Reviewing the provisions As per para 17, provision shall be reviewed at the end of each previous year and adjusted to reflect the current best estimate. If it is no longer reasonably certain that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision should be reversed. Further in case of contingent assets and related incomes, the provision shall be reviewed at the end of each previous year and adjusted to reflect the current best estimate. If it is no longer certain that an inflow of economic benefits will arise, the assets and related income shall be reversed.

Non Applicability of ICDS X a) Resulting from financial instruments b) Resulting from executor contracts c) Arising in insurance business from contracts with policy holders and d) Covered by another Income Computation and Disclosure standards

PRACTICAL ISSUES IN ICDS X Damages to be settled which are under litigation. Warranty claim Post balance sheet events Treatment of provision for proposed changes in Technology Treatment of provision for proposed changes in Legislation