Income Computation and Disclosure Standards (ICDS)

Notified ICDS Below are the notified 10 ICDS Effects of changes in Foreign Exchange Rates Accounting Policies Government Grants Borrowing costs Revenue Recognition Inventories Tangible Fixed Assets Construction Contracts Securities Provisions, Contingent Liabilities and Contingent Assets

ICDS II – Valuation of Inventories

ICDS II – Valuation of Inventories Deals with valuation of inventory Inventories defined as assets Held for sale in ordinary course of business In process of production for such sale In forms of materials or supplies to be consumed in production process or rendering of services Inventories shall be valued at cost or NRV, whichever is lower FIFO, specific identification, weighted average, standard costing method or retail method – permitted methods for cost measurement Exclusions WIP under construction contract / other ICDS Shares, debentures and Financial instrument held as stock-in-trade Producer’s Inventories of livestock, agriculture, etc. to the extent measured at NRV Machinery spares which can be used in connection with Tangible Assets – irregular in use Overview Standard costing has not been permitted under the revised ICDS Primarily in line with AS-2 except that AS-2 specifically exclude WIP for service providers

ICDS II – Cost of Inventories Cost of Purchases Cost of labour + other personnel cost (directly engaged in providing the service) + attributable overheads Cost of Services Cost of Conversion and Other costs Cost of conversion Directly attributable cost + allocation of fixed and variable overheads Unallocated overheads to be recognized as expense Cost of by products, scrap or waste - to be reduced from main product at NRV Purchase price + duties / taxes + freight inwards + other expenses directly attributable to the acquisition – trade discounts / rebates Unlike Indian GAAP, as per ICDS - cost of inventory includes cost of services. Thus, ambiguity still persists. The previously issued ICDS included the requirement of determining the cost of services in case of a service provider. - There were concerns with respect to the manner in which cost of services of a service provider should be valued as there was substantial subjectivity on estimation of inventory for professional firms, particularly in case of a fixed price project. Also, there could be service tax implication on the inventory of a service provider for incomplete work. It appears that to remove this anomaly, the revised ICDS has omitted words ‘in case of a service provider’ appearing in ICDS II for determining the cost of services. This aligns inventory and revenue accounting for service providers between accounting records and tax computations. The amended ICDS removes requirement of service inventory for service providers. Cost of services not specifically provided under AS-2 – whether required??

ICDS II – Valuation of Inventories Areas Current Accounting practice – Indian GAAP ICDS Cost of Purchase Cost of purchase, inter-alia, consists of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities) Does not specifically exclude duties and taxes subsequently recoverable – In line with provisions of Section 145A. So there should be no impact Distribution costs Distribution costs excluded Not specifically excluded – Companies do not include distribution costs in valuation of inventory. So there should be no impact. Cost of Purchase – The issue relating to whether the value of closing stock of the inputs, WIP and finished goods must include the element for which CENVAT Credit is available has been the matter of considerable litigation. Section 145A (came into force from A.Y. 99-00) - provides that the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head PGBP shall be in accordance with: The method of accounting regularly employed by the assesse, and Further adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation. It further clarifies that for the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment. As per the requirements of Section 44AB, auditors are also required to provide details of deviation, if any, from the method of valuation prescribed under section 145A, and the effect thereof on the profit or loss in Form 3CD. The Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961 ('the guidance note') has explained the adjustments envisaged by section 145A will not have any impact on the trading account of the assessee.

ICDS II – Valuation of Inventories Areas Current Accounting practice – Indian GAAP ICDS Change in method of valuation Change in accounting policy should be made only if - Required by statue Required by another Accounting Standard Results in more appropriate presentation of financial statements Does not permit change in method of valuation without ‘reasonable cause’ - However, ‘Reasonable cause’ not defined Following could be the illustrative examples of reasonable cause (as per judicial precedents): To represent true and fair view To meet statutory requirement More appropriate preparation and presentation of financial statements Reasonable person considers just and acceptable under normal circumstances Commercial or business need which will result into appropriate and fair presentation of transaction Issue – What is the meaning of the term ‘reasonable cause’? Position Paper – The Gujarat HC - ‘Reasonable cause’ means an excuse which a reasonable person considers just and acceptable in the circumstances of the case, that is, which appeals to the reason of a reasonable man. Various Courts have held that reasonable cause can be reasonably said to be a cause which prevents a man of ordinary prudence, acting under normal circumstances without negligence or inaction or want of bonafide. The Madras HC - Business exigency can amount to reasonable cause. Also, the genuineness of the transaction to meet the immediate necessity can amount to reasonable cause

ICDS II – Change in method of Valuation – Impact on Opening Stock Tax impact in the year of change of inventory valuation - Value of opening stock to be same as the value of closing stock of the immediate preceding year Contrary judgements exist: CIT v. Mahavir Aluminum Ltd. [Delhi HC] – Adjust opening inventory Melmould Corporation v. CIT [Bombay HC] – Do not adjust opening inventory DCIT v. Daman Ganga Paper Limited [Mumbai Tribunal] – Adjust opening inventory Refer illustration in the next slide Other Key Points ICDS II specifically provides a rule to ensure that there is continuity in valuation and the value of the closing stock is the value of the opening stock for the subsequent year

ICDS II – Change in method of Valuation – Case Study FIFO Method Weighted Average Cost Method Year 1 Particulars Amount Opening Stock 100 Sales 500 Expenses 400 Closing 200 Profit Total 700 In Year 2, the Method of Valuation is changed from FIFO to weighted average cost. Lets say, following the weighted average cost method results in increase in the valuation of closing stock by 10%. Year 2 Particulars Amount Opening Stock 200 Sales 800 Expenses 600 Closing 300 Profit Total 1,100 Year 2 Particulars Amount Opening Stock 220 Sales 800 Expenses 600 Closing 330 Profit 310 Total 1,130

ICDS II – Change in method of Valuation – Case Study Opening Stock – Not Adjusted Opening Stock - Adjusted Year 2 Particulars Amount Opening Stock 200 Sales 800 Expenses 600 Closing 330 Profit Total 1,130 Year 2 Particulars Amount Opening Stock 220 Sales 800 Expenses 600 Closing 330 Profit 310 Total 1,130 Impact Closing Stock 30 Opening Stock - Profit Impact Closing Stock 30 Opening Stock 20 Profit 10

ICDS II – Ind AS vs. ICDS Purchase of inventories on deferred settlement terms Purchase inventories on deferred settlement terms effectively contains a financing element Under Ind AS - The financing element, i.e. difference between the purchase price for normal credit terms and the amount paid, have to be recognized as interest expense over the period of the financing Under ICDS / Act – there is no such specific provision Therefore any difference arising on account of recording of expenses vis-à-vis Ind AS, will require adjustment

ICDS V – Tangible Fixed Assets

ICDS V – Overview Deals with treatment of tangible fixed assets Tangible fixed asset defined as Asset being land, building, machinery, plant or furniture; Held with the intention of using for producing / providing goods or services; and Not held for sale in the normal course of business Depreciation is as per the provisions of the Act Income arising on transfer of tangible fixed asset shall be computed as per the provisions of the Act

ICDS V – Tangible Fixed Assets Components of cost align largely with definition of actual cost in Section 43(1) of ITA Cost of fixed asset to include - Purchase prices, duties and taxes, expenses incurred to make the asset ready for intended use. Administration and general overheads not specifically attributable to be excluded – In line with AS-10 Costs to be capitalized – In line with AS-10 Expenditure incurred on start up and commissioning of the project Expenditure incurred on test runs and experimental production Expenditure that increases future benefits from existing asset beyond its previously assessed standard of performance (repairs and maintenance) Machinery spares to be charged to revenue as and when consumed Exception: Spares used only with tangible fixed asset, with irregular usage of spares – to be capitalized Capitalization of exchange differences relating to fixed assets shall be in accordance with Section 43A and other similar provisions of the Act – Para 5 and 6 of ICDS VI Can exchange difference arising on External Commercial Borrowings be claimed as an allowance, if used for acquiring domestic assets? No significant deviation on costs to be capitalised as per AS-10

ICDS V – Tangible Fixed Assets Several assets purchased for consolidated price - consideration to be apportioned on fair basis (for e.g. slump sale) ‘Fair basis’ not defined – As per AS 10, fair basis as per competent valuer In absence of valuation for assets purchased for consolidated price, AO may allocate more cost to non-depreciable assets – valuation report is essential Fixed asset acquired in exchange of another asset or shares: Particulars AS 10 ICDS Fixed asset acquired in exchange for another asset Recorded either at FMV of asset given up or asset acquired if this is more clearly evident, adjusted for any balancing receipt or payment of cash or other consideration Recorded at fair value of the tangible fixed asset so acquired Fixed asset acquired in exchange for shares or other securities Recorded at FMV of the assets acquired, or the FMV of the securities issued, whichever is more clearly evident

ICDS V – Capitalization of cost post Trial run Construction / acquisition of asset Trial run – Ready to use Commercial Production Capitalize or Revenue expense ? Capitalize Revenue expense AS-10 ICDS ICDS V – Capitalization of cost post Trial run Capitalize Revenue expense Asset ready for use – Depreciation can be claimed?

Date of borrowing Start of construction Date of utilization Asset ready to use / Asset put to use Capitalization Period AS-16 ICDS -General Borrowing ICDS -Specific Borrowing ICDS V – Capitalization of Borrowing cost to Qualifying Tangible assets AS-16 says, date of borrowing or date of construction, whichever is later for both general and specific. Pre-ICDS amendment, ICDS=36(1)(iii) and different from AS since qualifying asset for tangible assets was not defined. Post ICDS amendment, it is contradictory to 36(1)(iii) AS-16 and ICDS – Doesn’t cover capitalization of borrowing cost for non-qualifying assets Under the Act – As per Section 36(1)(iii), interest is required to be capitalised till the date asset is put to use even for non-qualifying asset – would override ICDS?

Asset is not a Qualifying Asset as per AS 16 and ICDS ICDS V – Tangible Fixed Assets Case Study 1A – Capitalization of borrowing cost (Specific Borrowing) Date Particulars Amount 1 April Borrows funds from bank @ 12% p.a. 1,000,000 1 July Full payment made to the vendor 1 August The machinery is supplied by vendor to the factory - 31 August The machinery is installed and put to use 31 December Loan repaid ABC Limited Bank Loan on 1 April Exchange of assets Payment on 1 July Supply on 1 August P&M Vendor Installation on 31 August Asset is not a Qualifying Asset as per AS 16 and ICDS

Tax Treatment as per Act ICDS V – Tangible Fixed Assets Case Study 1A – Capitalization of borrowing cost (Specific Borrowing) Particulars Treatment under AS 16 Tax Treatment as per Act ICDS (doesn’t cover) 36(1)(iii) Amount capitalized to fixed asset - Not applicable 50,000 (1,000,000*12%*5/12) Period of capitalization 1 April to 31 August (5 months) Interest expense charged to P&L a/c 90,000 (1,000,000*12%*9/12) 40,000 (90,000-50,000) Whether any capitalization required in case of general borrowing since non-qualifying assets are not covered under ICDS - ambiguity under Section 36(1)(iii)

Asset is a Qualifying Asset as per AS 16 and ICDS ICDS V – Tangible Fixed Assets Case Study 1B – Capitalization of borrowing cost (Specific Borrowing) Year Date Particulars Amount FY 15-16 1 May 15 Borrows funds from bank @ 15% p.a. 1,000,000 1 Aug 15 Construction of assets starts and borrowed funds are utilized FY 16-17 1 Sept 16 Asset acquired and put to use - 31 Dec 16 Loan repaid Exchange of assets Asset is a Qualifying Asset as per AS 16 and ICDS

Treatment as per Act read with ICDS ICDS V – Tangible Fixed Assets Case Study 1B – Capitalization of borrowing cost (Specific Borrowing) Particulars Treatment under AS 16 Treatment as per Act read with ICDS Period of capitalization 1 Aug 15 to 1 Sept 16 (13 months) 1 May 15 to 1 Sept 16 (16 months) Total amount capitalized to fixed asset 162,500 (1,000,000*15%*13/12) 200,000 (1,000,000*15%*16/12) Total interest expense charged to P&L a/c 87,500 (1,000,000*15%*7/12) 1 May 15 to 31 July 15 (3 months) 1 Sept 16 to 31 Dec 16 (4 months) (total 7 months) 50,000 (1,000,000*15%*4/12) 1 Sept 16 to 31 Dec 16 (4 months)

Q & A

Thank You Rohit Khandelwal