1. 11 INCOME COMPUTATION AND DISCLOSURE STANDARDS

2. 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

3. 33  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 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES

4. 44  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 144 30th January, 2016 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES

5. 55  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 ICDS 30th January, 2016 CA Anil J. Sathe

6. 66  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 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES

7. 77 ParticularsICDSASInd-AS Relevant StandardICDS 1AS 1 & AS 5Ind-AS 1 & Ind-AS 8 Fundamental Accounting Assumptions Going Concern Consistency Accrual Going Concern Consistency Accrual Going Concern Accrual 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 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES

8. 88 ParticularsICDSASInd-AS Change 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; or b)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 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES

9. 99  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

10. 10  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 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES - SIGNIFICANT ISSUES

11. 11  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” fails 30th January, 2016 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES - SIGNIFICANT ISSUES

12. 12  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 CA Anil J. Sathe ICDS I – ACCOUNTING POLICIES - SIGNIFICANT ISSUES

13. 13 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 CA Anil J. Sathe ICDS II – Valuation of Inventories

14. 14  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 services 30th January, 2016 CA Anil J. Sathe ICDS II – Valuation of Inventories

15. 15  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 CA Anil J. Sathe ICDS II – Valuation of Inventories

16. 16  Cost of Inventories It 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 overheads 30th January, 2016 CA Anil J. Sathe ICDS II – Valuation of Inventories

17. 17  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 CA Anil J. Sathe ICDS II – Valuation of Inventories – Cost of Inventories

18. 18  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 CA Anil J. Sathe ICDS II – Valuation of Inventories – Cost of Inventories

19. 19  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 CA Anil J. Sathe ICDS II – Valuation of Inventories

20. 20  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 CA Anil J. Sathe ICDS II – Valuation of Inventories

21. 21  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 CA Anil J. Sathe ICDS II – Valuation of Inventories

22. 22  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 CA Anil J. Sathe ICDS II – Valuation of Inventories

23. 23 Exclusion of Standard Cost Standard 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 CA Anil J. Sathe ICDS II – Valuation of Inventories

24. 24 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 CA Anil J. Sathe ICDS II – Valuation of Inventories – Other Aspects

25. 25 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 CA Anil J. Sathe ICDS II – Valuation of Inventories – Reasonable Cause

26. 26 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 CA Anil J. Sathe ICDS II – Valuation of Inventories

27. 27 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 CA Anil J. Sathe ICDS III – Construction Contracts

28. 28  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 CA Anil J. Sathe ICDS III – Construction Contracts

29. 29 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 sequence 30th January, 2016 CA Anil J. Sathe ICDS III – Construction Contracts

30. 30  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 CA Anil J. Sathe ICDS III – Construction Contracts

31. 31 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 CA Anil J. Sathe ICDS III – Construction Contracts

32. 32  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 CA Anil J. Sathe ICDS III – Construction Contracts

33. 33 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 profits 30th January, 2016 CA Anil J. Sathe ICDS III – Construction Contracts

34. 34 Contract RevenueContract 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 capitalization Contract costs relating to future activity to be recognized as an asset 30th January, 2016 CA Anil J. Sathe ICDS III – Construction Contracts

35. 35 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 CA Anil J. Sathe ICDS III – Construction Contracts

36. 36 YearContractUnrelated Income Total Income Computation Normal Income (ICDS) Book Profit 1 (<25 % work) Foreseeable loss (10,000)8,000 -2000 2 Contract concludes on loss8000-20008000 30th January, 2016 CA Anil J. Sathe ICDS III – Construction Contracts 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

37. 37 ParticularsAS 7/ Proposed Ind AS 11ICDS 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 revenue 30th January, 2016 CA Anil J. Sathe ICDS III – Construction Contracts

38. 38 ParticularsAS 7/ Proposed Ind AS 11ICDS 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 CA Anil J. Sathe ICDS III – Construction Contracts

39. 39 ParticularsAS 7/ Proposed Ind AS 11ICDS 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 CA Anil J. Sathe ICDS III – Construction Contracts

40. 40 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 CA Anil J. Sathe ICDS III – Construction Contracts

41. 41 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 31 st 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 1 st 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 1 st day of April, 2015 and subsequent previous years.” 30th January, 2016 CA Anil J. Sathe ICDS III – Construction Contracts

42. 42  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 CA Anil J. Sathe ICDS III – Construction Contracts

43. 43 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 CA Anil J. Sathe ICDS III – Construction Contracts

44. 44 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 CA Anil J. Sathe ICDS III – Construction Contracts

45. 45 30th January, 2016 CA Anil J. Sathe