SEMINAR ON
Income Computation and Disclosure Standards Analytical Study
10th August, 2015
At
Emami Conference Hall
6, Lyons Range, 3rd Floor, Unit-2
Kolkata -700 001
Organized by
ACAE Chartered Accountants Study Circle - EIRC
Income Computation and Disclosure Standards- Analytical Study
1.1 Original and Need
The Apex Court in the case of J.K.Industries Ltd Vs UOI(2008) 297 ITR 176(SC) in a long
judgement while considering the question as to “whether AS 22 entitled “accounting for taxes
on income” in so far as it relates to deferred taxation is inconsistent with and ultra vires the
provisions of the Companies Act,1956(“the Companies Act”) , the Income-tax Act,1961 (“the
I.T.Act”) and the constitution of India, While rejecting the arguments of the appellants, the
supreme court observed in a long judgement as follows:a) Meaning and purpose of Accounting Standards(AS)
In its origin, AS is a policy statement or document framed by the Institute. AS establish
rules relating to recognition, measurement and disclosures thereby ensuring that all
enterprises that follow them are comparable and that their financial statements are true, fair
and transparent. AS are based on a number of accounting principles. They seek to arrive at
the true accounting income. One such principle is matching principle. The other is the fair
value principle. The aim of the Institute is to go for a paradigm shift from the matching to
the fair view principle.
The main object sought to be achieved by Accounting Standards which is now made
mandatory is to see that accounting income is adopted as taxable income and not merely as
the basis from which taxable income is to be computed. Thus if the rules by which
inventories are to be valued are laid down in the Accounting Standards and are followed in
the determination of Accounting Income, then tax laws doesn’t need to lay down the rules
and the tax authorities do not need to examine the computation of the value of inventories
and its effect on computation of income. Similarly if there is an Accounting Standard on
depreciation which requires estimation of the useful life and prescribes the appropriate
method for apportionment of the cost of fixed asset over their useful life , it is unnecessary
for the tax laws to apply an artificial rule to decide the extent of allowance for depreciation.
Finally, the adoption of Accounting Standards and of accounting income as taxable income
would avoid distortion of accounting income which is real income.
Under Section 211(3A) Accounting Standards framed by the National Advisory Committee
on Accounting Standards constituted under Section 210A are now made mandatory. Every
Company has to comply with the said standards. Similarly under Section 227(3)(d) every
auditor has to certify whether the profit and loss account and balance sheet comply with
the accounting standards referred to in Section 211(3C). Similarly, under section 211(1) the
company accounts have to reflect a “true and fair” view of the state of affairs. Therefore the
object behind insistence on compliance with the AS and “true and fair” accrual is the
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presentation of accounts in a manner which would reflect the true income/profit. In our
view, the provisions of the Companies Act together with the rules framed by the Central
Government constitute a complete scheme. Without the rules, the Companies Act cannot be
implemented. The impugned rules framed under section 642 are a legitimate aid to
construction of the Companies Act as contemporaneaexpositio. Many of the provisions of
the Companies Act like computation of book profit, net profit etc cannot be put into
operation without the rules.
Para 79
In our view, it is the statutory function given to the central government to frame
Accounting Standards in consultation with the National Advisory Committee on
Accounting Standards(NAC) under Section 211(3C). It is not necessary for the Central
Government to adopt in every case the Accounting Standards issued by the Institute.
Nothing prevents the Central Government from enacting its own Accounting Standards
which may not be in consonance with the standards prescribed by the Institute. Similarly,
nothing prevents the Central Government from adopting the standards issued by the
Institute as is the case in the present matter.
This seems to be genesis of the matter. The accounting Standards which were so far working fine
were done away with by the Central Government by enacting its own accounting Standards.
There can be difference in the Accounting profit and taxable income of a Company because of the
differences in reporting period and because of the fact that ICAI AS enabled an entity with
flexibility of alternative accounting treatments which made it possible for a taxpayer to avoid
payment of correct taxes by choosing a particular system.While accounting profit is computed
based on the accounting standards, or generally accepted accounting policies(GAAP), the taxable
income is calculated using the provisions of Income-tax Act,1961 and Rules and thus need was felt
to standardise the alternatives in various standards so that the income for tax purposes can be
computed precisely as per the Act.
Matching Concept of Accounting
Matching concept is a very significant concept of accounting. According to this concept income
and expense must be recognised in the period to which they relate. In India Profit & Loss is
computed with two different set of provisions one set is profit and loss as per the Companies Act,
2013(earlier it was Companies Act, 1956( and the second one is Profit & Loss as per Income-tax
Act,1961. The root cause of difference between Income as per these two acts is different treatment
given to some items of income and expenditure and transactions. Some of these items are as
follows:1.
2.
3.
4.
5.
6.
Treatment of Interest during Construction period
Valuation of inventories
Depreciation rates
Accounting for changes in foreign exchange difference
Accounting for investment
Accounting for Impairment of assets
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7. Revenue recognition
8. Deferred revenue expenditure
9. Prepaid expenses- claimable under the Income-tax in one year as against accounting where
it can be claimed year to year- Recent Supreme Court judgement to give.
Treatment of work-in-progress in case of construction companies.
Morvi Industries ltd – 82 ITR 835(SC).
Recognition of revenue pauses problem where in reality it may not be feasible to account
the same as income and this causes the problem.
There can be other reasons also. Thus it has been seen that time and again courts have interpreted
the accounting standards in different manner as far as their effect is to be given for the purposes of
computation of Income under the Income-tax Act, 1961 and therefore the need for Income
Computation and Disclosure Standards can be said to have arisen.
1.2 Income Computation and Disclosure Standards- Details of Introduction
Chapter XIV of the Income Tax Act, 1961 deals with the “Procedure for Assessment”. The
provisions of Section 145 of the Income Tax Act, 1961 are contained in Chapter XIV as mentioned
above.
As a matter of fact, Section 145 of the Income Tax Act, 1961 traces its history to the provisions of
Section 13 of the Indian Income Tax Act, 1922, which read as follows:
“13. Method of accounting.—Income, profits and gains shall be computed, for the purposes of sections
10 11* and 12, in accordance with the method of accounting regularly employed by the assessee:
Provided that, if no method of accounting has been regularly employed, or if the method employed is such
that, in the opinion of the Income-tax Officer, the income, profits and gains cannot properly be deduced
therefrom, then the computation shall be made upon such basis and in such manner as the Income-tax
Officer may determine.”
The said section was incorporated as Section 145 in the new Act and the section had been divided
into two sub–sections. Sub-section (1) covered the cases where the accounts were correct and
complete. The first proviso empowered in case the method employed did not reveal proper
income, an assessment on a different basis and manner thought fit by the Assessing Officer.
Section 145 (2) dealt with situation where the accounts were not correct and complete, or where no
method of accounting had been regularly employed by the assessee. In such cases, the Assessing
Officer was empowered to make best judgment assessment in the manner provided in Section 144.
The latter portion was not provided in the 1922 Act.
Hence, after a series of amendments in Section 145 of the Income Tax Act, 1961, the Finance Act,
1995 (w.e.f. 1-4-1997) brought into existence a substituted section which read as follows:
“Method of accounting.
145.
(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
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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 accounting
standards to be followed by any class of assesses 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) or
accounting standards as notified under sub-section (2), have not been regularly followed by the
assessee, the Assessing Officer may make an assessment in the manner provided in section 144.
The scope and effect of it have been elaborated by the department in Circular No. 717 dated 14th
August, 1995. Paragraph number 44.1 of the circular read as follows:
“Methods of accounting and accounting standards for computing income
44.1 Section 145(1) of the Income-tax Act prior to its amendment by the Finance Act, 1995, provided for
computation of income from business or profession or income from other sources in accordance with the
method of accounting regularly employed by the assessee. Income is generally computed by following one of
the three methods of accounting, namely, (i) cash or receipts basis, (ii) accrual or mercantile basis, and (iii)
mixed or hybrid method which has elements of both the aforesaid methods. It was noticed that many assesses
are following the hybrid method in a manner that does not reflect the correct income. The Finance Act, 1995,
has amended section 145 of the Income-tax Act to provide that income chargeable under the head ‘Profits
and gains of business or profession’ or ‘Income from other sources’ shall be computed only in accordance
with either the cash or the mercantile system of accounting, regularly employed by an assessee. The first
proviso to sub-section (1) of section 145 has been deleted.”
After the above mentioned amendments, today we finally have Section 145 of the Income Tax Act,
1961 as amended by the Section 52 of the Finance (No. 2) Act, 2014 (w.e.f. 01.04.2015) wherein the
words “accounting standards” have been substituted by “income computation and disclosure
standards”. The term “income computation and disclosure standards” was introduced in clause 50 of
the Finance (No.2) Bill, 2014. Clause 50 of the Finance (No.2) Bill reads as follows:
“Section 145 of the Act provides that the method of accounting for computation of income under the heads
“Profits and gains of business or profession” and “Income from other sources” can either be the cash or
mercantile system of accounting. The Finance Act, 1995 empowered the Central Government to notify
Accounting Standards (AS) for any class of assesses or for any class of income. Since the introduction of
these provisions, only two Accounting Standards relating to disclosure of accounting policies and disclosure
of prior period and extraordinary items and changes in accounting policies have been notified.
The Central Government had constituted an Accounting Standard Committee vide Order dated
20thDecember, 2010 comprising of officials of the Tax authorities and professionals with the following terms
of reference:
1. To study the harmonisation of the ICAI AS with the Indian Tax Laws and to suggest the accounting
standards for tax compliance under the Income-tax Act, 1961 with suggestions for modifications
2. To suggest a method for determination of tax base for the purpose of computation of MAT in case of
companies migrating to IND AS in the initial year of adoption and thereafter.
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3. To suggest appropriate amendments to the Tax Laws in view of the transition to the IND AS.
The Committee has submitted its Final Report in August, 2012. The Committee recommended that the AS
notified under the Act should be made applicable only to the computation of taxable income and a taxpayer
should not be required to maintain books of account on the basis of AS notified under the Act. The Final
Report of the Committee was placed in public domain for inviting comments from stakeholders and general
public. After examining the comments/suggestions, the Committee inter alia recommended that the
provisions of section 145 of the Act may be suitably amended to clarify that the notified AS are not meant
for maintenance of books of account but are to be followed for computation of income.
In order to clarify that the standards notified under section 145(2) of the Act are to be followed for
computation of income and disclosure of information by any class of assesses or for any class of income, it is
proposed to provide that 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 or in respect of any class of
income. It is further proposed to provide that the Assessing Officer may make an assessment in the manner
provided in section 144 of the Act, if the income has not been computed in accordance with the standards
notified under section 145(2) of the Act.
This amendment will take effect from 1st April, 2015 and will, accordingly, apply in relation to the
assessment year 2015-16 and subsequent assessment years.”
Earlier, Accounting Standard I and Accounting Standard II were notified under Section 145 (2) of
the Income Tax Act, 1961 under NO. 9949 [F. NO. 132/7/95-TPL], DATED 25-1-1996.
Now we have a set of ten Income Computation and Disclosure Standards notified as on 31 st
March, 2015 by Notification no. 32/2015 F. No. 134/48/2010‐TPL.
1.3 Difference between Accounting Standards (AS), Indian Accounting Standards (IndAS),
Tax Accounting Standards (TAS) and Income Computation and Disclosure Standards
(ICDS)
In exercise of the powers conferred by section 133 read with section 469 of the Companies Act,
2013 (18 of 2013) and sub-section 210A of the Companies Act, 1956 (1 of 1956), the Central
Government, in consultation with the National Advisory Committee on Accounting Standards
came up with a notification on the 16th of February, 2015. The notification announced the
Companies (Indian Accounting Standards) Rules, 2015. These rules came into force on the 1 st day
of April, 2015.
In rule 4 of the Companies (Indian Accounting Standards) Rules, 2015, it has been clearly that the
companies and their auditors mentioned in this rule shall mandatorily comply with IndAS for
preparation of their financial statements and audit respectively. The companies mentioned in this
rule are:
(i)
any company may comply with the Indian Accounting Standards (Ind AS) for financial
statements for accounting periods beginning on or after 1st April, 2015, with the comparatives
for the periods ending on 31st March, 2015, or thereafter;
(ii)
the following companies shall comply with the Indian Accounting Standards (Ind AS) for the
accounting periods beginning on or after 1 st April, 2016, with the comparatives for the periods
ending on 31st March, 2016, or thereafter, namely:-
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(a) companies whose equity or debt securities are listed or are in the process of being listed on any
stock exchange in India or outside India and having net worth of rupees five hundred crore or
more;
(b) companies other than those covered by sub-clause (a) of clause (ii) of subrule (1) and having
net worth of rupees five hundred crore or more;
(c) holding, subsidiary, joint venture or associate companies of companies covered by sub-clause
(a) of clause (ii) of sub- rule (1) and sub-clause (b) of clause (ii) of sub- rule (1) as the case may
be; and
(iii)
the following companies shall comply with the Indian Accounting Standards (Ind AS) for the
accounting periods beginning on or after 1 st April, 2017, with the comparatives for the periods
ending on 31st March, 2017, or thereafter, namely:(a) companies whose equity or debt securities are listed or are in the process of being listed on any
stock exchange in India or outside India and having net worth of less than rupees five hundred
crore;
(b) companies other than those covered in clause (ii) of sub- rule (1) and sub clause (a) of clause
(iii) of sub-rule (1), that is, unlisted companies having net worth of rupees two hundred and fifty
crore or more but less than rupees five hundred crore.
(c) holding, subsidiary, joint venture or associate companies of companies covered under subclause (a) of clause (iii) of sub- rule (1) and sub-clause (b) of clause (iii) of sub- rule (1), as the
case may be:
Provided that nothing in this sub-rule, except clause (i), shall apply to companies whose
securities are listed or are in the process of being listed on SME exchange as referred to in
Chapter XB or on the Institutional Trading Platform without initial public offering in
accordance with the provisions of Chapter XC of the Securities and Exchange Board of India
(Issue of Capital and Disclosure Requirements) Regulations, 2009.”
Further, sub-rule 2 of Rule 2 of the Companies (Indian Accounting Standards) Rules, 2015 states
that Accounting Standards as mentioned in the annexure to the Companies (Accounting
Standards) Rules, 2006 shall be the Accounting Standards applicable to the companies other than
the classes of companies specified in rule 4 (as given above). Hence, we can conclude that
companies other than those mentioned in Rule 4 shall continue to apply the Accounting Standards
notified in Companies (Accounting Standards) Rules, 2006.
Further we see that, the Government had constituted a committee in July 2002 for formulation of
Accounting Standards for the purpose of notification under the Income Tax Act. This Committee
recommended for notification of the Accounting Standards issued by the ICAI without any
modification along with consequentiallegislative amendments to the Act for preventing any
revenue leakage.
Subsequently, the CBDT constituted another Committee to harmonize the AccountingStandards
issued by the ICAI with the provisions of the Act for the purposes of notification under theAct and
also to suggest amendments to the Act necessitated by transition to IndAS/IFRS. The Committee
recommended that the Accounting Standards to be notified under the Act may be termed as "Tax
Accounting Standards" (TAS), to distinguish the same from the Accounting Standards issued by
the ICAI. The Committee examined all the thirty one Accounting Standards issued by the ICAI
and noted that some of the Accounting Standards issued by the ICAI relate to 'disclosure'
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requirement, whilst some other contain matter that are adequately dealt within the Act. In view of
this, the Committee recommended that Tax Accounting Standards need not to be notified in
respect of seventeen Accounting Standards issued by the ICAI. The Committee then formulated
the drafts of Tax Accounting Standards on the issues covered by the rest of the fourteen
Accounting Standards issued by the ICAI.
After continuous review, the CBDT again came up with a set of twelve draft Income Computation
and Disclosure Standards (TAS being renamed) on the 8th of January, 2015 which was open for
public comments until 8th of February, 2015. Hence, finally on the 31st day of March, 2015, CBDT
came up with notification no. 32/2015 [F. No. 134/48/2010 – TPL]/ SO 892(E) issuing ten Income
Computation and Disclosure Standards (ICDS) listed as below:
Serial
No.
1
2
3
4
5
6
7
8
9
10
ICDS
No.
I
II
III
IV
V
VI
VII
VIII
IX
X
Name of the standard
Accounting Policies
Valuation of inventories
Construction contracts
Revenue recognition
Tangible fixed assets
Effects of changes in foreign exchange rates
Government Grants
Securities
Borrowing Costs
Provisions, contingent liabilities and contingent assets
The chart below gives a detail of the Accounting Standards issued by the ICAI which were
recommended for notification under the Act by the Committee and the ones which were not
recommended.
Serial
No.
1
AS No.
Recommended - Topic
AS No.
Not Recommended - Topic
1
Disclosure of Accounting
Policies
Valuation of Inventories
Contingencies and Events
Occurring
After
the
Balance Sheet Date
Net Profit or Loss for the
Period, Prior Period Items
and changes in Accounting
Policies
Construction Contracts
Revenue Recognition
Accounting
for
Fixed
Assets
3
Cash Flow Statements
6
14
Depreciation Accounting
Accounting
for
Amalgamations
15
Employee Benefits
17
18
20
Segment Reporting
Related Party Disclosures
Earnings Per Share
2
3
2
4
4
5
5
6
7
7
9
10
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8
11
The Effects of Changes in 21
Foreign Exchange Rates
Accounting
for 22
Government Grants
Accounting
for 23
Investments
9
12
10
13
11
12
13
16
19
26
Borrowing Costs
Leases
Intangible Assets
14
29
15
Provisions,
Contingent 28
Liabilities and Contingent
Assets
30
16
31
17
32
24
25
27
Consolidated
Financial
Statements
Accounting for Taxes on
Income
Accounting for Investments
in Associates in Consolidated
finance Statements
Discontinuing Operations
Interim Financial Reporting
Financial
Reporting
of
Interests in Joint Ventures
Impairment of Assets
Financial
Instruments
:
Recognition
and
Measurement
Financial
Instruments
:
Presentation
Financial
Instruments
:
Disclosures
1.4 Key Features of ICDS
1) Effective Date of ICDS is 01st April, 2015 i.e. FY: 2015-16 & AY: 2016-17.
2) ICDS applicable to all assesses i.e. Corporate & Non Corporate Assesses.
3) No Net Worth or Turnover Criteria Prescribed for applicability.
4) ICDS is meant for giving clarity in certain contentious tax issues and disclosures thereof. It
does not mandate requirement of separate books of accounts to be maintained.
5) In the case of conflict between the provisions of the Income‐tax Act, 1961 and Income
Computation and Disclosure Standard, the provisions of the Act shall prevail to that extent.
6) ICDS requires certain disclosures to be made. However, it is not prescribed as to how and
where to disclose such items. It is thus expected that Tax audit report and Tax return
format may further undergo significant changes to accommodate such disclosures.
1.5 A short detailed comparison between AS and ICDS has been stated below:
1. AS 1 and ICDS I: Accounting Policies
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
The AS specified that the primary consideration for selection of accounting policies
by an enterprises is that the financial statements prepared and presented on the basis
of such accounting policies should represent a true and fair view of the state of
affairs of the enterprise as at the balance sheet date and of the profit or loss of the
period ended on that date and criterion for selection in the Accounting Standard 1
was three fold:a) Prudence
b) Substance over form
c) Materiality
However, ICDS does not recognizes the concept of prudence and rather only
mentions about the disallowance of recognition of expected losses or marked to
market losses unless specifically permitted by any other standard.It may be noted
that currently no ICDS provides for dealing with mark to market losses on
derivatives. Moreover, without prudence being recognised in ICDS, there is a likely
hood that income may be recognised earlier than when it should have been or
expenses may be delayed from recognised.In this regard, it may be noted that ICDS
II provides for valuation of inventories at cost or lower of net realisable value,
whichever is lower. ICDS has remained silent on the treatment of mark-to-market
unrealized gains.As opposed to this, under the Indian AS, mark to market losses
are provided in view of the concept of prudence. Expected losses are also provided
in accordance with the relevant Indian GAAP standards. In this regard, the apex
court judgement of Vazir Sultan Tobacco is relevant.
Also, a major concept – materiality has also been removed in the current ICDS I. In
auditing materiality pertains to the largest number (threshold) of uncorrected errors,
misstatements, or erroneous disclosures or omissions that exist in the financial
statements and yet are not misleading. The auditor plans and executes an audit with
a reasonable expectation of detecting material misstatements. Keeping the above in
mind, ICDS I might cause implementation problems in the treatment of unadjusted
audit differences which may need to be considered in computing the taxable income.


Another change which might slightly affect the tax authorities is that ICDS does not
define the term “reasonable cause”. Hence, since it does not permit a change in the
accounting policy without any reasonable cause, it might end up into litigations and
thereafter judgments of the authorities. The present AS has been interpreted by
several courts and have held certain fundamental principles underlying change of
accounting policies. However, whether they will fit into the parameters of
“reasonable cause” is to be seen in coming days and months and years.
The AS 1 specifies that all significant accounting policies adopted in the preparation
and presentation of financial statement should be disclosed. The disclosure of the
significant accounting policies as such should form part of the financial statements
and the significant accounting policies should normally be disclosed at one place.
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
However under the ICDS there is no such mandate as to the place of disclosure. It
has also been specified that the disclosure of accounting policies or of changes
therein cannot remedy a wrong or inappropriate treatment of the item. Often it is
seen that the accounting policies state that this is the policy adopted which is though
consistently followed but not in accordance with the Accounting Standards issued
by ICAI or now may be CBDT.
AS 1 recognises that in the following areas different accounting policies may be
adopted by different enterprises:
a) Methods of depreciation, depletion and amortisation
b) Treatment of expenditure during construction
c) Conversion or translation of foreign currency Loans
d) Valuation of inventories
e) Treatment of goodwill
f) Valuation of investments
g) Recognition of profits on long term contracts
h) Valuation of fixed assets
i) Treatment of contingent liabilities
Though the above list is not an exhaustive list and there can be other items too.
Important cases
1. [1959] 37 ITR 1 (SC) SUPREME
Ltd.v.Commissioner of Income-tax
COURT
OF
INDIACalcutta
Co.
Section 28(i) , read with section 145 of the Income-tax Act, 1961 (Corresponding to
section 10(1), read with section 13 of the Indian Income-tax Act, 1922) - Business
deductions - Allowable as - Assessment year 1948-49 - Assessee dealt in land and
property and carried on land developing business - It maintained its accounts in
mercantile method - In relevant accounting period it sold certain plots and even
though assessee received only a portion of sale price, it entered in credit side of its
account books whole of sale price of plots - Under terms of side deeds assessee
undertook to carryout developments within six months from date of sale Accordingly, it estimated a sum as expenditure for developments to be carried out in
respect of plots sold out during relevant year and debited said sum in its books of
account as accrued liability - Department did not take any exception to said
estimated expenditure in regard to quantum but disallowed assessee's claim for
deduction of that sum by relying upon provisions of section 10(2) of 1922 Act Whether estimated expenditure which had to be incurred by assessee in discharging
a liability which it had already undertaken under terms of sale-deeds of lands in
question was an accrued liability which according to mercantile system of
accounting assessee was entitled to debit in its books of account for accounting year
as against receipts which represented sale proceeds of said lands - Held, yes
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2. AS 2 and ICDS II: Valuation of Inventories





ICDS II specifies various categories of inventories which are not to be valued as per
ICDS II and they are :a) Work in progress arising under construction contract including directly related to
service contractwhich is dealt with by Income Computation and Disclosure
standard on construction contracts.
b) Work in progress dealt with by any other ICDS
c) Shares, debentures and other financial instruments held as stock in trade which
are dealt with by ICDS on securities.
d) Producers inventories of livestock, agriculture and forest products, mineral oils,
ores and gases to the extent that they are measured at net realisable value.
e) Machinery spares, which can be used in conjunction with a tangible fixed asset
and their use is expected to be irregular, shall be dealt with in accordance with
ICDS on tangible fixed assets. In this regard, Accounting Standards
Interpretation(ASI) 2 has been issued which deals with which machinery spares
are covered under AS 2 and AS 10 and what should be the accounting for
machinery spares under the respective standards.
The definition of inventory remains the same under both the standard.
The cost of purchase under the ICDS includes duties and taxes even if subsequently
recoverable from taxing authorities. This is in line with the provisions of Section
145A of the Income-tax Act,1961. However, under the AS, the cost of purchase
doesn’t include duties and taxes if subsequently recoverable from taxing authorities,
though Section 145A overrides Section 145.
A major change which has been brought in the newly formulated ICDS is the
removal of Standard cost method as a technique for the measurement of cost of
inventories. This may cause a problem for the assessees valuing their inventories
using standard cost method. They will have to now value their inventories using the
retail method or any other method prescribed for the purpose of taxation.
Companies Act, prescribes Standard Cost method under the maintenance of cost
record rules.
ICDS provides that the inventory of a service provided is to be valued at cost or net
realisable value whichever is lower and cost of services to consist of labour and costs
of personnel directly engaged in providing the services including supervisory
personnel and attributable overheads. Under the AS-2 which did not provide for
valuation of work in progress arising in ordinary course for the service providers.
This Chartered Accountants now have to value inventory of services provided and
report the same which until now was not being done. Difficulty may arise where
the changeability itself depend on success of the services.
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



ICDS II specifies that the value of the inventory of a business as on the beginning of
a previous year shall be the cost of inventory available if any, on the day of
commencement of the business when the business has commenced during the
previous year. Under the AS-2 there is no specific mention about the opening
inventory.In cases of conversion of capital assets into stock in trade, they having
been specifically dealt with in Section 45(2) of the Act, there may not be any issues. If
a partner takes over running business of Firm/LLP, then the value agreed with other
partners for inter settlement shall be the cost to the partner.
Another major issue which might arise due the effective changes is the rise of
litigations due to the unexplained term “reasonable cause”. ICDS II says that method
of valuation of inventory shall not be changed without a reasonable cause. It has not
given any description on the meaning of the phrase “reasonable cause” which shall
again lead to the interruption of tax authorities for analyzing the reasonability of the
change in method by any assessee. AS 2 specifies that the method of valuation of
inventories may be changed if it is considered that the change would result in a more
appropriate presentation.
ICDS II deals with valuation of inventory in case of certain dissolutions and says that
in case of dissolution of a partnership firm or association of persons or body of
individuals, notwithstanding whether business is discontinued or not, the inventory
on the date of dissolution shall be valued at net realisable value. There being no
specific provision to allow such NRV as cost to the successor of the business, there
may be difficulties. In this regard,the decision of the Apex Court in the case of ALA
Firm 189 ITR 225(SC) in this regard may be referred to. Also the decision of the Apex
Court in the case of Sakthi Trading Co Ltd Vs CIT (2001) 250 ITR 871 may be looked
into. The existing AS 2 has no such mechanism because of the assumption of going
concern.
Regarding interest and borrowing cost, Para 11 of the ICDS II states that interest and
borrowing costs shall not be included in the cost of inventories , unless they meet the
criteria for recognition of interest as a component of the cost as specified in ICDS on
borrowing cost. In this regard, it may be noted that ICDS on borrowing costs defines
qualifying asset interalia as “inventories that require a period of twelve months or
more to bring them to a saleable condition and thus only these types of inventory is
eligible for inclusion of borrowing cost in the inventory. However, in Para 25 of this
ICDS dealing with transitional provisions it has been stated that the interest and
borrowing costs, which do not meet the criteria for recognition of interest as a
component of the cost as per para11 but included in the cot of opening inventory as
on the 1st day of April, 2015 shall be taken into account for determining costs of such
inventory for valuation as on the close of the previous year beginning on or after
1stday of April, 2015 if such inventory continue to remain part of inventory as on the
close of the pervious year beginning on or after 1st day of April, 2015.
13 | P a g e

The disclosure requirement specifies that the accounting policies adopted in
measuring inventories including the cost formulae used and the total carrying
amount of inventories and its classification appropriate to a person.
Important Cases
1. [1991] 54 TAXMAN 499 (SC)SUPREME COURT OF INDIACommissioner of
Income-tax v.British Paints India Ltd.
Section 145 of the Income - tax Act, 1961 - Method of accounting - Valuation of
closing stock - Assessment years 1963-64 and 1964-65 - Assessee - company was
engaged in business of manufacture and sale of paints - It had valued goods in
process and finished products exclusively at cost of raw materials and totally
excluding overhead expenditure, i.e., stock-in-trade was valued at 84.49 per cent
representing actual cost of raw material and overhead charges representing 15.51 per
cent of total cost had been excluded from assessee's valuation of stock - Whether ITO
was justified in rejecting assessee's method of valuation and in holding that
assessee's goods in process and Finished products were liable to be valued at 100 per
cent of cost which included overhead expenditure and not at 84.49 per cent as
claimed by assessee - Held, on facts, yes
2. [1991] 55 TAXMAN 497 (SC)SUPREME COURT OF INDIAA.L.A.
Firmv.Commissioner of Income-tax
Section 28(i) of the Income-tax Act, 1961 - Business income - Chargeable as Assessment year 1961-62 - On dissolution of assessee-firm, its stock-in-trade was
revalued and certain amount was shown as 'difference on revaluation' in the profit
and loss account - Whether, having valued stock-in-trade at market price, partners of
assessee could not contend that valuation should be on some other basis and, thus,
such surplus on valuation was to be charged to tax as profits of firm - Held, yes
3. [2007] 161 TAXMAN 162 (SC)SUPREME COURT OF INDIACommissioner of
Income-tax, Udaipur*v.Hindustan Zinc Ltd.
Section 145 of the Income-tax Act, 1961 - Method of accounting - Valuation of stock Assessment year 1996-97 - Whether correct principle of accounting is to enter stock
in books of account at cost unless value is required to be reduced by reason of fall in
market value of goods below original cost - Held, yes - Whether therefore, goods
should not be written down below cost price except where there is an actual or
anticipated loss - Held, yes - Whether if fall in price is only such as it would reduce
merely prospective profit, there would be no justification to discard initial valuation
at cost - Held, yes - Assessee- company was engaged in business of producing zinc
concentrate which was utilised by it captively - During assessment year 1996-97,
certain stock of zinc concentrate got accumulated - Since domestic consumption of
14 | P a g e
accumulated stock was not possible, assessee decided to export same - Assessee
estimated/valued net realisable value of stock by adopting London Metallic
Exchange Price which was lower than Weighted Average Cost (WAC) on 31-3-1996,
by Rs. 27.08 crores, while in past, it had been valuing closing stock of zinc
concentrate for captive consumption at WAC - Assessing Officer observed that
auditors’ report indicated that if accounting policy of earlier years was to be
followed, then in that event, profits would have increased by Rs. 27.08 crores and,
accordingly, added back Rs. 27.08 crores to income of assessee - Whether on facts,
assessee’s valuation could not be sustained - Held, yes
4. [2001] 118 TAXMAN 301 (SC)SUPREME COURT OF INDIASakthi Trading
Co.v.Commissioner of Income-tax
Section 145 of the Income-tax Act, 1961 - Method of accounting - Valuation of
closing stock - Assessment year 1984-85 - Whether where on dissolution of
assessee-firm because of death of one partner business is taken over by remaining
partners without discontinuance of its business and value of closing stock on date
of dissolution determined under regular method of accounting is accepted by
partners in settlement of accounts for dissolution purposes, it is impermissible for
Assessing Officer to substitute market value in respect of closing stock alone for
purpose of determining income of firm up to date of dissolution - Held, yes
5. [1991] 55 TAXMAN 497 (SC) SUPREME COURT OF INDIA, A.L.A.
Firv.Commissioner of Income-tax
Section 28(i) of the Income-tax Act, 1961 - Business income - Chargeable as Assessment year 1961-62 - On dissolution of assessee-firm, its stock-in-trade was
revalued and certain amount was shown as 'difference on revaluation' in the
profit and loss account - Whether, having valued stock-in-trade at market price,
partners of assessee could not contend that valuation should be on some other
basis and, thus, such surplus on valuation was to be charged to tax as profits of
firm - Held, yes
3. AS 7 and ICDS III: Construction Contracts


AS 7 specifies that it doesn’t deal with Real Estate Developers for which there is a
separate guidance note by ICAI. However, ICDS III doesn’t clarify this.
AS 7 provides for the recognition of losses including probable or expected losses to
be recognized fully and not as an asset when it is probable that these costs are
recoverable. ICDS C does not permit the recognition of expected losses on onerous
contracts.
15 | P a g e

AS 7 provided that contract revenue to be recognised if it is possible to reliably
estimate the outcome of a contract. However, ICDS III has omitted this criteria. ICDS
III says that contract revenue shall comprise of:
a) The initial amount of revenue agreed in the contract, including retentions; and
b) Variations in contract work, claims and incentive payments
I.
To the extent that it is probable that they will result in revenue; and
II.
They are capable of being reliably measured.
It is also specified that where contract revenue already recognised as income is
subsequently written off in the books of accounts as uncollectible, the same shall be
recognised as an expense and not as an adjustment of the amount of contract
revenue.

AS 7 does not permit the recognition of revenue during the early stages of a contract
but ICDS III provides for recognition of revenue only to the extent of cost incurred in
the early stages of a contract where the outcome cannot be estimated reliably. Also,
this early stage of contract shall not extend beyond 25% of the stage of completion.
These changes will happen to affect the accounting of various entities because where
earlier recognition of revenue not being allowed at all and now being allowed
partially. Also, the disallowance of recognition of expected losses on onerous
contracts will lead to accounting discrepancies among entities.
4. AS 9 and ICDS IV: Revenue Recognition



AS 9 doesn’t apply to Companies engaged in Insurance business. ICDS is silent on
the same and
AS 9 permits the use of both percentage completion method and completed service
contract method but ICDS IV permits only the use of percentage completion method.
Although, completed contract method does not accurately reflect revenues, expenses
and profits in the period in which they are incurred and earned, the tax advantages
of this method were obvious – the deferral of tax liability of future years. This cannot
be availed now due to the applicability of ICDS IV. Accounting entries shall also
slightly change in the percentage completion method.
Another change which has taken place is AS 9 provides for the postponement of
recognition of revenue in relation to any claim if the ability to assess the ultimate
collection with reasonable certainty is lacking. ICDS IV provides that where the
ability to assess the ultimate collection with reasonable certainty is lacking at the
time of raising any claim for escalation of price and export incentives, revenue
recognition in respect of such claim shall be postponed to the extent of uncertainty
involved. With regard to this what people could do was postpone the recognition of
revenue and thereby artificially reduce the amount of net profit after tax, reserves
and surpluses of the year and the net current assets leading to an effect on taxes also
16 | P a g e


but ICDS has limited the postponement only to escalation of price and export
incentives.
Revenue from Service transactions shall be recognised by percentage completion
method. Under this method, revenue from service transactions is matched with the
service transaction costs incurred in reaching the stage of completion, resulting in
the determination of revenuer, expenses and profits which can be attributed to the
proportion of work completed. ICDS on construction contract also requires the
recognition of revenue on this basis. The requirements of that standard shall
mutatismutandis apply to the recognition of the revenue and the associated
expenses for a service transaction.
Important cases
1. [2013] 38 taxmann.com 100 (SC)SUPREME COURT OF INDIACommissioner of
Income-taxv.Excel Industries Ltd.*
Section 28(iv) of the Income-tax Act, 1961 - Business income - Value of any benefit or
perquisite, arising from business or exercise of profession [Advance license and duty
entitlement pass book] - Whether until imports are actually made by assessee,
benefits under advance license or under duty entitlement pass book represent only
hypothetical income which cannot be brought to tax by applying provisions of
section 28(iv) - Held, yes [Paras 20 & 21] [In favor of assessee]
2. [1999] 104 TAXMAN 547 (SC)SUPREME
Bankv.Commissioner of Income-tax
COURT
OF
INDIAUCO
Section 5, read with sections 119 and 145, of the Income-tax Act, 1961 - Income Accrual of - Assessment year 1981-82 - Whether in view of CBDT circular, dated
9-10-1984, interest on a loan whose recovery is doubtful and which has not been
recovered by assessee-bank for last three years but has been kept in a suspense
account and has not been brought to profit and loss account of assessee, cannot
be included in income of assessee - Held, yes - Whether CBDT circular dated 910-1984 is in conflict with provisions of section 145 - Held, no
Section 119 of the Income-tax Act, 1961 - Central Board of Direct Taxes - Power to
issue circulars, etc. - Whether, since Board has considered it necessary to lay
down a general test for deciding what is a doubtful debt in circular dated 9-101984 and directed that all ITOs should treat such amounts as not forming part of
income of assessee until realised, this direction by way of a circular cannot be
considered as travelling beyond powers of Board under section 119 and such a
circular is binding under section 119 - Held, yes
3. [1971] 82 ITR 835 (SC)SUPREME COURT OF INDIAMorvi Industries
Ltdv.Commissioner of Income-tax
17 | P a g e
Section 37(1) , read with section 5 of the Income-tax Act, 1961 [Corresponding to
section 10(2)(xv), read with section 4(1)(b)(ii), of the Indian Income-tax Act, 1922]
– Business expenditure – Allowability of – Assessment years 1956-57 and 1957-58
– Assessee-company, being managing agent of its subsidiary company and
maintaining its accounts on mercantile system, relinquished certain amounts
representing fixed monthly officer allowance and commission on sales, payable
to it by managed-company in view of heavy financial losses suffered by managed
company – Amounts of commission were relinquished after they had become
"due" but before they were "payable" in terms of managing agencies agreement –
Tribunal held that relinquishment by assessee of its income after it had become
due was of no effect and that relinquishment was not for benefit of assessee so as
to allow assessee's claim for amounts relinquished as permissible deduction
under section 10(2)(xv) of 1922 Act – Whether postponement of date of payment
did not affect accrual of income, and fact that amount of income was not
subsequently received by assessee would not also detract from or efface accrual
of income – Held, yes – Whether since amounts of income for years in question
were given up unilaterally by assessee after they had accrued to it, assesseecompany could not escape liability to tax on those amounts – Held, yes –
Whether since there was nothing to show that amounts were relinquished on
grounds of commercial expediency or for advancing assessee's business interests,
assessee was not entitled to claim deduction of said amounts as business
expenditure under section 10(2)(xv) of 1922 Act – Held, yes
4. [1986] 24 TAXMAN 337 (SC)SUPREME COURT OF INDIAState Bank of
Travancorev.Commissioner of Income-tax
Section 5, read with section 145, of the Income-tax Act, 1961 - Income - Accrual of
-Assessee-bank, following mercantile system of accounting, charged interest on
advances considered doubtful of recovery, called sticky advances by debiting
concerned parties but, instead of carrying it to profit and loss account, credited it
to separate account styled 'Interest suspense account' In its return assessee
disclosed such interest separately and claimed that same was not taxable in its
hands as income of concerned years - Whether in view of concept of real income,
impugned interest, which had accrued to assessee, could be excluded from
assessee's taxable income of concerned years - Held, no
5. [1997] 091 TAXMAN 351 (SC)SUPREME COURT OF INDIAGodhra Electricity
Co. Ltd.v.Commissioner of Income-tax
Section 5 of the Income-tax Act, 1961 - Income - Accrual of - Assessment years
1969-70 to 1972-73 - Assessee-company a licensee to generate and supply
electricity to its consumers, from 1963 enhanced tariff - Suit was filed by
consumers which was decreed against assessee ultimately - Supreme Court
decided dispute in favour of assessee-company in 1969 - During pendency of
18 | P a g e
litigations assessee though accounting for enhanced tariff could not recover same
and even after decisions in its favour in view of Government's advice assessee
was prevented from realising amounts in question - Ultimately, company was
taken over by Government and later transferred to Electricity Board - Whether in
above circumstances, since assessee was not able to collect enhanced charges,
necessary entries made in its books of account represented only hypothetical
income and it could not be brought to tax as it did not represent income which
had really accrued even though assessee-company was following mercantile
system of accounting - Held, yes
5. AS 10 and ICDS V: Tangible Fixed Assets

ICDS V provides that “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 the sale in the
normal course of business. The definition is same except that the AS 10 refers to the
word “asset” as against the specific items of land, building, machinery, plant or
furniture referred to in ICDS V. Moreover, the AS specifically says that the standard
doesn’tdeal with the following items to which special consideration applies i.e.,
a) Forests, plantations and similar regenerative naturalresources;
b) Wasting assets including mineral rights , expenditure on the exploration for and
extraction of mineral oil, natural gas and similar non regenerative resources;
c) Expenditure on real estate development
d) Livestock
Though it has been specified in AS that expenditure on individual items of fixed
assets used to develop or maintain the activities covered in (i) to (iv) above, but
separable from those activities are to be accounted for in accordance with the AS 2.
AS 10 applies to Good will but ICDS doesn’t



One difference which can be highlighted majorly is the value at which an asset shall
be acquired in exchange for another fixed asset or shares or securities. AS 10 says to
record the fixed asset at the fair value of the asset given or acquired whichever is
more clearly evident while ICDS V says to record the asset acquired in exchange at
the actual cost of the asset so acquired. This although may not cause difficulties in
accounting but shall mandatorily lead to discrepancies in valuation of the fixed asset
and thereby shall affect the balance sheet also.
There is no concept of revaluation of fixed assets under ICDS whereas the AS 2
provides for revaluation of the fixed assets.
ICDS V says that depreciation on tangible fixed asset shall be computed in
accordance with the provisions of the Act and again specifies that income arising on
19 | P a g e

transfer of a tangible fixed asset shall be computed in accordance with the provisions
of the Act. AS 10 provides for guidance on retirements and disposals of the fixed
assets.
ICDS V specifically provides that the following disclosures shall be made regarding
the tangible fixed assets, namely:a) Description of asset or blocks of assets
b) Rate of depreciation
c) Actual cost or written down value, as the case may be
d) Additions or deductions during the year with dates, in the case of any addition of
an asset, date put to use, including adjustment on account of-Central Value added tax credit claimed and allowed under the Cenvat Credit
Rules, 2004
-change in rate of currency
-subsidy or grant or reimbursement, by whatever name called.
e) depreciation allowable
f) written down value at the end of the year.
The existing AS 10 has also disclosure requirement but not exactly in the above
manner.
There is no mention regarding maintenance of ICDS specific FA register , which was
though proposed earlier.
6. AS 11 and ICDS VI: Effects of Changes in foreign exchange rates


ICDS requires premium, discount or exchange differences on forward contracts that
are intended for trading or speculation purposes, or that are entered into to hedge
the foreign currency risk of a firm commitment of a highly probable forecast
transaction to be recognized at the time of settlement. This is different from the
recognition of gains and losses on mark to market basis or recognition of only losses
in line with the principle of prudence. Due to this the recognition of losses stands
delayed thereby leading to a rise in income and taxes because the settlement of the
losses on foreign currency and forward contracts usually takes time.
AS 9 provides for accumulation of exchange differences arising from the translation
of financial statements of non-integral foreign operations in a foreign currency
translation reserve in a balance sheet while ICDS VI provides for recognition of such
differences as income or expense. This implies that now since we have to route the
exchange differences through the profit and loss account, taxes shall be levied on the
same and the income shall be accordingly higher on a positive exchange difference
and lower on a negative exchange difference.
Important Cases
20 | P a g e
1. [1979] 116 ITR 1 (SC)SUPREME COURT OF INDIASutlej Cotton Mills
Ltd.v.Commissioner of Income-tax
Section 28(1) of the Income-tax Act, 1961 (Corresponding to section 10(1) of
Indian Income-tax Act, 1922) – Business loss/ deductions – Allowable as - –
Assessment years 1957-58 and 1959-60 – Assessee-company after remitting
certain amounts from Pakistan where it was doing business in fabrics, claimed
that it suffered business loss due to devaluation of Pakistani rupee – Revenue
authorities rejected assessee’s claim – High Court also took view that it was not a
business loss as it was caused by devaluation of rupee which was an act of state –
Whether where profit or loss arises to an assessee on account of appreciation or
depreciation in value of foreign currency held by him, on conversion into another
currency, such profit or loss would ordinarily be trading profit or loss if foreign
currency is held by assessee on revenue account or as a trading asset or as part of
circulating capital embarked in business – Held, yes – Whether, however, if
foreign currency is held as a capital asset or as fixed capital, such profit or loss
would be of capital nature – Held, yes – Whether therefore, matter was to be
remanded to Tribunal to firstly determine as to whether amounts in question
were held in Pakistan as capital asset or as trading asset – Held, yes
2. CIT Vs Woodward Governor India P Ltd (2009) 312 ITR 254(SC)
3. ACIT Vs EleconEngg. Co Ltd (2010) 189 Taxman 83(SC)
4. Oil & Natural Gas Corporation Ltd Vs CIT(2010) 322 ITR 180(SC)
7. AS 12 and ICDS VII: Government Grants


A major difference which ICDS VII has brought in is the disallowance of the use of
capital approach method for recording of government grants. Thus, with the effect
of ICDS, grants cannot be anymore treated as a part of the shareholder’s funds. It
has to be either treated as revenue receipt or reduced from the cost of the fixed asset
depending on the purpose for which the grant or subsidy is given. Thus, the theory
of recognizing government grants outside the profit and loss account merely
because it represents an incentive provided by the government without related costs
stands dismissed in the newly formulated ICDS.
ICDS VII mentions that recognition of government grants shall not be postponed
beyond the date of actual receipt even though all the recognition conditions in
accordance with the accounting standards are not met. This has been done in order
to reduce litigations regarding the recognition criteria and also to provide certainty
on the topic. Under the AS 12 it is provided that mere receipt of a grant is not
necessarily a conclusive evidence that conditions attaching to the grant have been or
will be fulfilled.
21 | P a g e


AS provides that Government Grant in the nature of promoters’ contribution
(i.e.,they are given with reference to the total investments in an undertaking or by
way of contribution towards its total capital outlay and no repayment is ordinarily
expected, are credited directly to shareholders funds. There is no such mention in
the ICDS.
Important cases
1. [1997] 94 TAXMAN 368 (SC)SUPREME COURT OF INDIASahneySteel & Press
Works Ltd.v.Commissioner of Income-tax
Section 4 of the Income-tax Act, 1961 - Income - Assessable as - Assessment year
1974-75 - According to a notification issued by Government of Andhra Pradesh,
certain facilities and incentives were to be given to new industrial undertakings
which commenced production on or after 1-1-1969 with investment capital not
exceeding 5 crores for five years from date of commencement - Production
incentives were not available unless and until production had commenced - In
terms of said notification assessee received refund of sales tax - Whether refund of
sales tax was a revenue receipt - Held, yes
2. [2009] 185 TAXMAN 409 (SC)Mepco Industries Ltd. v.Commissioner of Incometax
Section 154 of the Income-tax Act, 1961 - Rectification of mistakes - Apparent
from record - Assessment years 1993-94 and 1994-95 - Assessee, engaged in
business of manufacture of potassium chlorate, received power subsidy for two
years, which it initially offered as revenue receipt in its returns of income However, thereafter, it sought revision of assessment orders contending that
subsidy amount was a capital receipt and, hence, not liable to be taxed Commissioner allowed revision petitions - Subsequently, in case of Sahney Steel
& Press Works Ltd. v. CIT [1997] 228 ITR 253/ 94 Taxman 368 (SC), Supreme
Court held that incentive subsidy admissible to that company was a revenue
receipt and, hence, it was liable to be taxed under section 28 - Following said
judgment, Commissioner passed order of rectification on ground that power
tariff subsidy given to assessee was admissible only after commencement of
production and, consequently, it constituted operational subsidies and not
capital subsidies - Whether in each case one has to examine nature of subsidy
and this exercise cannot be undertaken under section 154 - Held, yes - Whether,
on facts, when Commissioner, while passing orders under section 264, had taken
view that subsidy in question was a capital receipt not taxable under Act, he was
justified in invoking section 154 and holding subsidy in question to be revenue
in nature based on judgment of Supreme Court in case of Sahney Steel & Press
Works Ltd. (supra) - Held, no
8. AS 13 and ICDS VIII:Accounting for Investments
22 | P a g e






This ICDS deals with securities held as stock in trade.
Accounting Standard 13 (Accounting for Investments) deals with current
investments, long term investments and property but excludes shares, debentures
or other securities which are held as stock in trade by any assessee. ICDS VIII
(Securities) on the other hand deals only with securities held as stock in trade.
Hence, since both the AS 13 and ICDS VIII deal with two totally irreconcilable
topics, collation of both shall stand unjustified. ICDS VIII requires the comparison of
cost and net realizable value for securities held as stock-in-trade to be assessed
category wise and not for each individual security. ICDS VIII also quotes that
securities that are not quoted or are quoted irregularly shall be valued at cost. This
could represent a change in practice for some entities.
ICDS provides that cost shall be determined on FIFO basis.
At the end of the previous year, securities held as stock in trade shall be valued at
actual cost initially recognised or net realisable value at the end of the previous year
whichever is lower.
Securities are attached importance in a sense that ICDS 2 does not deal with
securities and a specific standard has been provided for the securities.
Net realisable value is not defined in this Standard even though it is defined in the
ICDS 2. There are bound to be disputes in this regard. Only fair value is defined as
the amount for which an asset could be exchanged between a knowledgeable,
willing buyer and a knowledgeable willing seller in an arm’s length transaction.
9. AS 16 and ICDS IX: Borrowing Costs


The major changes which have taken place in AS 16 with regard to ICDS IX is in the
method of capitalization of borrowing costs. In AS 16 we are supposed to suspend
the capitalization of borrowing costs during extended periods in which active
development is interrupted while in that of ICDS IX, nothing about the same has
been mentioned hence we assume that capitalization of borrowing costs should not
be suspended even where active development of a capital asset is interrupted. Also,
in AS 16, capitalization of borrowing cost is to be done only on incurrence of
expenditure on qualifying asset, incurrence of borrowing cost and on activities that
are necessary to prepare the asset for its intended use or sale while in ICDS IX it is
mentioned to commence to capitalize the borrowing costs from the date on which
the funds have been borrowed. There has also been some changes in the
capitalization of general borrowings. These changes in the method and timing of
capitalization can bring about some discrepancies in accounting.
Also, in AS 16, income from temporary investments was to be deducted from
borrowing costs but in ICDS IX, no mention has been made about the same hence we
assume it as non-deductible and thereby a taxable income.
23 | P a g e


Borrowing in AS 16 specifies that exchange difference arises from foreign currency
borrowing to the extent that they are regarded as an adjustment to interest costs may
be included in Borrowing cost. However these are not covered in ICDS IX.
Hindustan Lever Ltdhas taken a loan of USD 10 Million on April 1, 2015, for a
specific project @3% p.a., payable annually. On April 1, 2015 the exchange rate Rs.
60/USD. The exchange rate, as at March 31, 2016, is Rs. 46/USD. The corresponding
amount could have been borrowed by HLL. in local currency @11% p.a. on April 1,
2015. In this case, AS 16 prescribed the calculation of difference attributable as
interest.
Qualifying asset is defined in a simple manner in the AS 16 as an asset which takes
substantial period of time to get ready for its intended use or sale. In this regard the
ASI explains the meaning of the term “Substantial period of time”. The following
assets ordinarily take 12 months or more to get ready for intended use or sale unless
the contrary is proved by the enterprise:
a) Assets that are constructed or otherwise produced for an enterprise’s own use
e.g. assets constructed under major capital expansions.
b) Assets intended for sale or lease that are constructed or otherwise produced as
discrete projects for example ships or real estate developments.
In case of inventories, substantial period of time is considered to be involved where
time is the major factor in bringing about a change in the condition of the inventory.
For example, liquor is often required to be kept in store for more than 12 months for
maturing.
ICDS however, says that qualifying asset means
a) Land, building, machinery, plant or furniture being tangible assets.
b) Know-how , patents, copy rights, trade marks, licences , franchises or any other
business or commercial rights of similar nature, being intangible assets.
c) Inventories that require a period of 12 monthor more to bring them to a saleable
condition.
Thus, as per ICDS all assets other than inventories (excluding inventories as given
hereinabove) are considered for capitalisation of borrowing costs. Until now , the Act
required that capitalisation of borrowing cost only when there was an extension of
business. This condition of extension is now removed by the Finance Act, 2015. Thus
iCDS is now in line with the Act
Important Cases
1. [1975] 98 ITR 167 (SC)SUPREME COURT OF INDIAChallapalli Sugars
Ltd.V.Commissioner of Income-tax
Section 43(1) , read with section 32 of the Income-tax Act, 1961 (Corresponding to
section 12B(1) of the Indian Income-tax Act, 1922) – Actual cost – Whether for
24 | P a g e
purpose of deduction on account of depreciation and development rebate, interest
paid before commencement of production on amount borrowed for acquisition and
installation of plant and machinery can be considered to be part of actual cost of
assets to assessee - Held, yes
2. [1997] 93 TAXMAN 502 (SC)SUPREME COURT OF INDIATuticorin Alkali
Chemicals &Fertilizers Ltd.v.Commissioner of Income-tax
Section 56 of the Income-tax Act, 1961 - Income from other sources - Chargeable as Assessment year 1980-81 - Whether interest earned on short-term investment of
funds borrowed for setting-up of factory during construction of factory before
commencement of business-has to be assessed as income from other sources and it
cannot be said that interest income is not taxable on ground that it would go to
reduce interest on borrowed amount which would be capitalised - Held, yes
3. [1999] 102 TAXMAN 94 (SC)SUPREME COURT OF INDIACommissioner of
Income-taxv.Bokaro Steel Ltd.
Section 28(i) of the Income-tax Act, 1961 - Business income - Chargeable as Assessment years 1965-66 to 1971-72 - Assessee-company was in process of
constructing and erecting its plant and had not started any business during relevant
assessment years - It received certain amounts through (i) rent charged by assessee
from its contractors for housing workers and staff employed by contractor for
construction work of assessee, (ii) hire charges for plant and machinery given to
contractors for use in construction work of assessee, (iii) interest from advances
made to contractors for purpose of facilitating work of construction, and (iv) royalty
for excavation and use of stones lying on assessee’s land for construction work - First
three receipts had been adjusted against charges payable to contractors and, thus,
had gone to reduce cost of construction - Whether first three receipts being
intrinsically connected with construction of assessee’s plant, would be capital receipt
and not income of assessee from any independent source - Held, yes - Whether
similarly royalty received for stone excavated from assessee’s land would go to
reduce cost of plant and could not be taxed as income - Held, yes
4. [2008] 167 TAXMAN 206 (SC)SUPREME COURT
Commissioner of Income-taxv.Core Health Care Ltd.*
OF
INDIADeputy
Section 36(1)(iii) , read with Explanation 8 to section 43(1), of the Income-tax Act,
1961 - Interest on borrowed capital - Assessment year 1992-93 - Whether proviso
inserted in section 36(1)(iii) with effect from 1-4-2004 has to be read as
prospectively - Held, yes - Whether what section 36(1)(iii) emphasises on is user
of capital and not user of asset which comes into existence as a result of
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borrowed capital, unlike section 37(1) which expressly excludes an expense of a
capital nature - Held, yes - Whether Legislature has, therefore, made no
distinction in section 36(1)(iii) between ‘capital borrowed for a revenue purpose’
and ‘capital borrowed for a capital purpose’ and an assessee is entitled to claim
interest paid on borrowed capital provided that capital is used for business
purpose irrespective of what may be result of using such borrowed capital Held, yes - Whether Explanation 8 to section 43 as well as concept of
determination of ‘actual cost’ have no application to section 36(1)(iii) as this
section does not incorporate concept of depreciation - Held, yes - Assessee had a
running business of manufacturing and selling of intravenous solutions - It
installed new machineries on which production was not started during relevant
year - Assessee claimed deduction of interest on borrowings made for purchasing
these machineries - Whether assessee’s claim was to be allowed - Held, yes
10. AS 29 and ICDS X: Provisions, Contingent Liabilities and Contingent assets

ICDS X specifically says that the standard deals with provisions, contingent
liabilities and contingent assts, except those
a) Resulting from financial instruments
b) Resulting from executory contracts
c) Arising in insurance business from contracts with policyholders; and
d) Covered by another ICDS
An important point to be noted is that the ICDS provides that the term provision is
also used in the context of items such as depreciation, impairment of assets and
doubtful debts which are adjustments to the carrying amounts of assets and are not
addressed in this ICDS. Thus, the issues relating to the provisions of bad and
doubtful debts which have been held to be not eligible for being deducted while
computing book profit are sought to be taken care of by this exception.



Unlike the existing AS 29, ICDS X requires the recognition of provisions only if it is
reasonably certain that an outflow of resources embodying economic benefits will be
required to settle the obligation and a reliable estimate can be made of the amount of
the obligation.The phrase “reasonably certain” has not been defined. As against this,
AS 29 uses the word “Probable” . This might cause a certain delay in the recognition
of provisions although not much.
The definition of the term Present obligation also uses the phrase “reasonably
certain” as against “Probable” used in AS 29.
AS 29 clarifies that “obligation” may be legally enforceable and may arise from
normal commercial business practice or to act in a desirable business atmosphere.
However, the ICDS does not define the term “obligation”. Thus, provisions made in
order to follow normal business practices arising out of good customer relationship
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
may not be allowed. Take the example of MNCs who are generally in the forefront in
this.
Contingent Assets and reimbursement claims are recognised if inflow of economic
benefits/ reimbursement is “virtually certain” as against “reasonably certain”. The
term “reasonably certain” has not been defined and thus prone to disputes.
Important judgement.
1. Rotork Controls India P Ltd (2009) 314 ITR 62(SC)
Section 37(1) of the Income-tax Act, 1961 - Business expenditure - Allowability of
- Assessment years 1991-92 to 1994-95 - Whether for a provision to qualify for
recognition, there must be a present obligation arising from past events,
settlement of which is expected to result in an outflow of resources and in respect
of which a reliable estimate of amount of obligation is possible - Held, yes Whether if historical trend indicates that in past large number of sophisticated
goods were being manufactured and defects existed in some of items
manufactured and sold, then provision made for warranty in respect of army of
such sophisticated goods would be entitled to deduction from gross receipts
under section 37(1), provided data is systematically maintained by assessee Held, yes
1.5 ICDS and MAT Computation
1. In case of MAT income- even though accounts are prepared as per AS- you are assuming
that to be correct for the purposes of payment of taxes. In the case of MAT you are
assuming that the accounts must be prepared as per the Accounting Standards where as for
normal computation you would not be doing so. Levying tax on book profit which is
determined as per the AS and again asking companies to restate the accounts using ICDS
appears to be a tedious task. May be the coming budget will see changes in the provisions
relating to MAT by including ICDS in Section 115JB and 115JC dealing with MAT and
AMT.
1.6 Some other Cases in relation to the Computation vis-à-vis accounting Standards
a) Taparia Tools Ltd (2015) 55 taxmann.com 361(SC)
b) Madras Industrial Investment Corporation Ltd Vs CIT(1997) 225 ITR 102(SC)
Thanking You,
CA Ramesh Kumar Patodia
ramesh.patodia@rkrr.in
Disclaimer: The analysis in this booklet is solely for information purposes. We are not offering it as a legal, accounting
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