INCOME COMPUTATION AND
DISCLOSURE STANDARDS
Presenter – CA Anil J. Sathe
anil@gokhalesathe.in
1
ICDS I – ACCOUNTING POLICIES

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
2
ICDS I – ACCOUNTING POLICIES

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
3
ICDS I – ACCOUNTING POLICIES

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
4
ICDS I – ACCOUNTING POLICIES






ICDS 1 is a disclosure Standard while the other standards are
computation standards.
Scope – to deal with significant accounting policies
Fundamental accounting assumptions:
 Going Concern
 Consistency
 Accrual
Impact if assessee is not a Going Concern?
Accounting Policies refer to specific accounting principles and methods
of applying those principles
Accounting policies to be chosen to represent true & fair view of state of
affairs & income
 Substance over legal form (Issue – Finance Leases)
 Marked-to-market loss not to be recognised unless provided by other
ICDS
5
30th January, 2016
CA Anil J. Sathe
ICDS I – ACCOUNTING POLICIES



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
6
ICDS I – ACCOUNTING POLICIES
Particulars
ICDS
AS
Ind-AS
Relevant Standard
ICDS 1
AS 1 & AS 5
Ind-AS 1 & Ind-AS 8
Fundamental
Accounting
Assumptions
Going Concern
Consistency
Accrual
Going Concern
Consistency
Accrual
Going Concern
Accrual
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 conditionrefer to applicable
Ind-AS
Consideration in
Does not recognise
the selection of
the concepts of
Accounting Policies prudence and
materiality for
selection of
accounting policies
30th January, 2016
CA Anil J. Sathe
7
ICDS I – ACCOUNTING POLICIES
Particulars
Change in
Accounting
Policies
30th January, 2016
ICDS
AS
Ind-AS
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 IndAS; 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.
CA Anil J. Sathe
8
ICDS I – ACCOUNTING POLICIES SIGNIFICANT ISSUES




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
9
ICDS I – ACCOUNTING POLICIES SIGNIFICANT ISSUES

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
10
ICDS I – ACCOUNTING POLICIES SIGNIFICANT ISSUES

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
11
ICDS I – ACCOUNTING POLICIES SIGNIFICANT ISSUES

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
12
ICDS II – Valuation of Inventories
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
13
ICDS II – Valuation of Inventories

Applicability
 Determine the value at which inventories are carried in the financials
statements
 Cost ascertainment
 Treatment of carrying cost of inventories

Measurement
 Inventories to be valued at lower of cost or net realizable value.

Assets
 Held for sale in ordinary course of business
 In process of Production for such sale
 Material or supplies to be consumed in the production process or in
the rendering of services
30th January, 2016
CA Anil J. Sathe
14
ICDS II – Valuation of Inventories

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
15
ICDS II – Valuation of Inventories


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
16
ICDS II – Valuation of Inventories –
Cost of Inventories

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
17
ICDS II – Valuation of Inventories –
Cost of Inventories

Exclusions
 Abnormal amounts of wasted materials & others
 Storage costs unless necessary
 Admin overheads not attributable to bring inventories to their present
location and conditions
 Selling & Distribution Overheads

Service Providers
 Definition of inventories does not include ‘Cost of services’ as part of
inventory. Words used are“materials or supplies to be consumed in
the rendering services. However clause 6 includes, cost of labour,
personnel and administrative overheads.
30th January, 2016
CA Anil J. Sathe
18
ICDS II – Valuation of Inventories

Inventory Valuation methods include the following:
 Specific Identification Method
 First In First Out
 Weighted Average
 Standard Cost
 Retail Method ( For retail trader)
30th January, 2016
CA Anil J. Sathe
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ICDS II – Valuation of Inventories

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
20
ICDS II – Valuation of Inventories

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
21
ICDS II – Valuation of Inventories



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
22
ICDS II – Valuation of Inventories
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
23
ICDS II – Valuation of Inventories –
Other Aspects
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
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ICDS II – Valuation of Inventories –
Reasonable Cause
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
25
ICDS II – Valuation of Inventories
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
26
ICDS III – Construction Contracts
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
27
ICDS III – Construction Contracts

Fixed Price Contract
 It is a construction contract in which the contractor agrees to a fixed
contract price, or a fixed rate per unit of output, which may be subject
to escalation clauses
 Eg: Construction of Residential or commercial properties etc.

Cost Plus Contract
 It is a construction contract in witch the contractor is reimbursed for
allowable or otherwise defined costs, plus a mark up on these costs or
a fixed fee
 Such contracts are entered into where cost is not easily ascertainable.
30th January, 2016
CA Anil J. Sathe
28
ICDS III – Construction Contracts
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
29
ICDS III – Construction Contracts

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
30
ICDS III – Construction Contracts
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
31
ICDS III – Construction Contracts

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
32
ICDS III – Construction Contracts
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
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ICDS III – Construction Contracts
Contract Revenue
Contract Cost
To be recognized when there is
reasonable certainty of its ultimate
collection
It includes direct cost, cost attributable from
date of securing contract to final
completion, costs specifically chargeable to
customer, Borrowing costs as per ICDS IX
Retention money to be included as part
of contract revenue
Identifiable costs for securing contract if
there is probability of obtaining contract
Variations in contract work, claims and
incentive payment, if cash flow is
probable and capable of being reliably
measured
Contract costs to be reduced by incidental
income except interest, dividends or capital
gains
ICDS IX does not permit reduction of
income from temporary investments of
borrowed funds for capitalization
30th January, 2016
Contract costs relating to future activity to
be recognized as an asset
34
CA Anil J. Sathe
ICDS III – Construction Contracts

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
35
ICDS III – Construction Contracts
Impact of MAT
Year
Contract Unrelated Total Income
Income Computation
Normal
Income Book
(ICDS) Profit
1
(<25 Foreseeable
% loss
work) (10,000)
2
Contract
concludes
on loss
30th January, 2016
8,000
8,000 -2000
8000
-2000 8000
CA Anil J. Sathe
 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
36
ICDS III – Construction Contracts
Particulars
AS 7/ Proposed Ind AS 11 ICDS III
Contract revenue to be
recognized on POCM basis if
Contract revenue to be
it is possible to reliably
recognized if there is
Recognition of
measure the outcome of a
reasonable certainty of its
contract revenue
contract
ultimate collection
Incentive payment/ claims to
be recognized if
Incentives can be reliably Incentives payments/ claim
measured and probability
to be recognized if:
Recognition of
exists that specified
Incentive/ claim is reliably
incentive
performance standards
measurable and it is
payments/claims would be met or exceeded, probable that it will result in
against customers customer will accept claim
revenue
30th January, 2016
CA Anil J. Sathe
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ICDS III – Construction Contracts
Particulars
AS 7/ Proposed Ind AS 11 ICDS III
Impact of
variation in
scope of
contract
Contemplates variation in
revenue on account of
increase or decrease in
scope of work
Contemplates variation due to
increase in scope of work and
does not specifically refer to
downward variation
Early stage
of
completion
There is no specific
percentage
Early stage shall not extend
beyond 25% of work completed
Parameters
to determine
stage of
completion
It can be determined in a
variety of ways including
the methods in ICDS III
• Cost incurred vis-à-vis total
cost
• Survey of work performed
• Completion of physical
proportion
30th January, 2016
CA Anil J. Sathe
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ICDS III – Construction Contracts
Particulars
AS 7/ Proposed Ind AS 11 ICDS III
Recognition of
contract WIP
Contract cost which relate
to future activity shall be
recognized as an asset if
recovery is probable
To be recognized as an asset
even if recovery not probable.
If the cost is not realizable the
loss is to be allowed under
provisions of the act
Reversal of
Revenue
Revenue already
recognized can be
reversed on account of
uncertainty in the future
Reversal of revenue needs to
be claimed separately as an
expense and is not to be
adjusted against the contract
revenue
30th January, 2016
CA Anil J. Sathe
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ICDS III – Construction Contracts


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
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ICDS III – Construction Contracts


Transitional Provisions
ICDS committee recommended notification of transitional provision
along with ICDS to address the issue of double taxation or non taxation
arising from ICDS becoming effective on a particular date
Transitional provision of ICDS III reads as follows
“Contract revenue and contract costs associated with the construction
contract, which commenced on or before 31st day of march, 2015 but not
completed by the said date, shall be recognized as revenue and costs
respectively in accordance with the provisions of the standard. The
amount of contract revenue , contract cost or expected loss if any,
recognized for the said contract for any previous year commencing on or
before the 1st day of April, 2014 shall be taken into account for
recognizing the revenue and costs of the said contract for the previous
year commencing on the 1st day of April, 2015 and subsequent previous
years.”
30th January, 2016
CA Anil J. Sathe
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ICDS III – Construction Contracts

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
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ICDS III – Construction Contracts
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
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ICDS III – Construction Contracts



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.
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