Presentation by CA M.R.HUNDIWALA M.R.HUNDIWALA & CO. CHARTERED ACCOUNTANTS AURANGABAD/PUNE

Presentation by CA M.R.HUNDIWALA M.R.HUNDIWALA & CO. CHARTERED ACCOUNTANTS AURANGABAD/PUNE

2 Synopsis of Contents Background of Section 145 Journey of notified standards under Section 145 Notified ICDS Common Basic Features of ICDS Consequent Issues that could arise Typical Features of ten notified ICDS

3 Background of Section 145 For computing income chargeable under Profits and gains of business or profession or Income from other sources. Method of Accounting regularly employed by assessee. Substitution by Finance Act 1995 : either cash or mercantile. Central Govt. may notify Accounting Standards. Notified Accounting Standards not being followed, Assessing Officer may make best judgment assessment u/s. 144.

Journey of notified standards under Section 145 4 Finance Act, 1995 empowered the Central Govt. to issue Accounting Standards by amending 145(2). Two Accounting Standards were notified by notification no. SO 69(E) dt. 25-01-1996 Disclosure of Accounting Policies Disclosure of prior period and extraordinary items and changes in accounting policies CBDT constituted committee in 2010 to suggest Accounting Standards for notification. Final Report submitted in 2012 along with 14 Draft Tax Accounting Standards. Finance Act 2014 substituted the term accounting standard in section 145(2) with ICDS. 10 ICDS notified in March, 2015 applicable from A.Y. 2016-17 by Notification No. 32/2015 F.N0. 134/48/2010-TPL. Eswar Committee recommended for deferment, applicability postponed to AY 2017-18, Stakeholders comment invited, ITR and Form 3CD amended for disclosures of impact, certain ICDS revised. FAQs issued to clarify certain implementation issues.

5 Notified ICDS Income Computation & Disclosure Standards Corresponding ICAI AS ICDS I Accounting Policies AS 1 ICDS II Valuation of Inventories AS 2 ICDS III Construction Contracts AS 7 ICDS IV Revenue Recognition AS 9 ICDS V Tangible Fixed Assets AS 10 ICDS VI Effects of Changes in Foreign Exchange Rates AS 11 ICDS VII Government Grants AS 12 ICDS VIII Securities ICDS IX Borrowing Costs AS 16 ICDS X Provisions, Contingent Liabilities, Assets AS 29

6 Amendments in Form 3CD : clause 13 (d) and (e) Whether any adjustment is required to be made to the profits or loss for complying with the provisions of ICDS notified u/s. 145(2) ICDS No. Particulars ICDS I If answer is affirmative, give details of such adjustments. Accounting Policies Increase in profit (Rs.) Decrease in profit (Rs.) Net effect (Rs.) ICDS II ICDS III ICDS IV ICDS V ICDS VI ICDS VII ICDS VIII Securities ICDS IX ICDS X Valuation of Inventories Construction Contracts Revenue Recognition Tangible Fixed Assets Change in Foreign Exchange Rates Government Grants Borrowing Costs Provisions, Contingent Liabilities and Contingent Assets

7 Amendments in Form 3CD : clause 13 (f) Disclosure as per ICDS Sr Particulars 1 ICDS I - Accounting Policies 2 ICDS II - Valuation of Inventories 3 ICDS III - Construction Contracts 4 ICDS IV - Revenue Recognition 5 ICDS V - Tangible Fixed Assets 6 ICDS VII - Government Grants 7 ICDS IX - Borrowing Costs 8 ICDS X - Provisions, Contingent Liabilities and Contingent Assets

8 Common Basic Features of ICDS Primarily simplified versions of corresponding AS issued by ICAI. ICDS are applicable to assesses having income from business or profession and income from other sources. ICDS are applicable to assesses following mercantile system of accounting. Not applicable in case of cash system. ICDS are to be complied while computing the income, no books of account are required to be maintained following ICDS. Where ICDS conflicts with the provisions of IT Act, then the provisions of IT Act shall prevail. Expressions used in ICDS but not defined, will have the meaning as defined in IT Act. Provision made for transition to ICDS during A.Y. 2017-18.

Applicability Of ICDS and Disclosure requirements In Tax Audit Report 9 Sr. Assessee Status ICDS Compliance Disclosure FORM 3CD Disclosure ITR 1 All assessees ( Ind., HUF, LLP, Partnership, Co., Others ) following cash system of accounting 2 All assesses ( Ind., HUF, LLP, Partnership, Co., Others )not having income from Business/Profession or income from Other Sources 3 Individual /HUF not required to get accounts audited u/s. 44AB 4 Partnership/AOP/LLP/Companies/Others not required to get audited u/s. 44AB 5 Partnership Firms under Presumptive Taxation 44AD ( Refer Q. 3 of FAQ) 6 Partners (Ind.) having remuneration and interest from firms and subject to audit u/s. 44AB 7 Companies subject to MAT provisions ( Refer Q. 6 of FAQ) Not Required Not Required Not Required Required Required Not Required Not Required Not Required Not Required Not Required Not Required Not Applicable Not Applicable Required Required Required Required Required Not Required Not Applicable Not Required 8 Assessees subject to AMT provisions ( Refer Q. 6 of FAQ) Required Required Required

10 Consequent issues that could arise.. When ICDS is in conflict with the Act, the provisions of Act will prevail, then why ICDS? When treatment as per ICDS is at cross purpose with a settled judicial opinion/interpretation, which will prevail? Mismatch between book profits under MAT and income as per ICDS. Challenge to maintain trail of reconciliations between accounts under AS/Ind. AS and carrying amounts under various ICDS. Will ICDS apply to assessees taxed on gross income basis for example under Sec. 44AD, 44AE, 44D, 44DA etc.. Can ICDS bring to charge any receipt which is not income as per Sec. 2(24). Huge responsibility of the auditors to certify compliance and disclosures under ICDS. Dual reporting responsibility in case of non corporate assessees under SA 700 and under ICDS.

11 ICDS I : ACCOUNTING POLICIES

12 ICDS I : Relating to Accounting Policies Generally based on the principles laid in earlier notified AS 1 under Section 145, similar to AS 1 of ICAI except few fundamental changes. Not merely a disclosure standard but also provides underneath principles. While framing accounting policies, although the concepts of Going Concern, Consistency and Accrual are accepted, the concept of Prudence and Materiality have been either curtailed or ignored. Materiality concept is not even adopted by the Income Tax Act. Prudence concept provided differential treatment to provision for expenses and provision for income. Change in accounting policy has to be for a reasonable cause. What is reasonable cause is not defined. CBDT has elaborated on this issue in FAQs ( No. 9) : the concept of Reasonable Cause is an existing concept under the Act and has evolved well over a period of time conferring desired flexibility to the tax payer in deserving cases.

13 Accounting Policies. an inappropriate treatment of an item of revenue or expenditure in computation cannot be justified or remedied by disclosure of such inappropriate treatment in accounting policy. Accounting Policies that divert from fundamental assumptions of going concern, consistency and accrual, need to be reported. Disclosure Requirements : a) All significant accounting policies adopted by a person shall be disclosed. b) Any change in an accounting policy which has a material effect shall be disclosed. c) If a fundamental accounting assumption is not followed, the fact shall be disclosed.

14 ICDS II : VALUATION OF INVENTORIES

15 ICDS II : Relating to Valuation of Inventories Generally aligned to AS 2 issued by ICAI. Except few changes suggesting very conservative approach. ICDS II not applicable to : * inventory covered by other ICDS ( contracts, securities, etc..) * producer s inventory of livestock, agriculture produce, mining, mineral oil, ores and gases * machinery spares of irregular use specific to a tangible fixed asset Inventories are assets : * held for sale in the ordinary course of business * In the process of production for such sale * In the form of material or supplies to be consumed in the production process or in rendering of services (Thus will include finished, WIP, raw material, consumables, tools etc.)

16 ICDS II : Relating to Valuation of Inventories Inventories are to be valued at lower of cost or net realizable value. Retail method is also accepted in case of retail trade. In case of Service Providers, whether unbilled services in progress to be accounted for at the year end or only material and supplies to be used in rendering services? ICAI view at para 7 page 46 of Technical Guide. Method of Valuation of Inventory not to change unless there is a reasonable cause. What is reasonable cause is not defined. Taxes, duties, cess, fee that are redeemable not to be reduced from cost of inventories. Aligned to provisions under section 145A. Interest not to form cost of inventory unless ICDS on borrowing cost permits. Cost of inventories to include : Cost of purchases, cost of services, cost of conversion, and other cost incurred in bringing inventory to present location and condition.

17 ICDS II : Inventory Valuation - Goods And Services Sr. Component Include Exclude 1 Cost of purchase 2 Cost of service 3 Cost of Conversion Purchase price including duties and taxes, freight inwards and other expenditure directly attributable to the acquisition. Labour and other costs of personnel directly engaged in providing the service including supervisory personnel and attributable overheads Cost directly related, Fixed Cost allocated to each unit of production based on normal production capacity, Variable costs allocated based on actual production. 4 Other Costs cost incurred in bringing the inventories to their present location and condition. Interest and other borrowing cost only if it is as per ICDS on borrowing costs. Trade discounts, rebates and other similar items. Abnormal wastage of services. Storage costs unless necessary during intermediate production process. Reduce realisable value of byproducts, scrap or waste material, abnormal wastage of material, if immaterial. Administration cost that do not contribute to bringing inventory to present location or condition. Selling costs

18 ICDS II : Inventory Valuation Principles of Costing Specific identification of costs for those items of inventory are not ordinarily interchangeable. Rarely applied ( e.g. inventory of painting gallery) Goods and Services used for Specific projects to be valued at specifically identified costs. General Inventory to be assigned First in First Out formulae or weighted average costs that fairly approximates to actual costs. Standard costing could be used with a condition that it is periodically reviewed and adjusted and fairly approximates to actual costs. Retail costing method could be used in retail trade, with a condition that average margins for each retail department would be reduced from selling price of inventory of that department. Net Realisable Value to be ascertained separately for each item of inventory unless they could be aggregated on account of similar features like purpose, end use, geographical location etc..

19 ICDS II : Inventory Valuation Principles of Costing Raw Materials and supplies inventory not to be valued below cost unless the prices of finished goods are reduced resulting into loss. Value of Opening Stocks to be continued as it is ( even if it does not comply with ICDS ) in case the material remains in stocks, till it's disposal. On dissolution of Firm, AOP or BOI, inventory to be valued at NRV, notwithstanding whether business continued or not. Supreme Court decision in Shakti Trading Co. overruled. ( capital asset - sec. 45(4)) Disclosure Requirements : The following aspects shall be disclosed, namely: a) the accounting policies adopted in measuring inventories including the cost formulae used; and b) the total carrying amount of inventories and its classification appropriate to a person.

20 ICDS III : CONSTRUCTION CONTRACTS

ICDS III : Construction Contract 21 Sr. Particulars Inclusions Exclusions 1 SCOPE Specifically negotiated contract for construction of an asset or group of assets. Contract for rendering of services - directly related 2 CONTRACT REVENUE Comprises of : Recognition : Contract for destruction, contract for restoration of an asset or environment after demolition of asset. Initially agreed revenue, including retentions, revenue for work variations, claims and incentives when probable and reliably measurable To be recognised when there is a reasonable certainty of ultimate collection. To be recognised as per stage of contract completion on reporting date Stage of completion to be determined with reference to proportion of cost incurred to total estimated cost or survey of work performed or physical completion of contract. Recognition in Early stage of contract : not to cross 25% of contract completion

22 ICDS III : Construction Contract Sr. Particulars Inclusions Exclusions 3 CONTRACT COSTS Comprises of : Directly related costs to a specific contract General costs that are attributable to contract activity and which can be allocable to contract Cost specifically chargeable to Customer under the Contract Borrowing costs, if any, as per ICDS on borrowing costs Incidental income other than interest, Dividend and Capital Gains Costs not attributable to construction activity or not allocable to specific contract Costs prior to securing of contracts, that is not allocable to specific contract Recognition : To be recognised as per stage of contract completion on reporting date The change in estimates of costs to be recognised in the year of change and subsequent years Costs related to future activity to be treated as asset till chargeable as per contract

23 ICDS III : Issues that may arise.. Completed contract method vis a vis Percentage completion method approved by judiciary in case of 334 ITR 194 ( Sai Hotels Mad.HC ), 275 ITR 30 ( Advance Construction Guj.HC), 186 ITR 428 ( Tirath Ram Ahuja SC ). Whether applies to real estate developer? Retention Money - ratio laid out by Supreme Court in 26 ITR 27 Whether borrowing costs forms part of contract costs. Treatment for unforeseen actual Loss in execution of contract, and revision in estimates. Treatment of expenditure on service contracts, the revenue from which is uncertain or depends on positive outcome. ICDS applicable to contracts commenced after 1-4-2016. Earlier contracts to continue with method regularly followed.

24 ICDS III : Relating to Construction Contracts (Cont..) Disclosure Requirements : A person shall disclose: a) the amount of contract revenue recognized as revenue in the period; and b) the methods used to determine the stage of completion of contracts in progress. A person shall disclose the following for contracts in progress at the reporting date, namely: a) amount of costs incurred and recognized profits less recognized losses upto the reporting date; b) the amount of advances received; and c) the amount of retentions.

25 ICDS IV : REVENUE RECOGNITION

26 ICDS IV : Relating to Revenue Recognition Like AS 9, revenues to be recognized in respect of sale of goods, rendering of services, and income arising due to use of resources by others. ICDS IV principles would not apply to those streams of income covered by other ICDS. Further to those income which do not arise in the ordinary course of activities of a person. Goods not defined in ICDS. Defined in Sale of Goods Act, 1930. Revenue is defined as gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of a person from the sale of goods, from the rendering of services, or from the use by others of the person s resources yielding interest, royalties or dividends. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.

27 Relating to Revenue Recognition Concept of transfer of risk and rewards, as stated in AS 9, is fully recognized by ICDS. Thus passage of risk and rewards is crucial for recognizing sales, rather than billing of goods. In respect of revenue from rendering of services, percentage completion method is required to be adopted for revenue recognition. ICDS III principles would apply to that extent. Reasonable certainty of ultimate collection principle is also recognized in case of sale of goods. Reference is made specifically in respect of export incentives and price escalations. M.R. HUNDIWALA & CO., CHARTERED ACCOUNTANTS

28 ICDS IV : Revenue Recognition ( arising in the course of ordinary activities of a person ) Sr. Revenue Comprises Of : Criteria Of Recognition 1. Sale of Goods Property in goods is transferred for a price Significant risks and rewards of ownership is transferred and Seller retains no effective control of goods usually associated with ownership Revenue to be recognised when there is reasonable certainty of ultimate collection When reasonable certainty is lacking, revenue recognition to be postponed to the extent of uncertainty involved. 2. Rendering of Services Revenue to be recognised on Percentage Completion Method Revenues to be matched to costs keeping stage of completion in mind.

29 ICDS IV : Revenue Recognition ( arising in the course of ordinary activities of a person ) Sr. Revenue Comprises Of : Criteria Of Recognition 2. Rendering of Services Revenue to be offered on straight line Method in case services are indeterminate over a period. 3. Use of Resources by Others (interest, royalty and dividend) Short term service contract (90 days ), revenue to be offered on completion or substantial completion Interest shall be recognised on time basis, on outstanding amount at applicable rates Interest on refund of tax, duty, cess to be recognised on receipt basis Royalty to be recognised as per agreement or other more scientific basis, if any. Dividend to be recognised as per Income Tax Act.

30 ICDS IV : Relating to Revenue Recognition (Cont..) Disclosure Requirements :Following disclosures shall be made in respect of revenue recognition, namely: a) In a transaction involving sale of good, total amount not recognized as revenue during the previous year due to lack of reasonably certainty of its ultimate collection along with nature of uncertainty; b) The amount of revenue from service transactions recognized as revenue during the previous year; c) the method used to determine the stage of completion of service transactions in progress; and d) for service transactions in progress at the end of previous year: i. amount of costs incurred and recognized profits less recognized losses upto end of previous year; ii. iii. the amount of advances received; and the amount of retentions.

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