- Introduction
- If the AO is not satisfied with the correctness or completeness of the assessee’s accounts;
- If the assessee has not regularly followed the chosen method of accounting; or
- If the income has not been computed in accordance with the applicable ICDS.
- An individual or HUF who is not required to get his books of account audited under Section 44AB for the relevant previous year; and
- Any assessee who has opted for presumptive taxation scheme.
- ICDS-I: ACCOUNTING POLICIES
- Going Concern
- Consistency
- Accrual
- Their substance shall govern the treatment and presentation of transactions and events and not merely by the legal form; and
- Marked-to-market loss or an expected loss shall not be recognised unless it is in accordance with the provisions of any other ICDS
- All significant accounting policies adopted by a person shall be disclosed;
- Any change in an accounting policy which has a material effect shall be disclosed. Where it is possible to ascertain the effect, the amount by which any item is affected by such change shall be disclosed. Where it is not possible to ascertain the effect, whether wholly or in part, the fact shall be indicated;
- Any change in an accounting policy which does not have material effect in current previous year but which is reasonably expected to have a material effect in later previous years, then such change shall be disclosed in both the years - year in which change is adopted and year in which such change has material effect for the first time; and
- Where fundamental accounting assumptions are followed, no specific disclosure is required. However where these assumptions are not followed, the fact shall be disclosed.
- ICDS-II: VALUATION OF INVENTORIES
- Work-in-progress arising under 'construction contract', including directly related service contract, which is dealt with by the ICDS-III (Construction Contracts);
- Work-in-progress, which is dealt with by any other ICDS;
- Shares, debentures and other financial instruments held as stock-in-trade which are dealt with by the ICDS-VIII (Securities);
- Inventories of producers which are measurable at net realisable value, i.e. inventories of livestock, agriculture & forest products, mineral oils, ores and gases; and
- Machinery spares, which can be used only in connection with a tangible fixed asset and their use is expected to be irregular, shall be dealt with in accordance with the ICDS-V (Tangible Fixed Assets).
- Held for sale in the ordinary course of business;
- In the process of production for such sale;
- In form of materials or supplies to be consumed in the production process or in the rendering of services.
- Cost of purchase;
- Cost of services;
- Cost of conversion; and
- Other costs incurred to bring the inventories to their present location and condition.
- Fixed Overheads: Fixed production overheads shall be those indirect costs of production that remain relatively constant regardless of the volume of production and such overheads are allocated on basis of normal production capacity of an entity.
- Variable Overheads: Variable production overheads shall be assigned to each unit of production on the basis of the actual use of the production facilities.
- Abnormal amount of wasted materials, labour, or other production costs;
- Storage costs, unless those costs are necessary in the production process prior to further production stage;
- Administrative overheads that do not contribute to bring the inventories to their present location and condition; and
- Selling costs
- Specific Identification Method
- First-in-First-out (FIFO) Method
- Weighted Average Cost Method
- The accounting policies adopted in measuring inventories including the cost formulae used;
- If standard costing has been used as a measure of cost then details of such inventories and a confirmation that standard cost approximates the actual cost; and
- The total carrying amount of inventories and its classification appropriate to a person.
- ICDS-III: CONSTRUCTION CONTRACTS
- ‘Construction Contract’ is a contract specifically negotiated for construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use and it includes:
- Contract for rendering of services which are directly related to the construction of asset, i.e., services of project managers, architects, etc.
- Contract for destruction or restoration of assets, and the restoration of the environment after demolition of asset.
- ‘Fixed Price Contract’ 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 cost escalation clauses.
- ‘Cost-Plus Contract’ is a construction contract in which contractor is reimbursed for allowable or otherwise defined costs, plus a mark-up on these costs or a fixed fee.
- “Retentions” are amounts of progress billings which are not paid until the satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified.
- “Progress billings” are amounts billed for work performed on a contract whether or not they have been paid by the customer.
- “Advances” are amounts received by the contractor before the related work is performed.
- Separate proposals have been submitted for each asset;
- Each asset has been subject to separate negotiation and contractor and customer have been able to accept or reject that part of the contract relating to each asset; and
- The costs and revenues of each asset can be identified.
- Group of contracts is negotiated as a single package;
- Contracts are so closely interrelated that they are, in effect, part of a single project with an overall profit margin; and
- Contracts are performed concurrently or in a continuous sequence.
- Additional asset differs significantly in design, technology or function from the asset or assets covered by the original contract; or
- Price of additional asset is negotiated separately without having regard to the original contract price.
- Initial amount of revenue agreed in the contract, including retentions; and
- Variation in contract work, claims and incentive payments to the extent that it is probable that it will result in revenue and it is capable of being reliably measured.
- Cost Proportionate Method
- Survey of Work Method
- Physical Completion Method
- The amount of contract revenue recognised as revenue in the period; and
- The method used to determine the stage of completion of contracts in progress.
- Amount of cost incurred and profit recognised (less recognised losses) up to the reporting date;
- The amount of advances received; and
- The amount of retentions.
- ICDS IV: REVENUE RECOGNITION
- Sale of goods
- Rendering of services
- Use by others of person's resources yielding interest, royalties or dividends.
- Sale of goods
- Rendering of services
- Interest
- Royalties
- Dividends
- All significant risks and rewards of ownership have been transferred to the buyer;
- Seller retains no effective control of the goods transferred to a degree usually associated with ownership; and
- There is no significant uncertainty over ultimate collection of consideration.
- In a transaction involving sale of good, total amount not recognised as revenue during the previous year due to lack of reasonably certainty of its ultimate collection along with nature of uncertainty.
- The amount of revenue from service transactions recognised as revenue during the previous year.
- The method used to determine the stage of completion of service transactions in progress.
- For service transactions in progress at the end of previous year:
- Amount of costs incurred and recognised profits (less recognised losses) upto end of previous year;
- The amount of advances received; and
- The amount of retentions.
- ICDS V: Tangible Fixed Assets
- ‘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 sale in the normal course of business.
- Fair market value of an asset means the amount for which the asset could be exchanged between knowledgeable parties in arm’s length transaction.
- In case of purchase of asset
The cost of an asset acquired by way of purchase comprises of its purchase price, duties and taxes which are non-recoverable, and all directly attributable expenditure incurred to make the asset ready for use in the manner as intended by the management of a company. Expenditure incurred on start-up, commissioning, test runs and experimental productions also form part of the cost. Trade discount and rebates, if any, shall be reduced while computing actual cost.
The expenditure incurred after the plant has begun commercial production, that is, production intended for sale or captive consumption, shall be treated as revenue expenditure.
Administration and general overhead expenses are also considered as part of the cost of an asset if they are incurred to make the asset ready for use in the manner as intended by the management.
The cost of a tangible fixed asset may undergo changes subsequent to its acquisition or construction on account of:
- price adjustment, changes in duties or similar factors; or
- exchange fluctuation as specified in Income Computation and Disclosure Standard on the effects of changes in foreign exchange rates.
- In case of self-construction of asset
The cost of self-constructed tangible fixed assets is determined in the same manner in which cost of a purchased asset is determined. Any internal profits shall be eliminated.
- In case of exchange of assets
Where any tangible fixed asset is acquired in exchange of another asset or securities, the fair market value of the asset so acquired shall be considered as its cost.
- In case of jointly-owned fixed asset
When a fixed asset is owned by two or more parties, the total cost of the asset is apportioned proportionately between the parties.
- In case of purchase of fixed assets in group
The cost of each asset is determined by apportioning the consolidated price on a fair and appropriate basis.
- Description of asset or block of assets
- Rate of depreciation
- Actual cost or written down value, as the case may be
- Additions or deductions during the year, including date of put to use and:
- Input tax credit under GST Acts
- Gains or losses due to exchange rate change
- Subsidy, grant or reimbursement
- Depreciation allowable
- Written down value at the end of the year
INCOME COMPUTATION AND DISCLOSURE STANDARDS (ICDS)
As per Section 145(1) of the Income-tax Act, 1961, an assessee having income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” (subject to the provisions of sub-section (2)) may adopt either the cash system or mercantile system of accounting, provided the method is consistently followed.
Section 145(2) empowers the Central Government to notify, via the Official Gazette, Income Computation and Disclosure Standards (ICDS) that must be followed by certain classes of assessees or in relation to specified classes of income. In exercise of this power, the Government has notified 10 ICDS, which are applicable from Assessment Year 2017–18 onwards.
As per Section 145(3) , the Assessing Officer (AO) is empowered to determine taxable income as per the best of their judgment in the following circumstances:
Applicability of ICDS
Every assessee earning income taxable under the head 'Profit and gains from business or profession' or 'Income from other sources' or both is required to compute taxable income in accordance with notified ICDS. However, the ICDS shall be followed only if assessee is maintaining accounts as per the 'Mercantile system' of accounting.
There is no threshold limit on the amount of turnover or taxable income for the applicability of ICDS. Thus, every assessee earning business income or residuary income shall be required to follow ICDS for computation of income. The applicability of ICDS shall be subject to certain exceptions.
The CBDT has clarified Circular No. 10/2017, dated 23-3-2017, that the general provisions of ICDS shall apply to all persons including banks, NBFCs, insurance companies, etc., unless there are sector specific provisions contained in the ICDS or the Act. For example, ICDS-VIII (Securities) contains specific provisions for banks and certain financial institutions and Schedule I of the Act contains specific provisions for Insurance business.
Exception 1: Exemption to certain assessees
Following assessees are not required to comply with the requirements of ICDS:
However, the CBDT has clarified in Circular No. 10/2017, dated 23-3-2017, that the relevant provisions of ICDS shall also apply to the persons computing income under the relevant presumptive taxation scheme. For instance, for computing presumptive income of a partnership firm under section 44AD of the Act, the provisions of ICDS on Construction Contract or Revenue recognition shall apply for determining the receipts or turnover, as the case may be.
Exception 2: Exemption for MAT Computation
The CBDT has clarified Circular No. 10/2017, dated 23-3-2017, that the provisions of ICDS are applicable for computation of income under the regular provisions of the Act, thus, the provisions of ICDS shall not apply for computation of MAT. However, where the assessee is liable to pay AMT under the provisions of Section 115JC , the provisions of ICDS shall be applicable for computation of AMT.
ICDS & Income-tax Act
ICDSs have to be applied for the purpose of computation of business income only and an assessee is not required to maintain books of accounts as per these standards. In the event of conflict between the provisions of the Act or Rules and ICDS, the provisions of the Act or Rule, as the case may be, shall prevail over ICDS.
ICDS-I: ACCOUNTING POLICIES
Scope
ICDS-I deals with significant accounting policies.
Fundamental Accounting Assumptions
At the time of preparing the financial accounts of an entity there are some accounting assumptions which are commonly followed.
The financial statements of an entity shall be prepared with an assumption that it shall continue the business for foreseeable future and it doesn't have any intention to liquidate the business or to limit the scale of business, profession or vocation materially for continuing the business and there is no necessity for doing so.
The next assumption is 'Consistency', which presumes that an entity shall follow the accounting policies, procedures, standards, etc. consistently over the period.
The last fundamental accounting assumption is 'Accrual'. Under this assumption, the revenue and cost should be recognised when they are earned or incurred (and not when money is received or paid) and recorded in the previous year to which they relate.
What does Accounting Policies mean?
The 'Accounting Policies' refer to the specific accounting principles and methods of applying those principles adopted by a person.
Basis for selection of Accounting Policies
Accounting policies adopted should reflect true and fair view of the state of affairs and income of the business, profession or vocation. The following factors should be considered while adopting accounting policies:
Change of Accounting Policy
An accounting policy once adopted by an assessee cannot be changed unless there is a reasonable cause for changing the same.
Disclosures of Accounting Policy
Following disclosures are required to be made in respect of accounting policies:
ICDS-II: VALUATION OF INVENTORIES
Scope
This ICDS shall be applied for the valuation of inventories, except for the following assets:
Definitions
The terms used in ICDS-II are defined as follows for the purpose of this Standard:
'Inventories' are assets:
Net Realisable Value
Net Realisable Value (NRV) means a price which is expected to be realised on sale in the ordinary course of business as reduced by the cost of completion and the estimated cost which has to be incurred while making sale.
Measurement of Inventories
Inventories shall be valued at cost or net realisable value whichever is lower.
Cost of Inventories
For the purpose of valuation of inventories, the cost shall comprise of following:
Cost of Purchase
Cost of purchase shall consists of purchase price, non-refundable duties & taxes, freight inwards and other expenditures which are directly attributable to the acquisition of inventories. Trade discounts, rebates, and other similar items, if any, shall be deducted when the cost of purchase is determined.
Costs of Services
Cost of services comprises all the costs incurred on labour and other personnel who are directly engaged in the acquisition or manufacturing of inventories. It also includes supervisory personnel costs and other allocated overheads related to relevant services.
Costs of Conversion
Cost incurred to convert raw materials into finished goods is considered as cost of conversion. It includes the cost directly related to the unit of production and systematic allocation of fixed and variable overheads which are incurred during the process of conversion.
Note:
Where a production process results in more than one product being produced simultaneously and the costs of conversion of each product are not separately identifiable, the costs shall be allocated between the products on a rational and consistent basis. Where by-products, scrap or waste material are immaterial, they shall be measured at net realisable value and this value shall be deducted from the cost of the main product.
Interest
Interest and other borrowing costs shall be included in costs of inventories, if they meet the criteria for recognition of interest as a component of the cost as specified in ICDS-IX (Borrowing Costs).
Other Costs
Other costs are included in the cost of inventories only to the extent they are incurred in bringing the inventories to their present location and condition.
Exclusions from Cost
Methods for measurement of cost
Specific Identification Method
In Specific Identification Method, specific costs are attributed to the identified items of inventory.
First-In-First-Out (FIFO) Method
The FIFO method assumes that the items of inventory which were purchased or produced first are consumed or sold first.
Weighted Average Method
In this method, cost of each item is determined on basis of weighted average of cost of similar items laying in the stock at the beginning of a period and the cost of similar items purchased or produced during the period.
Disclosure Required
ICDS-III: CONSTRUCTION CONTRACTS
Scope
This ICDS shall be applied in determination of income for a construction contract of a contractor.
Definitions
The terms used in ICDS-III are defined as follows for this Standard:
Combining or Segmenting Contracts
A single contract may represent two or more separately identifiable contracts or two or more separate contracts may represent a single contract because of their terms and conditions.
Segmenting of contracts
Segmenting of construction contract means dividing a single contract into two or more separate contracts so that this ICDS can be applied to each contract separately.
Construction of each asset under a single contract shall be treated as separate construction contract when:
Combining of contracts
Combining of construction contract means treating two or more separate contracts as a single contract on the basis of their substance.
A group of contracts should be treated as a single construction contract when:
Additional asset
When a customer requests contractor for construction of an additional asset, such asset shall be treated as a separate contract if:
Contract Revenue and Cost
The first step in determining the income from a construction contract is to calculate the contract revenue and contract cost.
Calculation of contract revenue
Contract revenue shall comprise of:
Contract revenue shall be recognized when there is reasonable certainty that the assessee will ultimately collect the amount of revenue.
Calculation of contract cost
Contract cost shall comprise of direct cost, attributable cost, contract securing cost and interest.
Percentage of Completion of Contract
The percentage of completion shall be determined using:
Disclosure Required
A person shall disclose:
A person shall disclose the following details for contracts in progress at the reporting date:
ICDS IV: REVENUE RECOGNITION
Scope
This ICDS deals with the bases for recognition of revenue arising in the course of ordinary activities of a person from:
This ICDS does not deal with the aspects of revenue recognition which are dealt with by any other ICDS.
Definition
The following term is used in this ICDS with the meanings specified:
'Revenue' is gross inflow of cash, receivables or other consideration arising in the course of ordinary activities of a person from following:
In an agency relationship, the revenue for the agent shall be the amount of commission and not the gross inflow of cash, receivables or other consideration.
Recognition of revenue from sale of goods
In a transaction involving sale of goods, the revenue shall be recognised when seller of goods has transferred to the buyer the property in the goods for a price. However, where transfer of property in goods does not coincide with the transfer of significant risks and rewards of ownership, revenue in such a situation shall be recognised when following conditions are satisfied:
The time of transfer of all significant risks and rewards of ownership to the buyer may differ from the time of transfer of title. In such cases, revenue should be recognized at the time of transfer of all significant risks and rewards of ownership.
Where ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, revenue recognition in respect of such claim shall be postponed to the extent of uncertainty involved.
Recognition of revenue from sale of services
Revenue from service transactions shall be recognised by the percentage of completion method (POCM). Under this method, revenue from service transactions is matched with the costs incurred in reaching the stage of completion, resulting in the determination of revenue, expenses and profit which can be attributed to the proportion of work completed.
ICDS-III (Construction Contracts) also requires the recognition of revenue on this basis. The requirements of that Standard shall apply mutatis mutandis to the recognition of revenue and the associated expenses for a service transaction.
When services are provided by an indeterminate number of acts over a specific period of time, revenue may be recognised on a straight line basis over the specific period.
Revenue from service contracts having duration of not more than 90 days may be recognised on basis of completed service contract method, i.e., recognition of revenue when rendering of services under that contract is completed or substantially completed. This method is available as an option only. Where assessee opts for this method but actual duration of contract exceeds 90 days significantly, then revenue has to be recognised as per percentage of completion method only.
Recognition of other revenue
Interest shall accrue on time basis determined by the amount outstanding and the rate applicable. If assessee follows mercantile system of accounting, the interest income shall be recognized on accrual basis even if it does not fall due.
Interest on refund of tax, duty or cess shall be deemed to be the income of the previous year in which such interest is received.
Any discount or premium on debt securities are recognised over the period of maturity, i.e., over the tenure of such debt security.
Royalty is a consideration received for giving right to use intellectual property rights, i.e., such as know-how, patents, trademarks and copyrights. It shall be recognised as revenue on accrual basis as per the terms of agreement. However, if having regard to the substance of the transaction, it is more appropriate to recognise revenue on some other systematic and rational basis, entity may use such basis.
Dividends are recognised in accordance with the provisions of the Income-tax Act, 1961.
Disclosure Requirements
Following disclosures are required to be made in respect of revenue recognition:
Scope
This ICDS provides guidance for classifying an asset as tangible fixed asset and for calculation of actual cost of tangible assets.
Definitions
The following terms are used in this ICDS with the meanings specified:
Often the revenue and taxpayer are at dispute with regard to the treatment of stand-by equipments, spare parts and servicing equipments. Through this ICDS, the CBDT has clarified how they should be treated for computation of business income.
Stand-by equipment and servicing equipment are to be capitalised. Machinery spares shall be charged to the revenue as and when consumed. When such spares can be used only in connection with an item of tangible fixed asset and their use is expected to be irregular, they shall be capitalised.
Guidance on determination of cost
Guidance on repair and maintenance cost
If repair and maintenance activity increases future economic benefits, the expenditure shall be added to the written down value. Otherwise, it shall be debited to profit or loss.
Addition of a new asset to an existing asset shall be capitalised accordingly.
Guidance on depreciation and transfer of asset
Depreciation on a fixed asset shall be computed in accordance with the Income-tax Act, 1961.
Where the block ceases to exist or WDV becomes nil, gains or losses shall be taxable under Capital Gains.
Disclosures Required
The following disclosures are required to be made in respect of tangible fixed assets: