We all are aware that new Indian Accounting Standards (Ind AS) are being implemented in phases, the first phase being made mandatory for certain class of companies with effect from 1 April 2016 while others to continue using existing accounting standards.
Close to its heels, on 31 March 2015, the Central Board of Direct Taxes (“CBDT”) notified ten Income Computation and Disclosure Standards (the “ICDS”) as the framework for computation of taxable income. The applicability of the same was deferred to FY 2016-17 (A.Y. 2017-18) via CBDT notification No. 87/2016 dated 29.09.2016.
The question arises why we are discussing accounting standards and disclosure standards together. What is the connection between the two?
To answer, we know that books are accounts are prepared in accordance with the accounting standards. On the other hand, taxable business income under Income Tax Act is computed using book profits calculated in accordance with ICDS. There are certain differences between ICDS and accounting standards. As such, book profits calculated as per accounting standards are to be adjusted to make them ICDS-compliant and so the understanding of those key deviations becomes a MUST.
These deviations must be mapped by assessees to assess the impact on taxable income including book profits as well as maintenance of relevant documentation.
We have presented those deviations and their implication in the forthcoming sections.
Please refer our article Income Computation and Disclosure Standards (ICDS) for understanding ICDS and related information.
Tabular presentation of areas of deviations of ICDS from AS and Ind AS and their implications:
1. Accounting Policies, Changes in Accounting Estimates and Errors
Related guidance:
ICDS: ICDS I relating to accounting policies
IGAAP: AS 1 – Disclosure of Accounting Policies, AS 5 – Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
Ind AS: Ind AS 1 Presentation of Financial Statements, Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | No concept of materiality. | ICDS do not dictate materiality. In absence of materiality, there may be tax impact on low value items though the tax impact may not be so significant. The treatment of unadjusted audit differences may need to be considered while computing taxable income. |
| 2. | Recognition of losses on prudence concept – derecognized. | ICDS mandates that the Marked to Market Loss (MTM loss) or an expected loss shall not be recognised unless the recognition of such loss is in accordance with the provisions of any other ICDS. Silent on MTM unrealized gains. This will lead to timing differences with respect to recognition of losses and resultant deferred tax asset or liability. Further there is ambiguity w.r.t. to deductibility of losses not covered by any specific ICDS |
| 3. | Change in accounting policy subject to a ‘reasonable cause’. However, ‘reasonable cause’ is not defined. | In absence of proper definition of reasonable cause, different stands possible. |
II. Valuation of Inventories
Related guidance:
ICDS: ICDS II relating to valuation of inventories
IGAAP: AS 2 – Valuation of Inventories
Ind AS: Ind AS 2 Inventories
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Standard cost method not accepted. | ICDS does not allow standard costing method as permitted under AS or Ind AS. This will entail change in method by entities following standard cost method to other acceptable methods as per ICDS. If the entity decides to continue to follow the same method then it shall entail maintenance of separate records for valuation using other acceptable method for income computation. |
| 2. | Inventory Cost includes cost of services | Definition of “cost of inventories” under ICDS includes cost of services. While Ind AS -2 contains guidance relating to cost of inventories for service providers which is in sync with ICDS-2, AS-2 does not. AS a result, entities (service providers) following AS will have to maintain inventory records. There will be practical difficulties in valuing the inventory in the case of service providers. Further, since, inventories are valued at lower of cost or NRV, the NRV of the services will have to be determined for the valuation of inventories which may be tedious as well. |
| 3. | Costs of purchase include duties and taxes | Costs of purchase under ICDS include duties and taxes as against AS & Ind-AS which exclude duties and taxes subsequently recoverable from the taxing authorities, and duty drawback. This will lead to differences in inventory valuation. |
| 4. | Allocation of fixed overheads | ICDS mandates allocation of fixed overheads using actual level of production (no option of normal capacity as in AS or Ind-AS), when actual level of production approximates to normal capacity. This will lead to differences in inventory valuation when normal capacity is used in books of accounts. |
| 5. | Inventories to be valued at NRV on dissolution whether business is continued or not. | AS and Ind AS do not contain any specific guidance on dissolution. Usually, where business is continued, the inventory is generally carried forward at cost only. Post ICDS, the inventory will mandatorily have to be valued at NRV and the same will lead to timing difference and creation of deferred tax asset. Further, it will lead to artificial income to taxation |
III. Construction contracts
Related guidance:
ICDS: ICDS III relating to construction contracts
IGAAP: AS 7 – Construction contracts
Ind AS: Ind AS 11 Construction contracts
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Revenue to be compulsorily recognized beyond 25% of stage of completion | ICDS is in consonance with the requirement of IGAAP however it goes further to define early stage of contract as not beyond 25% of stage of completion. The effect of the said definition is that the revenue cannot be further postponed once the contact reached 25% of the stage of completion and will have to be mandatorily recognized on reaching the said limit. |
| 2. | Expected loss on contract not to be recognized | The expected loss, if recognized in books of accounts will be disallowed in the computation of income, leading to creation of timing difference. |
| 3. | Retention money included in contract revenue | Contract revenue under ICDS has been defined to include retention money. Under ICDS, the same shall be added to contract revenue and taxed. Note: Since same does not accrue to the assessee till completion of contract, the same should not be made taxable on logical grounds. Such position will be debatable |
| 4. | Contract cost includes allocated borrowing costs in accordance with the Income Computation and Disclosure Standard on Borrowing Costs. | This is in sync with AS-7 while Ind AS 11 does not specifically include such cost. This might lead to differences in cost valuations. |
IV. Revenue Recognition
Related guidance:
ICDS: ICDS IV relating to revenue recognition
IGAAP: AS 9 – Revenue recognition
Ind AS: Ind AS 18-Revenue
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Completed contract method of revenue recognition not relevant anymore | ICDS has prescribed only one method i.e. percentage of completion method. (‘POCM’) (in sync with Ind AS-18 but not with AS-9 ) In view of the above, for entities following AS-9, the revenue recognition of services will have to be compulsorily done through percentage of completion method only. The entities recognizing revenue by completed contract method will have to switch their method or undertake extra compliance by maintenance of separate records of tax and computation of timing difference |
| 2. | Postponement of revenue recognition restricted to only few circumstances. | Under the ICDS, postponement of revenue due to uncertainty is restricted to claims for price escalation and export incentives. As such, revenue in relation to other claims may not be allowed to be postponed resulting in timing differences. |
| 3. | Interest income to be recognized on time basis. | Ind AS 18 requires interest to be recognised using effective interest rate method. As per ICDS and AS-9, interest income will have to recognized on time basis. This will result in different interest calculations. |
V. Tangible Fixed Assets
Related guidance:
ICDS: ICDS V relating to tangible fixed assets
IGAAP: AS 10 – Accounting for Fixed Assets, AS-6 Depreciation Acccounting
Ind AS: Ind AS 16 Property, Plant and Equipment
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Cost of tangible fixed asset acquired in exchange to be fair value of asset so acquired. | As per ICDS, in case where fixed asset is acquired in exchange of securities or other asset, the actual cost of the asset shall be the fair value of the asset so acquired. The same is in deviation from AS and Ind AS which has prescribed to take fair value of the asset given up to be the cost of asset acquired if the same is more evident. In light of such deviation, determination of depreciable base as well as deferred tax computation will be affected. |
| 2. | Specific treatment prescribed for stand-by equipment, servicing equipment and machinery spares. | As per ICDS, Stand-by equipment and servicing equipment shall be capitalized. Machinery spares shall be compulsorily charged to revenue as and when it is consumed, however, spares having irregular use and used only in connection with tangible fixed asset shall be capitalized. This is similar to AS-10 but different with Ind AS 16) While Ind AS suggest capitalization of above items only when they meet the definition criteria of PPE, the treatment of such items will have to be mandatorily done as per the aforesaid clarifications. |
| 3. | Treatment of expenses incurred between the date a project is ready to commence commercial production and the date at which commercial production actually begins | ICDS does not contain explicit guidance on the treatment of expenses incurred during the interval between the date a project is ready to commence commercial production and the date at which commercial production actually begins. In absence of clarification, the same may be subject to litigation. However, if we go by the principles laid down by the Act and the ICDS, the expenses between trial run and the commercial production will have to be capitalized. |
| 4. | Transfer or disposals | The ICDS mentions that income arising on transfer of a tangible fixed asset is determined in accordance with the Act. This leads to timing difference. |
| 5. | Depreciation | The ICDS mentions that depreciation on a tangible fixed asset is computed in accordance with the Act. This leads to timing difference. |
VI. The effect of changes in foreign exchange rates
Related guidance:
ICDS: ICDS VI relating to the effect of changes in foreign exchange rates
IGAAP: AS 11-The effect of changes in foreign exchange rates
Ind AS: Ind AS 21 The effect of changes in foreign exchange rates
Ind AS 39 Financial Instruments: Recognition and Measurement
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Translation of non-monetary items that are measured at fair value. | ICDS requires all non-monetary items to be translated using exchange rate at the date of transaction whereas Ind AS and AS requires non-monetary items measured at fair value to be translated using the exchange rates at the date when the fair value was determined. In view of the above, it may be possible that the exchange difference debited to the profit and loss account may not be allowed in the computation of income as per ICDS. |
| 2. | Recognition of exchange differences on Monetary items | As per ICDS, the item is to be translated at closing rate and the exchange difference arising out of the same is to be debited to profit and loss account. Same position is under AS and Ind AS except with respect to monetary item that forms part of a reporting entity’s net investment in a foreign operation as well as long term monetary items for which optional treatment exists. In view of the above, it may be possible that the more exchange difference to be debited to the profit and loss account in the computation of income as per ICDS. |
| 3. | Recognition of exchange differences on non-monetary items | As per ICDS, the non-monetary item is to be translated at closing rate and the exchange difference arising out of the same is to be debited to profit and loss account. While Ind AS provides that when a gain or loss on a non-monetary item is recognised in other comprehensive income, any exchange component of that gain or loss shall be recognised in other comprehensive income. In view of the above, it may be possible that the more exchange difference to be debited to the profit and loss account in the computation of income as per ICDS. |
| 4. | Definition of forward exchange contract | ICDS covers a foreign currency option contract or another financial instrument of a similar nature in the definition of forward exchange contract. When these contacts are entered into to hedge recognised assets or liabilities, the premium or discount is amortized over the life of the contract and the spot exchange differences are recognised in the computation of taxable income as per ICDS as against AS and Ind AS where they qualify the definition of derivative and are measured at fair value. This will lead to different valuations of such contracts and more exchange differences will be recognised in taxable income computation. |
| 5. | Foreign exchange difference on forward exchange contracts intended for trading or speculation purposes | ICDS requires premium, discount or exchange difference on forward contracts that are intended for trading or speculation purposes or are held to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction, to be recognised at the time of settlement. As a result, the exchange difference or premium / discount will be allowed in the computation of income only on settlement basis and not on MTM basis. |
| 6. | Limited definition of foreign operation | As per ICDS, Foreign operation covers branch only against AS and Ind AS which covers subsidiary, associate, joint arrangement or branch of a reporting entity. This might lead to differential interpretation and different treatments. |
| 7. | Translation of non-integral foreign operation (branch). | The exchange difference arising on translation of foreign non-integral operation is transferred to foreign currency translation reserve (FCTR) as per accounting standards. As per ICDS, the exchange difference has to be transferred to revenue account. As such, FCTR standing in the books will have to be treated as income and further, any difference arising on year to year basis will be treated on revenue account. |
| 8. | Translation of integral foreign operation. | The treatment under ICDS is in sync with AS-11 but not with Ind AS. Under Ind AS, translation of integral foreign operation is similar to translation of non-integral foreign operations under Indian GAAP. Consequently those preparing FS on Ind AS basis shall have to treat the FCTR as income. |
VII. Government grants
Related guidance:
ICDS: ICDS VII relating to government grants
IGAAP: AS 12 – Accounting for government grants
Ind AS: Ind AS 20 Accounting for government grants and disclosure of government assistance
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Recognition of Grants | As per ICDS, grants should be recognized when there is certainty that: • Grants will be received • Conditions attached to the grant will be complied with. This is in sync with AS and Ind AS. However, ICDS goes one step further stating that recognition of grants cannot be postponed beyond receipt of grant. As such, in post ICDS regime, grants need to be mandatorily recognized on receipt basis whether or not compliance to conditions is assured. |
| 2. | Treatment of grant relating to depreciable asset | ICDS mandates that the grants should be adjusted against the cost of the assets or WDV of block (in case of depreciable assets). AS 12 provides alternative method of deferred income as well while Ind AS prescribes deferred income method only. Hence in relation to depreciable asset, under ICDS, grants have to be adjusted from asset value, resulting in timing difference pertaining to depreciation. |
| 3. | Treatment of grants relating to non- depreciable assets | Under ICDS, Government grants related to non-depreciable assets, requiring fulfillment of some obligation, are credited to income over the period over which the related cost of meeting the obligation is charged to income. This is in sync with AS and Ind AS. For other cases, grant shall be recognized as income over the periods necessary to match them with the related costs which they are intended to compensate.(in sync with Ind AS). Whereas the AS-12 stipulates recognition of grants in capital reserve for grants related to non-depreciable assets other than those covered above. As such, entire grant credited to capital reserve has to be brought under income under ICDS. |
| 4. | Government grants in the form of non-monetary assets, given at a concessional rate | ICDS mandates recognition of such grant on the basis of acquisition cost of assets. This is in sync with AS but Ind AS requires recognition based on fair value. This will lead to differences in valuation of assets and consequently related expenses. |
| 5. | Refund of grant related to depreciable assets | AS per ICDS, Refund of government grants related to depreciable assets is recorded by increasing the actual cost or written down value of the block of assets by the refundable amount. Depreciation on the revised actual cost or written down value is provided prospectively at the prescribed rate. AS-12 differs by providing that refund is recorded either by increasing the actual cost or decreasing capital reserve or deferred income as appropriate by the refundable amount. While Ind AS suggests that refund of a grant related to an asset shall be recognised by reducing the deferred income balance by the amount refundable. Hence different treatments will result in timing differences |
VIII. Securities
Related guidance:
ICDS: ICDS VIII relating to Securities
IGAAP: AS 13 – Accounting for Investments
Ind AS: Ind AS 109 Financial Instruments
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Coverage | ICDS deals with securities held as stock in trade (excluding derivatives) while AS -13 do not cover them. |
| 2. | Recognition and initial measurement of securities | Securities are initially recorded at actual cost. Actual costs comprises of purchase price and acquisition charges such as brokerage, fees, tax, duty or cess. This is in sync with AS-13. While Ind AS mandates that securities are recorded at their fair value on the date of acquisition. Only in case of financial asset not designated at fair value through profit or loss, directly attributable transaction costs are included in amount recognised on initial recognition. This will result in different valuations of securities as well as treatment of transaction costs |
| 3. | Non-monetary exchange | ICDS requires the actual cost of a security acquired in exchange for another asset or for other securities is the fair value of the security so acquired. This is in sync with Ind AS which says that securities are recorded at their fair value on the date of acquisition. AS requires that the actual cost of a security acquired in exchange for other securities is fair value of the security issued. The actual cost of a security acquired in exchange for another asset is fair value of the asset given up or investment acquired, whichever is more clearly evident. As a result of this, different valuations will occur and they have to be reworked to arrive at valuations required by ICDS. |
| 4. | Valuation of quoted securities | ICDS mandates that the securities shall be valued on the end of the financial year at cost or NRV, whichever is lower. This is in sync with AS-13 when they qualify as current investments. Further Ind AS provides different valuation methods based on qualifying criteria. As a result of this, value determined under AS or Ind AS might have to be revised upwards or downwards to comply with ICDS. |
| 5. | Comparison of cost and NRV methodology | ICDS mandates that the securities shall be valued on the end of the financial year at cost or NRV, whichever is lower and such valuation shall be done category-wise (Shares, debt securities, convertible securities and any other securities). AS-13 require comparison of actual cost or fair value to be performed either on an individual investment basis or by category of investment, but not on an overall (or global) basis. It mentions the classes for valuation as equity shares, preference shares, convertible debentures etc. which deviates from ICDS. On the other hand, Ind AS permits global basis as well. As a result of this, different valuations will occur and they have to be reworked to arrive at valuations required by ICDS. |
| 6. | Valuation of unquoted or unlisted securities | As per ICDS, the unquoted securities are to be valued at cost only and shall not be evaluated on NRV basis as provided under AS-13. Even Ind AS does not restrict valuation to cost only. As a result of this if the said securities are valued at NRV (assuming NRV being lower) at beginning of the FY, it will be enhanced to cost for valuation at the end of the year, resulting in taxation of artificial gains. |
IX. Borrowing costs
Related guidance:
ICDS: ICDS IX relating to borrowing costs
IGAAP: AS 16 – Borrowing Costs
Ind AS: Ind AS 23-Borrowing Costs
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Limited Definition of borrowing costs | Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds. This is in sync with AS and Ind AS except that borrowing costs includes exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. In view of this, there are chances of judgement over inclusion of other costs under borrowing costs. |
| 2. | Condition of 12 months for qualifying asset removed | The period of 12 months for capitalizing borrowing cost is not applicable as per ICDS (except inventories). As such, borrowing cost can be capitalized even if asset takes less than 12 months’ time for its completion. |
| 3. | Income earned on the temporary investments of the borrowings not reduced from borrowing costs to be capitalized. | As per ICDS, income earned on the temporary investments of the borrowings specific to a qualifying asset is not reduced from the borrowing costs eligible for capitalisation. This is in deviation with accounting standards under which, income earned on the temporary investments of the borrowings specific to a qualifying asset is reduced from the borrowing costs eligible for capitalisation. As a result, such income would be subject to taxation under ICDS and not available for set off against capitalized cost. |
| 4. | Different formula to determine eligible costs for capitalization when funds are borrowed generally. | Both ICDS and accounting standards provide different methodology for determining eligible costs for capitalization when funds are borrowed generally. In view of the above, owing to different methods of capitalization, there will be substantial difference between interest to be capitalized as per accounting standards and as per ICDS. |
| 5. | Different date to determine eligible costs for capitalization in case of specific borrowings | In case of ICDS, the eligible costs include specific borrowing cost from date of borrowing to date of asset first put to use as against accounting standards which provides “date of asset being ready to use” In view of the above, owing to different methods of capitalization, there will be substantial difference between interest to be capitalized as per accounting standards and as per ICDS. |
| 6. | Different conditions for commencement of capitalization | Under ICDS, the capitalization of borrowing costs commences as below: a. in case of specific borrowings, , from the date of borrowing b. in case of general borrowings, from the date of utilization of funds. While accounting standards requires fulfillment of all three conditions viz. incurrence of capex, incurrence of borrowing cost and activities necessary to prepare the assets for its intended use or sale is in progress. In view of the above, owing to different dates of commencement of capitalization, there will be substantial difference between interest to be capitalized as per accounting standards and as per ICDS. |
X. Provisions, Contingent Liabilities and Contingent Assets.
Related guidance:
ICDS: ICDS X relating to Provisions, Contingent Liabilities and Contingent Assets
IGAAP: AS 29 Provisions, Contingent Liabilities and Contingent Assets
Ind AS: Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets
| S.No. | Area of significant deviations of ICDS from Ind AS/IGAAP | Implication |
|---|---|---|
| 1. | Recognition of provision based on reasonable certainty. | Under ICDS, a provision is recognised for a present obligation as a result of past event if the liability is considered reasonably certain and can be reliably estimated. The term ‘reasonable certain’ is not defined. This is similar to accounting standards except that standards use “ probable” instead of “reasonably certain” In view of this, recognition of provision will be deferred and consequently timing differences. |
| 2. | Obligation under proposed law | Under ICDS, an obligation under proposed law arises only when the legislation is enacted. Unlike ICDS, under accounting standards, the obligation arises when objective evidence exists that the proposed legislation is virtually certain to be enacted. In view of this, recognition of provision will be deferred and consequently timing differences. |
| 3. | Recognition of contingent assets and reimbursements based on reasonable certainty | ICDS mandates recognition of a contingent asset when the realization is reasonably certain as against virtually certain under accounting standards. Same is the view for recognition of reimbursement of expenditure required to settle a provision. In view of this, recognition of contingent and reimbursements will be preponed under ICDS regime and consequently timing differences. |
| 4. | No guidance on discounting | ICDS, IGAAP and Ind AS provides same basis for measurement of provisions except that Ind AS permits present value discounting in some cases. In view of the above, there could be difference between provision values. |
| 5. | Onerous Contracts not recognised | Under ICDS, obligations for onerous contracts are not recognised. Under IGAAP and Ind AS, a provision shall be made at best estimate for onerous contracts (unavoidable loss making contracts) Given that, the loss arising out onerous contract shall not be allowed on provision basis. |
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