Preamble
“This Income Computation and Disclosure Standard is applicable for computation of income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” and not for the purpose of maintenance of books of accounts.
In the case of conflict between the provisions of the Income-tax Act, 1961 (‘the Act’) and this Income Computation and Disclosure Standard, the provisions of the Act shall prevail to that extent.”
Introduction
This ICDS Income Tax deals with application of significant accounting assumptions and policies in computation of income for the purposes of the Act. Financial statements of an Assessee reflect his state of financial affairs. They form the base for computation of taxable income under the Act. The income for a particular year is significantly affected by the Accounting Assumptions and Accounting Policies followed in the preparation of the financial statements. To ensure uniformity, it is imperative to outline the accounting policies and assumptions that need to be applied while computing income for the year.
Comparative Study
| ICDS I-Accounting Policies | Accounting Standard 1 –issued by ICAI | Difference |
| This ICDS deals with application of significant accounting assumptions and policies in computation of income for the purposes of the Act. Financial statements of an Assessee reflect his state of financial affairs. They form the base for computation of taxable income under the Act. The income for a particular year is significantly affected by the accounting assumptions and policies followed in the preparation of the financial statements. To ensure uniformity, it is imperative to outline the accounting policies and assumptions that need to be applied while computing income for the year | The view presented in the financial statements of an enterprise of its state of affairs and of the profit or loss can be significantly affected by the accounting policies followed in the preparation and presentation of the financial statements. The accounting policies followed vary from enterprise to enterprise. Disclosure of significant accounting policies followed is necessary if the view presented is to be properly appreciated | No Difference |
Scope
This Income Computation and Disclosure Standard deals with significant Accounting Policies (Para 1)
This standard deals the Accounting Assumption and Accounting Policies adopted by the Assessee to make the financial statement under the head “Profit and Gain of Business or Profession” or “Income from Other Sources”. Accounting assumption and policies adopted by the Assessee have a significant impact on income computed in a particular year. However the scope of this standard is limited with those accounting policies which have significant impact on computation of income. An accounting policy shall be considered to be “SIGNIFICANT” when it has impact on the judgment of user of financial statement.
Further this standard is not applicable for the maintenance of books of accounts. The term of “Accounting Policies” should be read as “Income Computation Policies” This standard is not mere a presentation standard. Hence Assessee should adopt the accounting policies which are harmonious with the principle of this standard.
Comparative Study
| ICDS I-Accounting Policies | Accounting Standard 1 –issued by ICAI | Difference |
| This Income Computation and Disclosure Standard deals with significant Accounting Policies. | All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. | No Difference |
Accounting Assumption used in Preparation of Financial Statement (Para 2)
The Following are fundamental accounting assumptions:
a) Going Concern
Going concern” refers to the assumption that the person has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the business, profession or vocation and intends to continue his business, profession or vocation for the foreseeable future.
This is the first fundamental assumption which is used in the preparation of Financial Statement. Going Concern refer to an assumption that the person has neither the intention nor the necessity of liquidation or curtailing, materially the scale of the business, profession or vocation and intends to continue his business, profession or vocation for the foreseeable future. As financial statements are a periodic reflection of the entity’s status, computation of total income is also a periodic evaluation of the Assessee’s income. The common time horizon considered for this is 12 months. A going concern during such time horizon continues to operate and earn profits. Assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business.
Normally there is no need to disclose whether Assessee is followed “Going Concern Assumption” as it is presumed and accepted that financial statement is prepared on going concern basis. However if going concern assumption is not followed then disclosure has to be made.
This Computation and Disclosure standard doesn’t prescribe the basis of preparation of financial statement in case where going concern assumption is not followed. In this case reference should be made on Standard of Auditing SA-570 – Going Concern. SA-570 provides that in case where financial statement is not prepared on Going Concern basis, then alternative basis shall be used which should be liquidation basis.
Comparative Study
| ICDS I-Accounting Policies | Accounting Standard 1 –issued by ICAI | Difference |
| “Going concern” refers to the assumption that the person has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the business, profession or vocation and intends to continue his business, profession or vocation for the foreseeable future. | The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations | No Difference |
b) Consistency
Consistency” refers to the assumption that accounting policies are consistent from one period to another;
The second assumption which is used to prepare the financial statement is “Consistency” This assumption provides that Accounting Policies should be consistent from one period to another. Hence while computing the income, it should be insured that accounting policies have not been changed to make impact on total income of Assessee.
Comparative Study
| ICDS I-Accounting Policies | Accounting Standard 1 –issued by ICAI | Difference |
| Consistency” refers to the assumption that accounting policies are consistent from one period to another; | It is assumed that accounting policies are consistent from one period to another. | No Difference |
c) Accrual
Accrual” refers to the assumption that revenues and costs are accrued, that is, recognised as they are earned or incurred and not as money is received or paid and recorded in the previous year to which they relate
The definition of Accrual operated within the ambit of Section 145(2) read with Section 5 of Income Tax Act. Section 5 of Income Tax Act prescribes two bases (a) Accrues and (b) Received on which a particular sum or equivalent is included in computation of Income. Further ICDS will be applied only on that Assessee who follows Mercantile Accounting System with the base of Accrual.
Comparative Study
| ICDS I-Accounting Policies | Accounting Standard 1 –issued by ICAI | Difference |
| Accrual” refers to the assumption that revenues and costs are accrued, that is, recognised as they are earned or incurred and not as money is received or paid and recorded in the previous year to which they relate | Revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. (The considerations affecting the process of matching costs with revenues under the accrual assumption are not dealt with in this standard) | No Difference |
Accounting Policies (Para 3)
The accounting policies refer to the specific accounting principles and the methods of applying those principles adopted by a person.
Accounting Policies are the guideline under which the business prepares the financial statement. In the context of ICDS, accounting policies would refer principal and method for computing the total income of previous year.
The following are examples of the areas in which different accounting policies may be adopted by different enterprises.
a) Methods of depreciation, depletion and amortisation
b) Treatment of expenditure during construction
c) Conversion or translation of foreign currency items
d) Valuation of inventories
e) Treatment of goodwill
f) Valuation of investments
g) Treatment of retirement benefits
h) Recognition of profit on long-term contracts
i) Valuation of fixed assets
j) Treatment of contingent liabilities.
Basis of Selection of Accounting Policies (Para 4)
Accounting policies adopted by a person shall be such so as to represent a true and fair view of the state of affairs and income of the business, profession or vocation. For this purpose,
(i) The treatment and presentation of transactions and events shall be governed by their substance and not merely by the legal form; and
(ii) Marked to market loss or an expected loss shall not be recognised unless the recognition of such loss is in accordance with the provisions of any other Income Computation and Disclosure Standard.
Para 4 prescribes that accounting policies should reflect a true and fair view of the financial affairs and income of the business. True and fair view means that financial statement should be free from material misstatement and present the event on the basis of substance instead of legal form.
(a) As a first consideration of True and Fair View, transaction and event should be presented in financial statement on the basis substance of event and not merely by legal form. For example Lease requires the preparation of financial statements to consider the substance of lease arrangement when determining the type of lease for accounting purpose. When under a lease arrangement, an asset may be leased to a lessee without the transfer of legal title at the end of the lease term, in this case lease arrangement should be considered as a finance lease if for instance the lease term is substantially for entire useful life of the asset or the lease agreement entitles the lessee to purchase the asset at the end of the lease term at a very nominal price and it is very likely that such option will be exercised by the lessee in the given circumstance.
(b) The second consideration for true and fair representation of financial statement provides that marked to market loss or expected loss shall not be recognised unless, the such expected loss is required to be recognised in accordance to any other disclosure standard. This is in parity with the treatment of expected profit and expected losses.
The above provision has deviation from the Accounting standard recognised under Section 145(2) of Income Tax Act. IT-AS-1 prescribes three basics for selection of accounting policies
a) Prudence
b) Substance over Form
c) Materiality
Prudence specify that In view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information. ICDS 1 precludes the reorganization of expected loss, not covered by any other ICDS. However ICDS is silent on the provision of liability as it is dealt with ICDS X. Provision of liability is retention of certain sum for present liability to be paid in future such as Provision of gratuity on actuarial basis as specified under Section 40(7) of Income Tax Act.
Further, Section 37 covers expenditure laid out or expended wholly and exclusively for the purposes of the business. The phrase ‘laid out’ connotes setting aside or storage for future. The expression ‘laid out’ in section 37 thus encompasses not only actual outflow of expenses but amounts parked in the present for future settlement. Accordingly, the concept of Prudence is inherent in the business income deductions.
Materiality
The concept of materiality is a phenomenon concerning disclosure of amounts which may influence the decision of the user of the financial statements. Omission of the principle of ‘materiality’ is unlikely to impact the income computation under the provisions of the Act. This is because; income computation exercise is not driven by quantum consideration.
Based on the above discussion, we should understand that even ICDS, is silent on prudence and materiality, still Prudence and Materiality are inherent principle for recognition and selection of accounting policies.
Change in Accounting Policies: -(Para 5)
An Accounting Policy shall not be changed without reasonable cause. The ICDS prohibits change in accounting policies unless there is a reasonable cause for such a change. The expression “reasonable cause” has not been defined and would have to be examined on a case to case basis.
Disclosure of Accounting Policies
1. All significant accounting policies adopted by a person shall be disclosed. (Para 6)
As a disclosure under Tax Audit, following accounting policies should be disclosed as part and parcel of this standard:
a) Note on Use of Estimate
(i) The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Differences between actual results and estimates are recognized in the periods in which the results are known/materialize.
b) Selection of Segment and Segment Wise Disclosure
Accounting principle uses to identify the Segment based on business vertical and geographical information.
c) Accounting Policy for determination of Carrying amount of Investment
1. The carrying amount for current investments is the lower of cost and fair value. In respect of investments for which an active market exists, market value generally provides the best evidence of fair value. The valuation of current investments at lower of cost and fair value provides a prudent method of determining the carrying amount to be stated in the balance sheet.
2. Long-term investments are usually carried at cost. However, when there is a decline, other than temporary, in the value of a long term investment, the carrying amount is reduced to recognise the decline. Indicators of the value of an investment are obtained by reference to its market value, the investee’s assets and results and the expected cash flows from the investment. The type and extent of the investor’s stake in the investee are also taken into account. Restrictions on distributions by the investee or on disposal by the investor may affect the value attributed to the investment.
d) Recognition of Intangible Asset
The financial statements should disclose the following for each class of intangible assets, distinguishing between internally generated intangible assets and other intangible assets:
1. The useful lives or the amortisation rates used;
2. The amortisation methods used;
3. The gross carrying amount and the accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period; 11 Accounting Standard (AS) 28, ‘Impairment of Assets’, specifies the requirements relating to impairment of assets.
4. Reconciliation of the carrying amount at the beginning and end of the period showing:
(i) Additions, indicating separately those from internal development and through amalgamation;
(ii) Retirements and disposals;
(iii) Impairment losses recognised in the statement of profit and loss during the period (if any);
(iv) Impairment losses reversed in the statement of profit and loss during the period (if any);
(v) Amortisation recognised during the period; and
(vi) Other changes in the carrying amount during the period
e) Any other disclosures not covered by any other ICDS which have impact on financial statement, such as
(i) Goodwill Valuation.
(ii) Policy to written of preliminary expenses (in accordance to AS -26, miscellaneous expenditure not covered by any other AS has to be written off in the financial year in which they has been incurred, however as per Section 35D such preliminary expenditures should be written off in five years.)
(iii) Policy to amortization of expenditure incurred under Voluntary retirement scheme (As per AS-15 such expenditure should be transferred to Statement of Profit & Loss in the year of incurred, however Section 35DDA specify that such expenditure should be amortized in five years)
2. Any change in an accounting policy which has a material effect shall be disclosed. The amount by which any item is affected by such change shall also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact shall be indicated. If a change is made in the accounting policies which has no material effect for the current previous year but which is reasonably expected to have a material effect in later previous years, the fact of such change shall be appropriately disclosed in the previous year in which the change is adopted and also in the previous year in which such change has material effect for the first time.
This ICDS deviates from the disclosure norms from IT-AS-1 specified under Section 145(2) and AS-1. It provides for disclosure of such change in two years namely, the year in which change is adopted and when it takes effect for the first time.
3. Disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item. (Para 8)
4. If the fundamental accounting assumptions of Going Concern, Consistency and Accrual are followed, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact shall be disclosed. (Para 9)
Transitional Provisions
All contracts or transactions existing on the 1st day of April, 2016 or entered into on or after the 1st day of April, 2016 shall be dealt with in accordance with the provisions of this standard after taking into account the income, expense or loss, if any, recognised in respect of the said contract or transaction for the previous year ending on or before the 31st March, 2016” (Para 10)
This prescribes that all contracts or transactions entered into by the Assessee on or after 1.4.2016 shall be in accordance with this ICDS. This recognition should be carried out after considering the income, expense or loss (if any) which have already been recognised on or before 31.3.2016. This implies that contracts or transactions already reported as per Accounting Standard 1 in the previous years prior to previous year 2016-17 would have to comply with the prescription of this ICDS so far as computation of income is concerned.
Migration from income computation under IT-AS 1 to this ICDS could result in change of accounting policies such as ‘non-recognition of MTM losses’. Such change however should not impact the recognition of the MTM losses made in the earlier years. An ICDS would govern the computation of income of that year to which the ICDS is applicable. Each year is a self contained unit. This ICDS which is effective from AY 2017-18, cannot have a retrospective effect. Consequently, a view is possible that recognition of losses relating to earlier years should remain intact, and would not result in a reversal of loss during the transitional year due to the transitional provisions.
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Very Nicely presented & explanation in simple words