Prelude
The Pronouncement of CBDT on Income computation and disclosure standards has significantly impacted the computation of deferred taxes. This article aims at bringing light on the deferred tax aspect of ICDS.
CBDT has pronounced 10 standards applicable from AY 2016-17 for all assessee having their income assessed under the head profits and gains of business/profession or income from other sources. These standards are applicable to all entities, following mercantile basis of accounting irrespective of their turnover and other classifications. This introduction has paved way to lot of potential issues and qualms for industry at large.
Impact created on computation of Deferred Tax
1. Valuation of Inventory
Accounting standard 2 governing the valuation of inventory for books of account provides, inventory shall be valued at Cost or NRV, whichever is lower. It has also recognized following methods for arriving cost:
- Specific Identification Method
- FIFO
- Weighted Average Cost
- Retail Method
- Standard Cost
However, while standard cost is applied, the entity shall substantiate that cost arrived under this method is approximately near to thereof value that would have been arrived if any other method is applied. On the other hand, ICDS 2 does not accept standard cost as method of valuation.
A company which maintains inventory valuation under standard cost for books of account has to maintain another inventory valuation mechanism for ICDS (either FIFO or weighted average) for computation of taxable income.
This difference arising in inventory valuation is temporary in nature as the impact will be subsequently reversed in opening stock computation in ensuing financial year.
2. Construction contracts
Accounting standard 7 - Construction contracts gives a detailed analogy on recognition of revenue and corresponding cost during the tenure of the contract.
ICDS 3 – Construction Contracts, has array of differences with AS7 as discussed below:
a. Foreseeable losses
As per accounting standard 7, foreseeable losses are allowed as when it is envisaged considering prudence. ICDS 3 is silent on allow ability the foreseeable losses. However, combined reading of ICDS 3 with ICDS 10 (Provisions) indicates that no cost which is expected to be incurred in future can be allowed as expenditure. This results in foreseeable losses not being an eligible deduction under ICDS 3.
This distinction on account of foreseeable losses is permanent in nature as in point of time foreseeable losses will be allowed under ICDS.
Incurred Losses
Accounting standard 7 by Para 33 mandates when it’s not probable to recover the contract costs which are incurred, the same shall be treated as an expense immediately. This treatment is not indicated/suggested in ICDS 3, and allowability of such losses will be no different from other recoverable cost/ expenses, which will be absorbed as expenditure over the period of the contract by applying percentage of completion.
i.e. The cost that are deemed to be irrecoverable will be allowed in full while arriving at profits for books of account, but under ICDS only a part of it, being in proportion to the percentage of completion will be allowed. These expenses absorbed in ICDS shall be reviewed on a year on year basis considering the movement in percentage of completion.
This distinction on allowability of incurred losses will create a timing difference resulting in deferred tax asset in the initial years when the taxable income will be on the higher side as against the profits arrived under AS 7.
b. Stage of estimation of Revenue
In line with accounting standard 7, Revenue recognition can be commenced when a reasonable estimate on outcome of contract can be reliably measured and till this point, cost incurred shall be treated as amount of revenue. Although ICDS is having similar footing on point of revenue recognition, it provides for the maximum time lag. Revenue recognition cannot be postponed beyond 25% of contract completion.
Accordingly, when reasonable estimate of outcome of a contract could not measure even beyond 25%, for compliance under ICDS an entity has to mandatorily reckon revenue, while the revenue need not be reckoned for books of account. This treatment will be resulting in deferred tax asset on account of increased taxable income till the project reaches more than 25% completion.
3. Revenue Recognition
Accounting standard 9 and ICDS 4 are postulating the point of revenue recognition for Sale of goods, rendering of service and usage of other's resources. While accounting standard 9 accepts both proportionate completion method and completed contract method for rendering of services, ICDS 4 is mandating only proportionate completion method. This distinction will result in timing difference on account of increased taxable income in years where percentage completion method is adopted for ICDS and completed contract method is adopted for books for account.
4. Fixed Asset
While AS 10 and ICDS 5 are congruent in most of the postulates regarding fixed assets, there are divergent views on treatment to be adopted in accounting for exchange of assets. In accordance with AS 10, fair value of asset foregone or asset acquired whichever is more clearly evident shall be taken as value of acquisition. ICDS on the other hand provides that fair value of the asset acquired shall be the actual cost of acquisition.
Similarly, if asset is acquired in exchange of securities, fair value of asset acquired shall be taken as actual cost for ICDS 5, on the other hand for AS 10, transaction can be recorded at fair market value of asset acquired or the securities issued, whichever is more clearly evident.
These two distinctions will result in two distinct asset valuation, one for books of account and another for ICDS, giving corroborative impact on deprecation.
This difference arising in deprecation and corresponding written down value of the assets would craft way to deferred tax impact.
5. Foreign Currency Translation
ICDS 6 and Accounting standard 11 dealing with effects of changes in foreign exchange rates, classifies entity’s foreign operation as integral and non-integral. This classification depends on various factors such as degree of autonomy, repatriation ability and etc. While both these standards are providing similar judgments and parameters to define the integral and non-integral operations; they differ in treatment of losses/gain arising on account of translation of financial statements of non-integral foreign operations.
Accounting standard 11 mandates creation of foreign currency translation reserve towards this losses/gain and does not permit routing losses/gains through the statement of profit and loss. ICDS 6 requires an entity to recognize the losses as expenses and gains as income, while computing the taxable income.
This difference in treatment of exchange losses between books of account and ICDS is permanent in nature as these foreign currency translation reserves will be set off against losses/ gains on disposal of such non integral operation and not anytime earlier.
6. Government Grants
Classification and recognition of government grants are dealt by AS 12 and ICDS 7, while the former is detailing with books of accounts, latter provides for computation for taxable income. The distinctions between these two standards are given below:
a. Promoter grants
Government grants are classified into three different categories under AS 12 viz.
- Specific/General Asset realted
- Revenue Grants
- Promoter Grants
Asset related grants shall be accounted either as a reduction from the value of corresponding asset or as liability which shall be amortised over the period of grant.
Revenue grants shall be credited to reduce the expenditure against which the grant was received. Grants in the nature of Promoters’ contribution are to be treated as capital reserve which can be neither distributed as dividend nor treated as deferred income.
ICDS on the other hand classifies the government grants into following categories, such as
- Grants relatble to depreciable fixed asset
- Revenue Grants
- Other Grants
Treatment and recognition of grants relating to depreciable fixed asset and revenue are similar to that of AS 12. Government grant not directly relating to the asset being in nature of promoter’s grants shall be deducted from the actual cost of the asset or from the WDV of block of assets based on the following formula
Total Government Grants X Assets acquired / Total Assets in respect of grants are received.
This discretion would result in two different asset valuations, one at actual cost of acquisition being purchase value under books of account and other at original value reduced by grants for compliance with ICDS. This will result in timing difference on account of depreciation computed on these two distinct values.
b. Recognition of Government Grants
Government grants shall be recognized in books of account only if there is a reasonable assurance that the enterprise will comply with the conditions laid down along with the allotment of grant and it is reasonably certain that grant will be received.
While ICDS is accepting this analogy, it provides that recognition cannot be postponed beyond the date of actual receipt of grant.
This would result in timing difference, when the grants received could not be recognized in books of account but ought to be recognized for compliance under ICDS.
For the sake of brevity, the entire discussion is tabulated and provided in Table contained in Annexure 1.
In Part II of the article the author shall address accounting of securities, borrowings cost and provisions, contingent assets and liability and its consequent impact of deferred taxation.
