SCOPE OF ICDS
The said ICDS is based on Accounting Standard-2 (AS-2) on Valuation of Inventories notified by the Companies (Accounting Standard) Rules 2006. The ICDS however, has made some departures from the accounting treatment prescribed for preparation of financial statements. The intent behind the change seems to be to address certain matters which have been subject to litigation. As explained earlier in case of conflict between the provisions of Income-tax Act 1961 (the Act) and this ICDS, the provisions of the Act shall prevail.
Inventories under the ICDS is defined as assets-
- held for sale in the ordinary course of business
- in the process of production for such sale
- in the form of materials or supplies to be consumed in the production process or in the rendering of services.
From the above definition of ‘inventories’, it would be clear that the ICDS requires measurement of inventory even in case of service providers. This aspect is not covered under AS-2. The ICDS further provides that the method of valuation for service providers would also be cost or NRV whichever is lower, which is the prescribed method for all other types of inventories.
NRV is defined as the estimated selling price in the ordinary course of business less estimated costs of completion and the estimated costs necessary to make the sale. This definition is similar to the definition given in AS-2.
As stated hereinabove, the ICDS adopts the accepted accounting measurement criteria for Inventories i.e. cost for NRV whichever is lower. Changes have however been made in the definition of costs. AS-2 defines the costs of purchase as consisting of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase.
The ICDS has modified the said definition inasmuch as words “other than those subsequently recoverable by the enterprise from the taxing authorities” has been deleted. This implies that cost of purchase would necessarily include the element of duty for which cenvat credit is available. For accounting purposes a company is required to follow the exclusive method of accounting wherein taxes which are recovered subsequently are not included as cost of purchase. This ICDS however seems to follow the inclusive method of accounting. The ICAI in its Guidance Note on Tax Audit has taken a view that the adjustments envisaged by section 145A of the Act will not have any impact on the trading account of the assessee. In other words both under exclusive method of accounting and inclusive method of accounting, the gross profit in the trading account will remain the same. The view taken by the Guidance Note has also been affirmed by a Mumbai ITAT judgment in the case of Raj Petro Speciality Pvt. Ltd. vs ACIT (2013) 34 taxman.com 76.
In respect of valuation of services, the ICDS provides that the cost of services should include the cost of labour and other costs of personnel directly engaged in providing the service including supervisory personnel and attributable overheads. This could lead to a difficult situation as it may not be possible to prescribe value for certain type of service revenues. For example, commission income.
Value of opening inventory
The ICDS specifically provides guidance on value of inventory as on the beginning of the previous year so as to put to rest litigation on this aspect. The ICDS provides that the value of opening inventory shall be –
- the cost of inventory available, if any, on the day of the commencement of the business when the business has commenced during the previous year, and
- the value of inventory as on the close of the immediately preceding previous year in any other case.
Thus, if during the course of assessment proceeding the value of inventory is increased by the Assessing Officer then the said amount would have to be taken as the value of opening inventory in the subsequent assessment year. The guidance provided on this aspect would certainly help in reducing litigation.
Change of method of valuation of inventory
The method of valuation of inventories once adopted by a person in any previous year shall not be changed without reasonable cause. What constitutes ‘reasonable cause’ has not been defined. According to AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies a change in an accounting policy should be made only if the adoption of a different accounting policy is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise. This should be used as a guiding principle to determine “reasonable cause”.
Valuation of inventory in place of dissolution
The ICDS provides that in case of dissolution of a partnership firm, or AOP or a BOI notwithstanding whether business in discontinued or not, the inventory on the date of dissolution shall be valued at the net realisable value. This decision adopted by the ICDS seems to overrule the decision of Hon’ble Supreme Court in the case of Sakthi Trading Co. vs. CIT (2001) 118 Taxman 301 (SC).
The Hon’ble Supreme Court in the said case had held that where a firm got dissolved due to death of a partner and business was reconstituted and continued without any interruption with the remaining partners, the closing stock was to be valued at cost or market price, whichever was lower, and not at market value. The ICDS overrules this decision by providing that in all cases of dissolution of partnerships, the inventory shall be valued at NRV on the date of dissolution.
ICDS II has tried to provide guidance on a few aspects which would certainly reduce litigation but the requirement to follow the inclusive method of accounting is not correct. This unnecessarily requires the taxpayer to make complex reconciliations which goes against the intent of the Government to make the law simple.