Clause 13 of Form 3CD – Reporting Method of Accounting & ICDS

Clause 13 of Form 3CD pertains to the method of accounting employed by the assessee and ensures compliance with the Income Computation and Disclosure Standards (ICDS) as notified under Section 145(2) of the Income-tax Act, 1961. This clause ensures the correct basis of accounting is followed and adjustments are made to align the computation of taxable income with the notified ICDSs, wherever applicable.

Table of Contents

1. About
2. Text of Clause 13
3. Applicability of Clause 13
4. Chapter at a Glance
5. What Clause 13 Require?
6. Method of Accounting Employed in the Previous Year

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1. About

Part B of Form No. 3CD comprises Clauses 9 to 44. In Clause 13 of Form 3CD, the tax is required to report regarding –

• the method of accounting followed by the assessee,
• whether there is a change in the method of accounting during the year,
• the details of such change and the effect thereof on the profit or loss,
• whether any adjustment is required to the profit or loss to comply with the Income Computation and Disclosure Standards (ICDSs),
• details of such adjustment ICDS-wise in tabular format and
• disclosures as required by ICDSs, ICDS-wise.

2. Text of Clause 13

Sub-clauses (a) to (f) of Clause 13 require reporting of various matters as under –

(a) Method of accounting employed in the previous year.

(b) Whether there had been any change in the method of accounting employed vis-à-vis the method employed in the immediately preceding previous year?

(c) If the answer to (b) above is in the affirmative, give details of such change and the effect thereof on the profit or loss.

Serial Number	Particulars	Increase in Profit (`)	Decrease in Profit (`)

(d) Is any adjustment required to be made to the profits or loss to comply with the provisions of income computation and disclosure standards (ICDS) notified under Section 145(2)?

(e) If the answer to (d) above is in the affirmative, give details of such adjustments –

ICDS No.	Name of the ICDS	Increase in Profit (`)	Decrease in Profit (`)	Net Effect (`)
ICDS I	Accounting Policies
ICDS II	Valuation of Inventories
ICDS III	Construction Contracts
ICDS IV	Revenue Recognition
ICDS V	Tangible Fixed Assets
ICDS VI	Changes in Foreign Exchange Rates
ICDS VII	Governments Grants
ICDS VIII	Securities
ICDS IX	Borrowing Costs
ICDS X	Provisions, Contingent Liabilities and Contingent Assets
	Total

(f) Disclosure as per ICDS –

S. No.	ICDS	Disclosure
i.	ICDS I Accounting Policies
ii.	ICDS II Valuation of Inventories
iii.	ICDS III Construction Contracts
iv.	ICDS IV Revenue Recognition
v.	ICDS V Tangible Fixed Assets
vi.	ICDS VII Government Grants
vii.	ICDS IX Borrowing Costs
viii.	ICDS X Provisions, Contingent Liabilities and Contingent Assets

See How to fill Clause 13 in the e-filing utility

3. Applicability of Clause 13

Sub-clauses (a) to (c) of Clause 13 apply to all assessees. Clauses 13(d) to (f) apply only to assessees following the mercantile system of accounting as the ICDSs under section 145(2) apply only to assessees following the mercantile system of accounting.

4. Chapter at a Glance

This Chapter explains how the tax auditor should fill Clause 13 of Form No. 3CD and what matters he needs to verify and report in it. This Chapter is structured as follows –

• What the clause requires
• Method of accounting employed in the previous year under audit
• Mercantile System/Accrual Basis of Accounting
• Cash basis of accounting
• Point of time when the tax auditor should ascertain the method of accounting followed by the assessee
• Change in the method of accounting
• Details of change in method of accounting and the effect on the profit or loss
• Whether Adjustment is required to profit/loss to comply with ICDS
• Details of adjustments required to profit or loss to give effect to ICDSs
• ICAI’s views
• Details/MRL to be obtained from the auditee
• Linkages of this clause with Form 3CA or Form 3CB or with other clauses of Form 3CD
• Consequential impact on reporting in other clauses of Form No. 3CD if assessee is following the cash system of accounting
• Consequential impact on reporting in other clauses of Form No. 3CD if assessee is following the mercantile system of accounting
• Tax Audit checklist for Clause 13 of Form No. 3CD
• Checklist on clause 13(a)
• Checklist on clause 13(b)
• Checklist on clause 13(c)
• Checklist on Clause 13(d)
• Checklist on clause 13(e)
• Checklist on Clause 13(f)
• Checklist for disclosures in accordance with ICDS-I – Accounting Policies
• Checklist for disclosures in accordance with ICDS-II – Valuation of Inventories
• Checklist for disclosures in accordance with ICDS-III – Construction Contracts
• Checklist for disclosures in accordance with ICDS-IV – Revenue Recognition
• Checklist for disclosures in accordance with ICDS-V – Tangible Fixed Assets
• Checklist for disclosures in accordance with ICDS-VII – Government Grants
• Checklist for disclosures in accordance with ICDS-IX – Borrowing Costs
• Checklist for disclosures in accordance with ICDS-X – Provisions, Contingent Liabilities and Contingent Assets
• Worksheets for Clause 13
• Worksheet for Clause 13(c)-Change in method of accounting from cash to mercantile
• Worksheets of adjustments required to give effect to ICDS-I
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-I (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-I (Revised)
• Worksheets of adjustments required to give effect to ICDS-II [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-II (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-II (Revised)
• Worksheets of adjustments required to give effect to ICDS-III [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-III (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-III (Revised)
• Worksheets of adjustments required to give effect to ICDS-IV [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-IV (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-IV (Revised)
• Worksheets of adjustments required to give effect to ICDS-V [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-V (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-V (Revised)
• Worksheets of adjustments required to give effect to ICDS-VI [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-VI (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-VI (Revised)
• Worksheets of adjustments required to give effect to ICDS-VII [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-VII (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-VII (Revised)
• Worksheets of adjustments required to give effect to ICDS-VIII [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-VIII (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-VIII (Revised)
• Worksheets of adjustments required to give effect to ICDS-IX [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-IX (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-IX (Revised)
• Worksheets of adjustments required to give effect to ICDS-IX [Clause 13(e)]
• Worksheet showing adjustments to net profit/loss as per AS financials required to comply with ICDS-X (Revised)
• Worksheet showing adjustments to net profit/loss as per Ind AS financials required to comply with ICDS-X (Revised)
• How to fill Clause 13 in the e-filing utility
• Audit Documentation or working papers
• Precautions for reporting
• Disclaimers/Qualifications/Clarificatory notes
• Auditing issues/issues of interpretation of tax laws/FAQs

5. What Clause 13 Require?

This Clause requires reporting of the following –

• Method of accounting employed in the previous year under audit
• Change in the method of accounting
• Details of change in method of accounting and the effect on the profit or loss
• Whether Adjustment is required to profit/loss to comply with ICDS
• Details of adjustments required to profit or loss to give effect to ICDSs
• Disclosures required by ICDSs

6. Method of Accounting Employed in the Previous Year

The “method of accounting employed in the previous year” in Clause 13(a) refers not the accounting policies followed by the entity in terms of the GAAP applicable to the entity (Ind AS/AS). What is required to be reported in Clause 13(a) is whether the entity has followed the mercantile basis of accounting or cash basis of accounting to record its financial transactions and prepare its financial statements.

Prior to its amendment by the Finance Act, 1995 with effect from assessment year 1997-98, section 145 provided that income under the heads “Profits and Gains of Business or Profession” or “Income from Other Sources” were to be computed in accordance with the method of accounting regularly employed by the assessee.

Section 145(1), as amended by the Finance Act, 1995, provides that income chargeable under the heads “Profits and Gains of Business or Profession” or “Income from Other Sources” shall be computed in accordance with either cash system of accounting or mercantile system of accounting regularly employed by the assessee.

There are three methods of accounting viz. Cash, mercantile and hybrid. Prior to the amendment of section 145 in 1995, the assessee was free to follow any of these three methods of accounting for any source of income under the aforesaid two heads of income. The amendment in 1995 rules out the hybrid method and limits the choices in the method of accounting to cash and mercantile systems. The provisions of sub-section (1) have been made subject to the provisions of sub-section (2). Accordingly, the income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” is to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee, subject to the provisions of sub-section (2). Sub-section (2), as amended by the Finance Act, 2014, with effect from the assessment year 2014-15, empowers the Central Government to notify Income Computation and Disclosure Standards to be followed by any class of assessees or in respect of any class of income. So, the method of accounting shall be either the cash system or the mercantile system for income under the heads “Profits and Gains of Business or Profession” or “Income from Other Sources”. The method of accounting shall be regularly employed for computing income subject to adjustments required for compliance with ICDSs notified under sub-section (2). The adjustments for variances between accounting treatment and treatment prescribed by ICDSs shall not be made in books of account/accounts but shall be made in the statement of computation of total income. The adjustments required are to be indicated by the tax auditor in Form No. 3CD against clause 13(e). So far, CBDT has notified ten Income Computation and Disclosure Standards (ICDSs). All these pertain to the mercantile system of accounting. No ICDSs have been so far prescribed for cash system of accounting. If the assessee-auditee is following a mercantile system of accounting, he shall comply with ICDSs also.

In CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), the Supreme Court explained the distinction between the mercantile system and cash system as under –

Mercantile System	Cash System
Entries are posted in the books of account on the dates of the transactions, i.e., the date the rights accrue or liabilities are incurred, irrespective of the date of payment.	Entries are posted when money or money’s worth is actually received, collected or disbursed
Some of the debts may have to be written off when they are found to be irrecoverable.	No question of write-off of bad debts

Section 145 does not permit the use of the hybrid (mixture of mercantile and cash) method of accounting.

The following points are noteworthy –

• Under section 128(1) of the Companies Act, 2013, all companies are required to follow the accrual basis of accounting.
• Section 34(1) of the LLP Act, 2008 requires LLPs to follow either the accrual or cash basis of accounting.

Companies are legally bound by the Companies Act of 2013 to follow the mercantile/accrual system of accounting. Although section 145 does not prevent companies from following the cash basis, a company and its directors would be liable for prosecution and punishment under the Companies Act, 2013 if they followed the cash basis.

Assessees other than companies may follow either the cash or the mercantile system of accounting. The choice is not limited to the mercantile system for, say, “Profits and Gains from business or profession” and the cash system for “Income from other sources”. There is a choice to follow one method for one source and another method for another source under the same head. For instance, an assessee may have a manufacturing business and a separate commission agency business. Both these sources of income fall under the head “Profits and Gains from business or profession”. He may follow the mercantile system of accounting for his manufacturing business and a cash system of accounting for his commission agency business. However, he may not follow a hybrid system for either business. It is permissible for assessees other than companies to adopt the cash system for one source of income and the mercantile system for another source within the head “Profits and Gains from business or profession”/“Income from other sources”. Adopting mercantile for one source and cash for another would not amount to a “hybrid system”. It is a hybrid system only if a mixture of cash and mercantile systems is adopted for any source of income.

ICAI’s Technical Guide on Income Computation and Disclosure Standards (hereinafter referred to as “The Technical Guide” or “ICAI’s Technical Guide”) clarifies as under –

• The intent of the 1995 amendment to section 145, as clarified by CBDT vide CBDT Circular No. 717, dated 14th August 1995, was only to prevent the assessees from following the hybrid method in a manner that did not reflect the correct income.
• The intent behind the amendment was not to change the computation of income from a source-wise basis to a head-wise basis. Even after the 1995 amendment, there is no requirement that one method (either mercantile or cash system) should be followed for all sources under a head.
• Following different methods of accounting for different sources of income does not distort the correct income for the particular source.
• What is not permissible is following of a hybrid method for the same source of income.
• Therefore, an assessee continues to have the choice of following the mercantile system of accounting for certain sources of income or the cash system of accounting for other sources of income.

However, Form 3CD does not allow tax auditors to disclose distinct accounting methods for various sources of income. Therefore, it is advisable to declare the accounting method used for the primary income source in Form 3CD. Regarding any alternative accounting method selected for other business activities, this should be disclosed by way of a note in clause (3) of Form No. 3CA or clause (5) of Form No. 3CB, as the case may be.

Mercantile System/Accrual Basis of Accounting – The Act does not define the accrual basis of accounting/mercantile basis of accounting. ICAI’s “Guidance Note on Accrual Basis of Accounting” defines ‘Accrual basis’ or ‘Mercantile basis’ as having the following characteristics –

• Revenues, costs, assets and liabilities are reflected in the accounts in the period in which they accrue.
• It includes considerations relating to deferrals, allocations, depreciation and amortisation.
• In Taparia Tools Ltd. v. Jt. CIT [2003] 126 Taxman 544 (Bom.), the Bombay High Court defined the mercantile system of accounting as under –

“. . . Basically, it is a Double Entry System of accounting. . ., under the Mercantile System of Accounting, in order to determine the net income of an accounting year, the revenue and other incomes are matched with the cost of resources consumed [ex­penses]. . . Under this matching concept, revenue and income earned during an accounting period, irrespective of actual cash inflow, is required to be compared with expenses incurred during the same period, irrespective of actual outflow of cash. . .”

The Guidance Note issued by ICAI on ‘Terms Used in Financial Statements’ defines accrual as under –

“Accrual

Recognition of revenues and costs as they are earned or incurred (and not as money is received or paid). It includes recognition of transactions relating to assets and liabilities as they occur irrespective of the actual receipts or payments.”

The said Guidance Note also defines “Accrual Basis of Accounting”/“Mercantile Basis of Accounting” as under –

• It is the method of recording transactions by which revenues, costs, assets and liabilities are reflected in the accounts in the period in which they accrue.
• The ‘accrual basis of accounting’ includes considerations relating to deferrals, allocations, depreciation and amortisation.
• This basis is also referred to as the mercantile basis of accounting.

How do we ensure that the accrual basis has been followed? – The accounting treatments contained in the Accounting Standards, Guidance Notes, and Statements issued by ICAI are primarily based on accrual accounting. Thus, the adoption of accounting treatments recommended in these pronouncements of ICAI would ensure that an entity has followed the accrual basis of accounting. [Para 8.1 of the Guidance Note on Accrual Basis of Accounting]

So far as preparation and presentation of accounts under the mercantile system of accounting are concerned, the Accounting Standards, Guidance Notes and Statements issued by ICAI have to be followed even if these are at variance with ICDSs. Accounts should be prepared as per pronouncements of ICAI and not as per requirements of ICDSs. The variance between accounting treatment as per the above pronouncements of ICAI, which are followed in accounts, and the requirements of ICDSs should not be adjusted in accounts and should be adjusted in the computation of total income. Such adjustments are required to be indicated by the tax auditor in clause 13(e).

ICDS-I – Accounting Policies stipulates that “Accrual” is one of three fundamental accounting assumptions. ICDS-I defines “accrual” as “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.” This is in line with the definition in (AS) 1 and in line with the accounting definition given above.

The Technical Guide analyses the accrual/mercantile basis of accounting as follows:

• Revenues accrue as they are earned and recorded in the previous year to which they relate.
• Costs accrue as they are incurred and recorded in the previous year to which they relate.
• Actual receipt or payment is irrelevant for accruing/recording the revenues and costs in the accounts.
• Incomes are said to accrue when they are ‘earned’ and ‘recorded’ in the previous year to which they relate.
• Earning and recording together constitute accrual of income which connotes crystallisation of the right to receive in favour of the assessee.

The following views expressed in the Technical Guide are noteworthy –

• Section 145(2) governs the ICDS’s definition of the mercantile basis of
  accounting, as analysed above.
• Under the Act, recognition of income on an accrual basis has its genesis in section 5, which deals with the scope of total income.
• Under section 5, accrual, arisal and receipt form the basis for taxing incomes.
• Section 5 is the charging section. It is the basis on which a particular sum is included in total income. In doing so, one of the tests is the ‘accrual’ of income.
• The definition in ICDS-I does not alter the scope and ambit of ‘accrual’ in section 5 of the Act.
• The concept of “accrual”, as outlined judicially under section 5, means the enforceable right of the recipient to receive with a corresponding obligation to pay on the payer.
• A definition of “accrual” under ICDS notified under section 145 cannot alter the understanding of accrual under section 5. This is because the supremacy of section 5 over section 145 has been judicially recognised.

In CIT v. Standard Triumph Motor Co. Ltd. (1979) 119 ITR 573 (Mad.), it was held that Section 145(1) is only an enabling provision to effectuate the charge. It is only a machinery provision and cannot override the charging section i.e. section 5. The machinery provision of section 145 cannot be read so as to render the charging section otiose.

Thus, the definition of “accrual” under ICDS-I nor any of the provisions of ICDS can go contrary to the concept of “accrual” under section 5 of the Act. In E.D. Sassoon & Co. Ltd. v. CIT (1954) 26 ITR 27, the Supreme Court discussed the three words “accrue”, “arise” and “receive” used in section 5 as under –

• ‘Accrues’, ‘arises’ and ‘is received’ are three distinct terms.
• So far as receiving income is concerned, there can be no difficulty; it conveys a clear and definite meaning.
• The words ‘accrue’ and ‘arise’ are also not defined in the Act. The ordinary dictionary meanings of these words must be taken as the meanings attached to them.
• ‘Accruing’ is synonymous with ‘arising’ in the sense of springing as a natural growth or result. The three expressions ‘accrues’, ‘arises’ and ‘is received’ having been used in the section, strictly speaking, ‘accrues’ should not be taken as synonymous with ‘arises’ but in the distinct sense of growing up by way of addition or increase or as an accession or advantage; while the word ‘arises’ means comes into existence or notice or presents itself.
• The former connotes the idea of growth or accumulation, and the latter of the growth or accumulation with a tangible shape so as to be receivable.
• The two words (‘accrue’ and ‘arise’ seem to denote the same idea or very similar ideas. The difference only lies in that one is more appropriate than the other when applied to particular cases. Both words are used in contradistinction to the word ‘receive’ and indicate a right to receive. They represent a state anterior to the point of time when the income becomes receivable and connote a character of the income which is more or less inchoate

The Apex Court in CIT v. Excel Industries Limited (2013) 358 ITR 295 observed –

“19. This Court further held, and in our opinion more importantly, that income accrues when there “arises a corresponding liability of the other party from whom the income becomes due to pay that amount.”

Cash Basis of Accounting – The dictionary http://financial-dictionary.thefreedictionary.com/Cash+basis+accounting gives the following definition of cash basis of accounting –

Cash Basis Accounting – Cash basis accounting is one of two ways of recording revenues and expenses. Using this method, a company records income on its books when it receives a payment and expenses when it makes a payment.

In accrual accounting, by comparison, a company counts revenue as it’s earned and expenses as they’re incurred.

For example, when a magazine company sells annual subscriptions, it receives the cash for the subscriptions at the beginning of the year, but it doesn’t earn the whole amount of the subscription cost until it has sent the subscriber a full year’s issues of the magazine.

In cash basis accounting, paid subscriptions are recorded as revenue when the company receives the payments. In accrual ac­counting, the company records revenue only as the subscription is fulfilled.

A $24 subscription for 12 monthly issues of a magazine would result in immediate revenue of $24 in cash basis accounting, versus an accrual of $2 of revenue each month under accrual accounting.

A system of accounting that recognises revenue in the order in which it is received, and expenses on the same basis. Cash basis accounting does not deal with accounts receivable or accounts payable and only recognises transactions actually paid for. This accounting system is easiest and perhaps best for organisations with few or no credit sales.”

www.answers.com explains that there are two types of cash basis accounting as under

“Two types of cash-basis accounting exist strict cash-basis and modified cash-basis. Strict cash-basis follows the cash flow exactly. Modified cash-basis includes some elements from accrual-basis accounting such as inventory and property capitalisation.”

The Income-tax Act of 1961 does not stipulate whether one should follow a ‘strict cash basis’ or a ‘modified cash basis’. In Commissioner of the Inland Revenue v. Cock, Russell & Co. Ltd. [1949] 29 Tax Cases 387/(1949) All E.R. 889, it was held that

“. . . But whatever may be the system, whether it is cash or mercantile. . . in a trading venture it would be impossible accurately to assess the true profits without taking into account the value of the stock-in-trade at the beginning and at the end of the year. . . .”

In CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), the Supreme Court held that

“. . . whichever method of book-keeping is adopted in the case of a trading venture, for computing the true profits of the year the stock-in-trade must be taken into account. . . .”

Thus, as per the above judicial decisions, a ‘strict cash basis’ is not permissible.

ICAI’s “Technical Guide on Preparation of Financial Statements under Cash basis of Accounting” (hereinafter referred to as “the Technical Guide”) also recognises that there are two approaches to the cash basis of accounting  “Strict Cash Basis” and “Modified Cash basis”. According to the Technical Guide on CBA, Under Pure Cash basis of accounting/Strict cash basis of accounting, transactions are recorded only when there is an actual flow of cash. Revenue is recognised only when it is actually received. Expenditure is recognised only on the outflow of cash. This would result in recognition of cash received or spent during the year, even though it may relate to different periods. Further, non-cash items, such as depreciation and impairment losses, do not get recognised since they same does not involve an outflow of cash. Further, opening and closing stocks do not get recognised in financial statements. Also, financial statements do not give a complete and true and fair picture of liabilities. The only merit of the pure cash basis of accounting is its simplicity. Recognition and measurement of all the elements of financial statements under a pure cash basis of accounting would provide information about cash received or spent during the year, even though it may relate to different periods. In other words, considering the information available under a pure cash basis of accounting, receipts and payment accounts can be prepared. While this provides some relevant information, it may not meet all the information needs of the stakeholders. Therefore, such entities also prepare income and expenditure accounts and balance sheets and recognise non-cash items, such as depreciation, impairment of assets, write-down inventories, bad debts, etc. Thus, to make the information relevant and to present a fair picture of the financial affairs of the entity, these non-cash items are also required to be recognised in the financial statements. Therefore, the Technical Guide on CBA recommends a Modified cash basis of accounting which recognises such non-cash items and complies with accounting standards to the extent applicable to the cash basis of accounting.

The principles of modified cash basis accounting as recommended by the Technical Guide are set out below –

General Principles

• Entities while following cash basis of accounting shall follow Accounting Standards as and when and to the extent these are applicable to them.
• Accordingly, elements of financial statements (assets, liabilities, incomes, expenses and equity) are to be recognised on receipt and payment basis subject to meeting definitions of the relevant items and meeting the relevant recognition criteria under Framework and the Accounting Standards.
• The measurement of elements of financial statements similar to cash basis of accounting would be at the amount of cash paid or received.

Plant, Property and Equipment (AS-10)

• If recognition criteria for recognising an item as Property, plant and equipment as laid down under AS 10 is met, however, cash for asset is not paid instead other cost attributable to asset, such as, installation expenses, have been paid in cash, then asset shall be recognised when cash outflows take place and the measurement shall be at amount of cash paid for installation expenses.
• While following cash basis of accounting, the entity shall recognise an item of PPE when recognition criteria as per AS 10 is met and the cost of the asset has been paid.
• Cost paid after the asset is in the location and condition necessary for it to be capable of operating in the manner intended by the management, shall be expensed off.

Intangible Assets (AS-26)

• Recognise an intangible asset if it meets the recognition criteria as per AS 26 and when the intangible asset’s cost has been paid.

Revenue Recognition (AS-9)

• Revenue shall be recognised when cash has been received.

Interest, Royalties, Rental on Investments and Dividends (AS-9)

• Interest, royalties, rental on investments and dividends shall also be recognised on receipt basis.

Revenue Not Received on Which TDS Has Been Deducted by the Payer

• Revenue may not have been received in cash. However, tax may have been deducted at the source and deposited by the payer. In such a case, revenue shall be recognised as equivalent to the amount of tax deducted at the source.

Government Grants (AS-12)

• Government Grant shall be recognised when it has been received.
• The disclosure regarding the nature of grants recognised in the financial statements, including non-monetary grants given at a concessional rate or free of cost, shall be provided.

Employee Benefits (AS-15)

• Employee benefits are recognised as and when paid. The information that enables users of financial statements to evaluate the nature of employee benefit expenses shall be disclosed.

Borrowing Costs (AS-16)

• Borrowing costs shall be capitalised or expensed in the period in which they are paid.
• Capitalisation of borrowing costs shall commence when expenditure for the acquisition, construction or production of a qualifying asset is paid and all the activities necessary to prepare the qualifying asset for its intended use or sale are in progress.
• Borrowing costs paid after substantial completion of all the activities necessary to prepare the qualifying asset for its intended use or sale shall be expensed off.
• The following disclosures shall be provided

1. 1. accounting policy adopted for borrowing costs; and
   2. the amount of borrowing costs capitalised during the period.

Lease Payments (AS-19)

• Lease payments under both operating and finance lease shall be recognised as per AS 19 when paid.

Foreign Currency Transactions and Losses or Gains Arising Due to Exchange Rate Variation on Derecognition of Monetary Assets or Liabilities (AS-11)

• Foreign currency transaction shall be accounted for in the reporting currency by applying to the foreign currency amount, exchange rate between the reporting currency and the foreign currency at the date of receipts and payments.
• Losses or gains arising due to exchange rate variation on derecognition of monetary assets or liabilities recognised under cash basis of accounting, such as, foreign currency borrowings, shall be recognised as loss or gain.
• Cash and Bank balances in foreign currency shall be restated in accordance with AS 11, The Effects of Changes in Foreign Exchange Rates.
• The entities shall disclose the amount of exchange differences included in the net profit or loss for the period.

Recognition of Depreciation and Impairment of Assets [(AS-10) and (AS-28)]

• While following cash basis of accounting, entities shall also recognise depreciation and impairment of assets as expense in profit and loss account so that the periodic net result of operations of the entity reflects the use of the asset.
• While the Technical Guide recommends recognition of depreciation, it says nothing as to whether depreciation is to be computed with reference to the entire cost of the PPE asset or with reference to only so much part of the cost of the PPE asset as has been recognised on cash basis based on actual payment.
• It may be noted that use of asset in business is of entire asset and not only the portion of the asset in respect of which payment has been made. Therefore, it appears that depreciation recognised should be with reference to the entire cost of the PPE asset and not merely the proportion of cost which has been actually paid. The Issues on Tax Audit, published by ICAI many years ago, had clarified that depreciation should be claimed for income tax purposes on entire actual cost and not merely on the proportion of actual cost which has been actually paid.

Bad Debts Written Off

• Bad debts written off represents impairment of assets (receivables)
• Entity following cash basis should recognise bad debts in P&L account though it is a non-cash item.
• This recommendation of Technical Guide on CBA to recognise bad debts written off seems to be contrary to the Supreme Court decision in CIT v A. Krishnaswami Mudaliar [1964] 53 ITR 122 wherein the Court had held that “Again where the cash system is adopted, there is no question of bad debts or out standings at all, in the case of mercantile system against the book profits some of the bad debts may have to be set off when they are found to be irrecoverable.”

Differences Arising on Valuation of Inventories (AS-2)

• Entities engaged in manufacturing/trading of goods while following cash basis of accounting, shall value inventories at lower of cost and net realisable value and recognise difference between the two in the profit or loss account.
• In Commissioner of the Inland Revenue v. Cock, Russell & Co. Ltd. [1949] 29 Tax Cases 387/(1949) All E.R. 889, it was held that

“. . . But whatever may be the system, whether it is cash or mercantile. . . in a trading venture it would be impossible accurately to assess the true profits without taking into account the value of the stock-in-trade at the beginning and at the end of the year. . . .”

• In CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), the Supreme Court held that

“. . . whichever method of book-keeping is adopted in the case of a trading venture, for computing the true profits of the year the stock-in-trade must be taken into account. . . .”

• The entity shall disclose the accounting policies adopted in measuring inventories, including the cost formula used and the total carrying amount of inventories and its classification

Recognition of Income Tax Paid (AS-22)

• The tax paid for the financial year shall be recognised as expense in the profit and loss.
• If tax paid is more than the current tax for the financial year, and the entity is reasonably certain that the additional tax paid will be received as tax refund, then, it shall expense off the amount in the profit or loss to the extent of actual current tax and recognise the balance amount as ‘tax refund receivable’ in the balance sheet.