They say the first important phase of one’s life is the 10th Board Exams. The second phase is the 12th Board exams or diploma. The third one is the graduation of the individual. Post-graduation and doctorate follow. One cannot do graduation after 10th board exams or doctorate after graduation. There is a standard set for the level of education. Standardizing the process makes it easier to follow. But when somebody tries to play with the standards, the process gets complicated. Whenever there is a deviation from a standard, there is always a godfather to bring the things back on track. Section 145 of the Income Tax Act is that godfather when it comes to non-compliance with the accounting standards.
To maintain a similar process of recording income, expenses, assets and liabilities of every business certain standards are designed, known as the methods of accounting.
The methods of accounting are divided into two types:
Time of recording a transaction in books of accounts is when there is inflow or outflow of cash. In simple words, cash coming in is called as cash inflow and cash going out is called as cash outflow.
E.g., Ms Vrushali sells 100 fans for Rs 1000 each to Ms Mamta on 13th April 2018 and Ms Mamta pays the amount at that very moment. Therefore, there is an inflow of Rs 1,00,000 in the account of Ms Vrushali and is recorded on the same day, i.e. the time when cash is received.
A transaction is recorded when there is an income, or an expense accrues. In this method, the transactions are recorded despite whether the cash is received or paid.
E.g., Mr Vivek sells 100 fans for Rs 1000 each to Mr Ganesh on 13th April 2018. Mr Ganesh will make the payment of these 100 fans on 13th July 2018. But, in the account of Mr Vivek, this transaction is recorded on 13th April 2018 itself despite cash inflow being later.
|Cash Method of Accounting||Mercantile Method of Accounting|
|It is a simple method of accounting||It is a complex method of accounting|
|This method is not recognised as per the Companies Act||This method is recognised as per the Companies Act|
|The income statement derived from this accounting method depicts lower income.||The income statement derived from this accounting method depicts comparatively higher income.|
|No matching concept is applicable||Matching concept is applicable.|
|Cash is received, Cash is paid.||Revenue is earned, Expense is incurred.|
|The degree of accuracy is low||The degree of accuracy is comparatively high|
In case the individual is adopting Mercantile Method of accounting, then he or she should follow the Income Computation and Disclosure Standards which are:
|ICDS-II||Valuation of Inventory|
|ICDS-V||Tangible Fixed Assets|
|ICDS-VI||Effects of changes in foreign exchange rates|
|ICDS-X||Provisions, Contingent Liabilities and Contingent Assets|
Section 145 of the Income Tax Act, 1961 provides the method of accounting by the individual taxpayer.
Section 145 is divided into three sub-sections
Section 145(1) provides that income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall be computed by either cash or mercantile system of accounting regularly employed by the individual who is paying taxes. There are some assessees which follow the mixed method of accounting, i.e. both Cash method and Mercantile Method which does not compute the accurate income. Now the assessees cannot use the mixed method. They have to either use Cash method or Mercantile Method.
Provision 1: When the accounts are correct and complete but the method of accounting deployed does not compute accurate income then, the computation of income will be done by the assessing officer with the accounting method of his choice.
Provision 2: When an assessee has no regular method of accounting his income will be calculated as per the method of accounting deployed for the last financial year.
Provision 3: If any interest on security that an individual receives has not been charged in the earlier years, that does not mean that he won’t be charged for that in this year.
The Central Government may change the provisions related to the accounting standards in the official gazette from time to time. These accounting standards must be followed by all the assessees irrespective of the income slab he or she falls in.
Accounting Standards notified under section 145(2):
Provides that where the Assessing Officer is not satisfied
The assessing officer can reject the books of accounts concerning the following discrepancies
After rejecting the books of accounts due dissatisfaction with the correctness of the accounts produced by the assessee, the Assessing Officer must pass the best judgement which is complying all the considerations of Section 145 of the Income Tax Act 1961.
Method of accounting in certain cases—Notwithstanding anything to the contrary contained in section 145, the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head “Profits and gains of business or profession” shall be
For the purpose of determining the income chargeable under the head “Profits and Gains of business or profession”:
Section 145B is broadly categorized into three sub-sections 145B(1), 145B(2) and 145B(3)
Notwithstanding anything to the contrary contained in section 145, the interest received by an assessee on any compensation or on enhanced compensation, as the case may be, shall be deemed to be the income of the previous year in which it is received.
Any claim for escalation of price in a contract or export incentives shall be deemed to be the income of the previous year in which reasonable certainty of its realisation is achieved.
The above-mentioned section deals with two types of income
The income from subsidy, grant or reimbursement shall be deemed to be the income of the previous year in which it is received, if not charged to income-tax in any earlier previous year.
The assessee must follow any one of the accounting methods Cash Accounting or Mercantile Accounting for their income from profit and gains of business or profession and income from other sources. The Central Government can make changes in the provisions related to the accounting standards. All the assessees should follow those changes despite their income slab. The Assessing Officer, before rejecting the books of account, has to bring on record material on the basis of which he has arrived at the conclusion with regard to correctness or completeness of the accounts of the assessee or the method of accounting employed by it. The obligation on the part of the assessee is to bring the accounts/documents before the Assessing Officer whenever it is required. The Assessing Officer may resort to best assessment, the power of which shall be exercised judicially and not violate the principles of natural justice. The valuation of purchase and sale of goods and the deemed to be income of the previous year shall be followed as per the provisions made by the Income Tax Department.
Maintaining any type of record can be confusing and abiding by the set method can lead you to have more confusion than ever. Same goes for tax filing. Well, you can now leave all your tax filing woes to us at H&R Block India and we will take care of it for you.