One of the biggest areas of confusion for students, accountants, and business owners is the difference between Accounting Standards and Income Tax rules. Many people assume that whatever is shown in the Profit & Loss Account must be accepted for income tax also. In reality, this is not true.
This blog explains:
- Why Accounting Standards and Income Tax Act follow different rules
- What ICDS (Income Computation and Disclosure Standards) are
- How profits in books and taxable income differ
Understanding this topic is very important for exams, tax planning, and financial reporting.
Purpose of Accounting Standards
Accounting Standards are made to ensure:
- True and fair view of financial statements
- Comparability between companies
- Transparency in reporting
- Uniform accounting practices
They focus on how financial statements should look and how transactions should be recorded.
Purpose of Income Tax Act
The Income Tax Act is made to:
- Collect revenue for the government
- Decide how much tax a person or business must pay
It follows tax policy, not accounting fairness. Therefore, many items allowed in accounting may not be allowed for tax, and vice versa.
Why Book Profit and Taxable Profit Are Different
Accounting profit is calculated using Accounting Standards. Taxable income is calculated using Income Tax Act and ICDS.
This is why:
- Some expenses allowed in books are not allowed for tax
- Some incomes shown in books are exempt from tax
- Some tax deductions are not recognised in books
Example – Depreciation
A classic example is depreciation.
Under Accounting Standards:
- Depreciation is charged based on useful life of assets
Under Income Tax:
- Depreciation is allowed as per Income Tax Act rates
So:
- A company may show one depreciation amount in its accounts
- But a different amount for tax purposes
Example – Finance Lease (AS 19)
Under AS 19:
- The lessee records the asset
- Lessee charges depreciation
Under Income Tax:
- The lessor is treated as the owner
- Lessor claims depreciation
So, accounting treatment and tax treatment differ.
Revenue Recognition Difference
Sometimes income is recognised in books even though it is tax exempt.
Example:
- Interest income may be shown in accounts
- But may be exempt under Section 10 of Income Tax Act
So:
- It appears in books
- But is not taxed
What Are ICDS?
ICDS stands for Income Computation and Disclosure Standards.
These are special rules made under Section 145(2) of the Income Tax Act for calculating taxable income.
They apply when:
Income is computed under :-
- Profit & Gains of Business or Profession
- Income from Other Sources
They apply to:
- All assessees (except individuals and HUFs not liable to tax audit)
- Following mercantile system
List of ICDS
There are 10 ICDS:
- ICDS I – Accounting Policies
- ICDS II – Valuation of Inventories
- ICDS III – Construction Contracts
- ICDS IV – Revenue Recognition
- ICDS V – Tangible Fixed Assets
- ICDS VI – Effects of Changes in Foreign Exchange Rates
- ICDS VII – Government Grants
- ICDS VIII – Securities
- ICDS IX – Borrowing Costs
- ICDS X – Provisions, Contingent Liabilities & Contingent Assets
Why ICDS Were Introduced
ICDS were introduced to:
- Remove confusion in tax computation
- Reduce litigation
- Bring uniformity in taxable income calculation
They are not used for financial statements. They are only for tax purposes.
Key Difference: Accounting Standards vs ICDS
| Accounting Standards | ICDS |
| Used for financial statements | Used for tax computation |
| Focus on true & fair view | Focus on taxable income |
| Issued by ICAI & MCA | Issued by Government under Income Tax Act |
| Apply to companies & enterprises | Apply only for computing taxable income |
Why This Topic Is Very Important
This topic helps you:
- Understand why tax and book profits differ
- Solve exam questions
- Avoid confusion in real life accounting
- Prepare reconciliation statements
What’s Next?
Now that you understand Accounting Standards and Income Tax difference, the next important topic is:
Revised MSME & Large Entity Classification (ICAI 2024)
FAQs
1. What is the difference between Accounting Standards and Income Tax Act?
Accounting Standards are used to prepare financial statements, while the Income Tax Act is used to calculate taxable income for tax purposes.
2. Why is accounting profit different from taxable profit?
Because some expenses and incomes are treated differently under Accounting Standards and the Income Tax Act.
3. What does ICDS stand for?
ICDS stands for Income Computation and Disclosure Standards. These are rules for calculating taxable income under the Income Tax Act.
4. Who must follow ICDS?
ICDS must be followed by businesses and professionals who follow the mercantile system and are subject to tax audit.
5. Do ICDS apply to financial statements?
No. ICDS are used only for tax calculation and not for preparing financial statements.
6. Why was ICDS introduced?
ICDS was introduced to bring uniformity in income computation and reduce tax disputes.
7. Can depreciation differ under Accounting Standards and Income Tax?
Yes. Depreciation under Accounting Standards is based on useful life, while tax depreciation follows Income Tax rates.
