K.C. SINGHAL, J.M. ORDER Since common issues are involved in these Departmental appeals, same are being disposed of by common order for sake of convenience. 2. main common issue, arising in appeals pertaining to asst. yrs. 1989- 90 to 1 99 3-94, 1 99 5-96 and 1 99 6-97, relates to additions made on account of loss in respect of incomplete contracts. 3. Briefly stated, facts, as gathered from assessment order are that assessee-company is premier company engaged in execution of long- term contracts for installation of elevators and escalators manufactured by it. method of accounting adopted by assessee is explained hereafter. When contract commences, direct materials consumed in each of contract are charged to respective contract by way of works billing. direct labour costs incurred on each contract are charged by way of hourly rates depending on labour mix for each of contract on basis of time sheets maintained at factory at standard rate. Various standard materials purchased and consumed at site of installations are charged to said contract directly on basis of expense vouchers prepared by various sites and/or regional offices. 4. In addition to aforesaid direct expenses/costs, various indirect costs namely, salaries and wages, freight and forwarding, insurance charges, sales cost, commission payable to business agents on respective contracts, if any, excise duty paid/incurred at time of removal of goods from factory to sites of installation, octroi duty, free OTIS services, administrative burden, etc. are allocated to various contracts that executed during year. However, expenses like interest, bad debts/advances written off and provisions for doubtful debts and advances are not allocated between contracts since these are not items of expenses incurred in manufacturing and sales. 5 . assessee-company maintains contract-wise sub-ledgers wherein expense/cost incurred in relation to each contract, is recorded. Further, assessee-company follows completed contract method whereby sales are recognized only on completion of contract. Although, contract value for each of contract is ascertained at time of entering into contract, actual profit is determined only on completion of contract, after ascertaining actual total cost incurred on contract which is recorded in books of account. Contracts which remain incomplete at end of year are treated as works-in-progress. 6. In case of incomplete contract, where at end of year, actual cost exceeds contract price, necessary provisions are made for resultant loss. Hence, assessee-company charges to P&L a/c of year, losses incurred during year both, on contracts completed during year and on contracts remaining incomplete at end of year, even though in terms of completed contract method profits arising on incomplete contracts are not credited to P&L a/c. 7. provisions for losses on incomplete contracts are reversed in year in which contracts are completed. scheme of creating provision for losses on incomplete contracts and reversal thereof is explained by assessee-company as under : (i) At beginning of year, value of works-in-progress will be equal to value of works-in-progress as on last day of immediately preceding previous year. At time of valuation of works-in-progress as on last day of immediately preceding previous year for purpose of P&L a/c and balance sheet, total/gross value of works-in-progress were reduced by aggregate value of losses, i.e., excess cost over value of sales price of loss making contracts. However, in works-in-progress registers values were maintained at gross value and no reduction on account of losses have been made in order to keep track of actual cost of each and every contract in progress. Therefore, in order to neutralize effect given in preceding P&L a/c and balance sheet as on last day of preceding year to losses provided for loss making contracts, same were reversed only to extent of contracts which are still in progress as at end of this previous year by set of journal entries in books of account in this year. Once again losses incurred on loss making contracts as at end of this year are provided for at end of this year by another set of journal entries. This in other words means P&L a/c is charged only to extent of fresh losses incurred on loss making contracts during this previous year. (ii) As regards contracts which were closed during year and for which losses were provided up to end of preceding year, same were reversed in order to arrive at actual cost of contract and sales are also taken into revenue of year and this is accounted by set of journal entries. This in other words means profit and loss is charged only with amounts of fresh losses incurred during previous year while accounting for entire sales value. This is how it is reflected by term "losses reversed on completion" in Annex. to our letter dt. 19th March, 1 99 3. Though apparently it may appear that there can be no reversal of losses, at time of sales, earlier losses provided are reversed and are taken to enhance value of cost of sale and, therefore, net effect of scheme of entries is that only amount of fresh losses incurred on such contracts closed during year are charged to P&L a/c by this scheme of entries. 8 . crux of above explanation is that in respect of incomplete contracts, losses are booked in year in which actual cost of contract exceeds contract price to extent of excess of expenditure over contracted price and in subsequent year balance amount of expenditure incurred is claimed as loss. Thus, loss is claimed in two years. However, in some contracts, there is escalation clause under which assessee may realize additional value on account of price increase. In such cases, assessee makes provisions to extent of estimated amount realizable and if still expenditure is more than realizable value, then losses are booked to that extent in P&L a/c. In this manner, assessee claimed loss of Rs. 1,02,31,801 for asst. yr. 1 99 1-92. In similar manner, losses were claimed in other years also. 9. Since assessee was following contract completion method, AO asked assessee to show cause as to why such loss should not be disallowed. assessee vide letter dt. 15th Feb., 1 99 3 replied (i) that method adopted by assessee was in accordance with Accounting Standard (AS) 7 as well as international AS 11; (ii) that assessee is entitled to value closing stock either at cost or realizable market price. It also relied on judgment of Supreme Court in case of Challapalli Sugars Ltd. vs. CIT 1974 CTR (SC) 309 : (1975) 98 ITR 167 (SC), for proportion that recommendations of ICAI should be followed. Thus, it was pleaded that in view of provisions of s. 145, claim of assessee could not be rejected. 10. AO did not accept explanation of assessee. According to him, purpose of valuing during stock was to determine profits on sales effected by assessee but in case of contract completion method, valuation of closing stock was not relevant factor. Secondly, he observed that no profits or losses could be said to accrue by unilateral transaction such as valuation of closing stock. It was also observed that loss claimed by assessee was merely provisions in book since such loss is reversed in next year. In view of these observations, he held that such loss on incomplete contracts could not be allowed. 11. On appeal, learned CIT(A) allowed loss by observing as under : "13. In appellant s case, it cannot be denied that incomplete contracts have been executed by way of payment or receipt of goods during year. work-in-progress of incomplete contracts cannot also be regarded under IT Act as anything else apart from stock-in-trade. It is also true that provision for loss is based on valuation of such stock-in-trade at market price, which is lower than cost. contention of AO that such loss cannot be allowed, as work-in-progress (stock-in-trade) of incomplete contracts cannot be taken into account for computation of profit under computed contract method is, in my opinion, criticism of Accounting Standard only. Such is also view of Board of Inland Revenue (UK) as it will appear from their statement (Appendix 3 to Statement of Standard Accounting Practice relating to stocks and work-in-progress issued by Institute of Chartered Accountants of England and Wales) where they observe that where loss on contract as whole is foreseen, proportion of overall loss calculated either by reference to time normally upto due completion date under terms of contract, or to expenditure incurred, may normally be taken into account year-by-year during remainder of contract period, so long as all contracts profitable or otherwise are dealt with similarly (para 8). In other words, such losses can be taken into account under percentage computation method only. I am afraid that though such view may appeal to common sense, it cannot be accepted in face of specific provisions in Accounting Standard for deduction of such losses even under completed contract method and it has to be held that such loss is deductible according to accepted accounting practice. I have also pointed out that such claim of loss is allowable under IT Act also, as loss/expenditure has actually been incurred by way of costs incurred till date. In view of above, I have no option but to allow claim of anticipated loss from incomplete contracts of Rs. 1,02,31,801 made by appellant in computation of profits from long-term contracts and following completed contract method." Aggrieved by same, Revenue is in appeals before Tribunal. 12. learned Departmental Representative has assailed order of learned CIT(A) by reiterating reasonings given by AO and, therefore, same need not be repeated. However, it was contended by him that legislature has given option to maintain its accounts in accordance with any method of accounting of his choice. But once choice is opted by assessee, then profit and loss must be disclosed in accordance with such method. It was pleaded by him that once assessee had chosen to maintain its account on basis of contract completion method then profit or loss has to be determined i n year of completion only and not in any other year. Therefore, AO was justified in disallowing loss in respect of incomplete contracts. Proceeding further, he referred to matching concept as dealt with by Hon ble Bombay High Court in case of Taparia Tools Ltd. vs. Jt. CIT (2003) 180 CTR (Bom) 256 : (2003) 260 ITR 102 (Bom). According to him, expenditure must match with income. Therefore, expenditure incurred cannot be allowed as deduction unless matched with connected income. Since assessee had not shown any income by way of receipts, question of allowing any loss does not arise. Proceeding further, he drew our attention to escalation clause in contract and submitted that loss claimed was contingent or premature till escalation price is received by assessee. Accordingly, it was pleaded by him that order of AO may be restored. AO may be restored. 1 3 . On other hand, learned counsel for assessee has vehemently supported order of learned CIT(A). According to him, assessee is entitled to adopt any of methods of accounting. It was further submitted that assessee had been maintaining such method of accounting s in c e decades and consistently being followed and also accepted by Department. Therefore, AO could not deviate from such method from disallowing losses. Reliance was placed on Bombay High Court judgment in case of Manilal Kher Ambalal & Co. vs. A.G. Lulla, ITO (1988) 72 CTR (Bom) 44 : (1989) 176 ITR 253 (Bom). Proceeding further, it was submitted that method of accounting adopted by assessee is in consonance with AS 7 as well as international AS 11 and, therefore, such method is acceptable method. Hence, learned CIT(A) was justified in accepting same. It was also submitted by him that assessee is entitled to value works-in-progress (stock- in-trade) either at cost or market value whichever is less as per Supreme Court judgment in case of Chainrup Sampatram vs. CIT (1953) 24 ITR 481 (SC). He also relied on Supreme Court judgment in case of A.L.A. Firm vs. CIT (1 99 1) 93 CTR (SC) 133 : (1 99 1) 189 ITR 285 (SC), for contention that realizable value can be taken into consideration. Accordingly, assessee could value work-in-progress at contractual price since that was realizable value. He also objected to contention of learned Departmental Representative that due to escalation clause in agreement, loss was contingent. It was contended by him that provisions had been made by assessee in respect of estimated amount realizable under escalation clause and, therefore, contention of learned Departmental Representative is without force. 1 4 . In reply, learned Departmental Representative submitted that Accounting Standards prescribed by ICAI are meant for accounting purpose and n o t for taxation purposes. He also pointed out that AS 7 has not yet been accepted or notified by Central Government, under amended provisions of s. 145. According to him, Accounting Standards are normally prescribed to satisfy shareholders and cannot be applied to determine accrual of loss. Proceeding further, he submitted that valuation of closing stock is relevant only where profits are determined on year-to-year basis and same is not relevant where contract completion method is adopted by assessee. He reiterated that in case of contract completion method, profit/loss can only be determined in year of completion. 15. Rival submissions of parties have been considered carefully. question for our consideration is whether method of accounting adopted by assessee in respect of incomplete contracts could be rejected in law by AO for purpose of disallowing losses declared by assessee in such incomplete contracts. answer to this question would depend on interpretation of provisions of s. 145 of Act, which gives option to assessee to adopt any method of account. Sec. 145 as applicable to years under consideration, reads as under : "145. Method of accounting (1) Income chargeable under head "Profits and gains of business or profession" or "Income from other sources" shall be computed in accordance with method of accounting regularly employed by assessee : Provided that in any case where accounts are correct and complete to satisfaction of AO but method employed is such that, in opinion of AO, income cannot properly be deduced therefrom, then computation shall be made upon such basis and in such manner as AO may determine : Provided further that where no method of accounting is regularly employed by assessee, any income by way of interest on securities shall be chargeable t o tax as income of previous year in which such interest is due to assessee : Provided also that nothing contained in this sub-section shall preclude assessee from being charged to income-tax in respect of any interest on securities received by him in previous year if such interest had not been charged to income-tax for any earlier previous year. (2) Where AO is not satisfied about correctness or completeness of accounts of assessee, or where no method of accounting has been regularly employed by assessee, AO may make assessment in manner provided in s. 144." 1 6 . above section corresponds to s. 13 of 1922 Act and these provisions have been construed by various Courts from time-to-time. bare reading of above provisions clearly shows that profits and gains of business have to be computed as per method of accounting regularly employed by assessee. It is duty of AO to compute income of assessee in accordance with method regularly employed by him unless case of assessee falls within provisions of any of proviso. Such method of accounting may be mercantile method or cash/receipt method of accounting. In respect of these two methods, there is no dispute between parties. However, disputes have arisen where method regularly employed by assessee is neither purely mercantile nor cash system but is mixed system of accounting which is normally called as hybrid system of accounting. case study reveals that such system of accounting has also been accepted by Courts. Hon ble Supreme Court in case of CIT vs. A. Krishnaswami Mudaliar & Ors. (1964) 53 ITR 122 (SC), had taken note of hybrid system of accounting being followed. jurisdictional High Court in case of CIT vs. Citi Bank, N.A. (1 99 4) 119 CTR (Bom) 383 : (1 99 4) 208 ITR 930 (Bom), has accepted hybrid system of accounting by observing at p. 937 as under : "Though cash system and mercantile system of accounting are two most common systems of accounting prevalent in country, there can be no dispute about fact that there are also innumerable other systems of accounting besides these two systems. Such systems are commonly known as "hybrid systems of accounting". In such system, there is certain element of both cash and mercantile systems. As assessee following such system may employ one method of accounting for one class of business or one class of customers or transactions and different method for another class. If assessee follows such hybrid system and in respect of certain loan transactions does not follow mercantile system of accounting for debiting interest to accounts of parties and crediting same to P&L a/c, no fault as such can be found with system followed by assessee. only power ITO has, in such cases, is power under proviso to s. 145(1) of Act which permits him, on being satisfied that method employed by the Act which permits him, on being satisfied that method employed by assessee is such that his income cannot be properly deduced therefrom, to compute his income upon such basis and in such manner as he may determine. Evidently this is not case falling under proviso to s. 145(1) in view of categorical finding of Tribunal in this regard. Besides, ITO himself has been accepting this system which had been followed by assessee throughout in past as proper method of accounting and profits had in fact been determined on basis thereof in past as well as in two of three assessment years under consideration. fact that assessee, for its convenience, kept separate note of all those parties in whose case mercantile system of accounting had not been followed and interest on amounts due from them had not been debited to their accounts cannot in any way militate against fact that assessee was not following mercantile system of accounting in respect of loans in question. system of accounting followed in respect of interest on such loans was in fact cash system. above system of accounting followed by assessee does not in any way affect real income of assessee because, as soon as amount of interest is recovered on any such loan, record of which is kept in form of memorandum record, it is treated as income of assessee of that year and subjected to taxation. We, therefore, do not find any infirmity in finding of Tribunal. According to us, Tribunal was justified in holding that having found no fault with method of accounting followed by assessee, it was not open to ITO to compute interest on loans in question on presumption that assessee having generally followed mercantile system of accounting in respect of most of its transactions it was not open to it to follow different system of accounting in respect of category of loans classified by assessee as problem loans ." 17. In view of above judgment, it is held that any system of accounting could be employed by assessee provided it is regularly employed and AO was bound to determine profits in accordance with such system of accounting. 18. only exception to above legal position is provided in first proviso i.e., where true profits cannot be deduced from method of accounting employed by assessee. If such method of accounting depicts distorted picture of profits of business carried on by assessee then AO can invoke proviso to s. 145 even though such method is being employed consistently as held by Hon ble Supreme Court in case of CIT vs. British Paints India Ltd. (1 99 1) 91 CTR (SC) 108 : (1 99 1) 188 ITR 44 (SC). But powers of AO under such proviso are not arbitrary and must be exercised in judicious manner as held by Hon ble Supreme Court in case of A. Krishnaswamy Mudaliar (supra). 1 9 . legal position which emerges is that it is entirely within discretion of assessee to adopt any method of accounting provided it discloses true picture of his profits and gains. Such method of accounting may be mercantile or cash basis or even hybrid system of accounting. However, if system followed by assessee does not show true picture of profits of business carried on by assessee then certainly, AO can invoke provisions of proviso to s. 145 though such powers are to be exercised judiciously. 2 0 . In above backdrop, let us examine system followed by assessee. Assessee being contractor can adopt either percentage completion method or contract completion method, which are duly recognized by ICAI. It can also employ any other method provided which shows true profits of its business. In present case, assessee has adopted contract completion method in general. According to this method, assessee goes on accumulating expenditure year after year in respect of each contract and contract price is credited in year in which contract is completed and resultant profit is shown in books in that year. However, there is exception t o such system of accounting. In some cases, where, during pendency of contract, expenditure incurred exceeds contracted price, excess amount is booked as losses in P&L a/c and only contracted price is carried forward to next year and so on. Thus, in case of loss in particular contract, it is shown in more than one year. In case of escalation clause in contract, provision is made by assessee of estimated escalation price. This system of accounting is being employed by assessee since decades and was also being accepted by Revenue till asst. yr. 1988-89. 2 1 . system of accounting adopted by assessee in respect of incomplete contracts resulting in losses can be explained by example. For instance, contract price is Rs. 20 lakhs and contract is to be completed in 4 years, estimated escalation price is taken at Rs. 30,000. entries made by assessee in various years, as per chart furnished by assessee, can be illustrated as under : Year I P&L a/c By To raw 8,00,000 closing 19,30,000 material WIP To direct 5,00,000 labour To direct 3,00,000 overheads To indirect 3,30,333 overheads 19,30,000 19,30,000 Year II P&L a/c To By loss opening 19,30,000 on incomplete 70,000 balance contract To raw By 80,000 20,30,000 material closing WIP To 30,000 direct labour To direct 40,000 overheads To indirect 20,000 overheads 21,00,000 21,00,000 Year III P&L a/c To By loss opening 20,30,000 on incomplete 40,000 balance contract To raw By 10,000 20,30,000 material closing WIP To 10,000 direct labour To direct 10,000 overheads To indirect 10,000 overheads 20,70,000 20,70,000 Year IV P&L a/c To By Sales opening 20,30,000 20,30,000 a/c balance By losses To raw 5,000 on completed 20,000 material contracts To 5,000 direct labour To direct 5,000 overheads To indirect 5,000 overheads 20,50,000 20,50,000 22. reasoning given by assessee in adopting above system is that contract price is fixed and, therefore, where expenditure incurred already exceeds realizable price, losses are incurred which are ascertained and, therefore, can be booked to P&L a/c. Therefore, assessee is entitled to set off same against profits of business of that year. However, where expenditure incurred is less than realizable price, assessee continues to accumulate same and profits are determined in year of completion. In our opinion, explanation of assessee is plausible, bona fide and must be accepted. 23. At this stage, it would be appropriate to refer to AS 7 prescribed by ICAI in case of contractors. Para 7 onwards of AS 7 prescribes various methods which may be adopted by contractor. Para 13.1 permits contractor to book losses where estimated loss is indicated. Para 13.1 reads as under : "13.1 When current estimates of total contract costs and revenues indicate loss, provision is made for entire loss on contract irrespective of amount of work done and method of accounting followed. In some circumstances, foreseeable losses may exceed costs of work done to date. Provision is nevertheless made for entire loss on contract." Para 19 which is also relevant, reads as under : "19. foreseeable loss on entire contract should be provided for in financial statements irrespective of amount of work done and method of accounting followed." Similar methods are recognized by international AS-I, AS II and need not be repeated. Copies of same are placed in paper book. 24. discussion in preceding para, clearly shows that in case of foreseeable losses, same can be booked to P&L a/c. Therefore, it is held that system of accounting employed by assessee is on consonance with accounting standard prescribed in India and also outside India. 25. only question which remains to be considered is whether such system depicts distorted picture of profits of business carried on by assessee. In our opinion, answer is "no". contracted price is fixed under contract. Therefore, if during construction period, cost incurred has exceeded contract price, loss accrues to assessee to extent of excess expenditure. learned Departmental Representative has argued that such loss is contingent in view of escalation clause in contract. This contention of learned Departmental Representative is also untenable. Firstly, because such escalation clause is not in every contract. Secondly, wherever there is escalation clause, provision is made of such escalation price on estimate basis. Such method has been judicially recognized by apex Court in case of Calcutta Co. Ltd. vs. CIT (1959) 37 ITR 1 (SC). Therefore, we hold that system of accounting employed by assessee consistently since decades cannot be rejected. 2 6 . Before parting with this order, we may mention that judgment of Hon ble Supreme Court in case of Chainrup Sampatram (supra) relied upon by assessee s counsel, in support of proposition that closing stock is to be valued at cost or market price, cannot be applied in case of contractor. Such method is applicable only where closing stock is sold as trader or manufacturer since profits are to be determined on year-to-year basis in respect of sales affected by assessee during year. When assessee, as contractor, chooses completion method, question of valuing stock does not arise since work-in-progress is to be computed on basis of accumulated expenditure. Hence, such contention of assessee is rejected. 27. In view of above discussions, issue is decided in favour of assessee. orders of learned CIT(A) are, therefore, upheld on this issue. 28. next common issue pertaining to asst. yrs. 1 99 -91 to 1 99 3-94, 1 99 5-96 and 1 99 6-97 relates to additions made by AO on account of Modvat credit. Both parties are agreed that this issue stands covered in favour of assessee by judgment of Hon ble Supreme Court in case of CIT vs. Indo Nippon Chemicals Co. Ltd. (2003) 182 CTR (SC) 291 : (2003) 261 ITR 275 (SC). Respectfully following same, issue is decided in favour of assessee. orders of learned CIT(A) are, therefore, upheld on this issue. 29. next issue arising from asst. yr. 1 99 5-96 relates to computation of relief under s. 80HHC of Act. AO, while computing such deduction, excluded 90 per cent of interest income and export incentive from business profits but did not exclude these elements from total turnover. learned CIT(A) was of view that such income could not be included in turnover. Revenue is aggrieved from such order of learned CIT(A). In our opinion, learned CIT(A) has rightly excluded same from turnover. turnover relates to sales of goods sold by it either locally or in course of export. interest income has no relation to sales transaction. Accordingly, we do not find any infirmity in order of learned CIT(A). Accordingly, same is upheld on this issue. 3 0 . last issue relates to addition of Rs. 1,02,95,655 in intimation sheet issued under s. 143(1)(a) for asst. yr. 1 99 1-92. This adjustment was by way of disallowance under s. 43B in respect of unpaid sales- tax. However, on appeal, learned CIT(A) deleted addition being outside scope of s. 143(1)(a). Aggrieved by same, Revenue is in appeal before Tribunal. After hearing both parties, we do not find any infirmity in order of learned CIT(A) under s. 143(1)(a). No adjustment was possible unless it was apparent from record that payment was not made before due date of return. In absence of such detail, AO was not justified in making such adjustment under s. 143(1)(a). Accordingly, we hold that learned CIT(A) was justified in directing AO to delete such adjustment. order of learned CIT(A) is, therefore, upheld on this issue. 31. In result, appeals of Revenue stand dismissed. *** DEPUTY COMMISSIONER OF INCOME TAX v. OTIS ELEVATOR CO. (I) LTD.