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Accounting Standard 12 deals with the accounting for government grants. Such grants are offered by the government, government agencies and similar bodies including local, national or international.
These government grants are sometimes referred to as subsidies, cash incentives, duty drawbacks etc.
However, AS 12 does not deal with the following items:
- Specific problems arising on account of accounting for government grants in financial statements. Such problems showcase the impact of changing prices or other information similar in nature.
- Government support other than the one that is in the form of government grants
- Participation of government with regards to ownership in an enterprise
Thus, this article talks about what are government grants, accounting treatment of government grants, recognition of government grants and their presentation in the financial statements.[/vc_column_text]
What are Government Grants?
Government grants refer to the support given by the government to an enterprise either in cash or kind. Such grants are given for an enterprise to meet past or future compliance along with certain conditions. However, these grants do not include any form of government support:
- that cannot be reasonably valued and
- the ones that cannot be separated from the normal trading transactions of an enterprise
Thus, receipt of government grants is an important issue to be considered while preparing financial statements for an enterprise. There are two reasons that make the receipt of government grants significant for an enterprise:
- the enterprise has to adopt an appropriate accounting method to account for the government grants thus received
- an enterprise needs to indicate the amount of benefit derived from such government grants during the reporting period. This is important because it facilitates an enterprise to compare current financial statements with that of prior periods as well as undertake inter company comparisons.
Accounting Treatment of Government Grants
An enterprise can adopt any two of the accounting approaches to undertake the accounting treatment of government grants. These include:
- Capital Approach
- Income Approach
It must be noted that the accounting treatment of a government grants must be based upon the nature of grant itself. Thus, grants that have attributes similar to those of promoters’ contribution must be treated as a part of the shareholders’ fund.
While other set of grants must be treated as income. Accordingly, government grants treated as income must be recognized in the P&L statement. Such income must be matched with the related cost in a reporting period.
Furthermore, government grants received on receipt basis cannot be recognized as income in P&L statement. This is because such a grant is not an income as per the accrual accounting assumption.
Mostly, the costs and expenses related to a government grant that needs to be recognized over a number of periods, is typically determined with ease. Therefore, grants related to specific expenses are treated as income in the same period in which such expenses are recognized.
According to the capital approach, the government grants are treated as a part of capital or shareholders’ funds or promoter’s contribution. Such grants are given as a part of the total investment in an enterprise.
Furthermore, the government does not expect any repayment in case of such grants. Therefore, such government grants are credited to the shareholders’ funds.
The second argument in favor of the capital approach towards treating government grants is that it is not justified to recognize government grants in P&L statement. This is because such grants are not earned rather they are considered as an incentive provided by the government without any related costs.
As per the income approach, the government grants are treated as income over one or more periods. Following are the arguments that support the income approach for accounting treatment of government grants:
- As per the definition of government grants mentioned above, government grants refer to the assistance that an enterprise receives from the government on complying with the conditions and meeting the prescribed obligations. Thus, grants are not given without any reason. Therefore, it is logical to consider the government grants as income and match such income with the costs that such a grant tends to compensate.
- Government grants are similar to the income tax or other taxes charged against the income of the enterprise. This is because these form part of the fiscal policies of the government. Just like income tax or other taxes are charged against income in the P&L statement, the government grants should also be treated in the same way.
- There may be entities that may follow capital approach and treat grants as part of shareholders’ fund. In such cases, no relationship exists between the accounting treatment of a grant and accounting treatment of expense to which it associates.
Recognition of Government Grants
As per the definition, the enterprise must account for the government grants only where:
- The enterprise complies with the conditions attached to such government grants and
- The benefits of such government grants have been earned by the enterprise. Furthermore, there is a reasonable certainty that the enterprise will collect such a grant.
This means that merely receiving a grant does not necessarily authenticate that the enterprise has complied or will comply with the conditions attached to such a grant. Also, appropriate amounts of benefits earned by an enterprise with regards to such a grant are estimated on a prudent basis. Such an estimated amount is credited to the income of the reporting period. This is despite the fact that the actual amount of benefits are settled or received after the end of the relevant accounting period.
In addition to this, there are cases where a government grant is given in order to provide financial support to the enterprise rather than as an incentive to cover certain expenditure.
It must be noted that such grants are restricted to an individual enterprise and are not available to the entire class of enterprises. In such cases, the government grant is treated as an extraordinary item in the period in which the enterprise gets qualified to receive such a grant.
However, an enterprise gets qualified to receive government grants to compensate for expenses or losses incurred in prior accounting periods. Such a government grant is treated as an extraordinary income in the income statement of the period in which becomes receivable.
Non-Monetary Government Grants
Sometimes, the government grants take the form of non-monetary assets like land given at reduced prices. In such circumstances, these assets are accounted for at their acquisition cost. Further, in case the non-monetary assets are given free of cost, then such assets are recorded at a nominal value.
Asset Related Grants Presentation
Some government grants are given in the form of specific fixed assets. Now, the primary condition for an enterprise qualifying for such a grant is that it should purchase, construct or otherwise acquire such assets.
Besides this, there are other set of conditions like restricting the type or location of assets or period during which such assets should be acquired.
So, to present such assets in the financial statements, following two methods have been suggested.
Grant Shown As A Deduction From the Gross Value of the Asset
Under this method, the government grant is shown as a deduction from the gross value of the asset concerned in order to arrive at its book value.
Further, the grant itself is recognized in the P&L Statement over the useful life of a depreciable asset by way of a reduced depreciation charge.
In addition to this, the entire cost of the asset is shown at a nominal value in the balance sheet.
Grants Treated as Deferred Income
There can be two types of grants: grants related with depreciable assets and grants related with non-depreciable assets.
Grants Related To Depreciable Assets
Government grants pertaining to depreciable assets are treated as deferred income. Such a deferred income is recognized in the P&L statement over the useful life of the asset on a systematic and rational basis.
In addition to this, the allocation of such deferred income is made over the periods and in proportions in which depreciation on related assets is charged.
Grants Related To Non-Depreciable Assets
Such grants are credited to capital reserve as per this method. This is because there will be no charge to income with respect to such non-depreciable assets.
However, there can be certain cases where grants pertaining to non-depreciable assets demand certain obligations to be met. In such scenarios, the grant is credited to income. Such income is credited over the same period over which the cost of meeting such obligations is charged to income.
The deferred income is suitably disclosed in the balance sheet pending its apportionment to profit and loss account.
Now, it is important to note that there is a major movement in the cash flow of an enterprise whenever it purchases assets and receives related grants. Such cash flow movements are shown as separate items in the ‘Statement of Changes in Financial Position’.
Further, these cash flow movements are shown separately irrespective of whether or not the grant is deducted from the related asset for the purpose of balance sheet presentation.
Revenue Related Grants Presentation
Grants pertaining to revenue are sometimes credited in the P&L statement either separately or under a general heading such as ‘Other Income’. Alternatively, such grants are deducted in reporting the related expense.
Promoter’s Contribution Related Grants Presentation
Some government grants are given by the way of contribution towards the equity capital of an enterprise and no repayment is expected in respect of such grants.
Thus, grants of the nature of promoter’s contribution are treated as capital reserve. Such a reserve can neither be used for distributing dividends nor can be considered as a deferred income.
Refund Of Government Grants
Sometimes government grants become refundable. This happens on account of certain conditions not being fulfilled by an enterprise. Thus, in such scenarios, the government grant that becomes refundable is treated as an extraordinary item.
Following is the accounting treatment of the various types of government grants that become refundable.
Revenue Related Grants
The amount refundable in respect of a government grant related to revenue is first charged against any un-amortised deferred credit remaining in respect of the grant. In case the refundable amount exceeds the deferred credit or where no deferred credit exists, such excess amount is charged to the P&L account.
Specific Assets Related Grants
The amount refundable in respect of a government grant related to a specific fixed asset is recorded by:
- increasing the book value of the asset or
- reducing the capital reserve or deferred income balance by the amount refundable
In case an enterprise follows the first method, depreciation on the revised book value is also provided.
Grants of the Nature of Promoter’s Contribution
There are scenarios where the grants in the nature of promoters’ contribution become refundable to the government in part or in full due to non-fulfillment of certain conditions. In such cases, the appropriate amount to be recovered by the government is reduced from the capital reserve.
An enterprise receiving government grants needs to make the following disclosures in its books of accounts.
- accounting policy adopted by an enterprise for government grants. This includes the methods of presentation in the financial statements.
- nature and extent of government grants recognized in the financial statements. This includes grants of non-monetary assets given at a concessional rate or free of cost.