IAS 20 - Accounting for Government Grants and Disclosure of Government Assistance (detailed review)

Objective

This Standard deals with the accounting treatment of government grants, along with the disclosure requirements for government grants and government assistance.

Scope

The requirements of this standard are applicable for the recognition and measurement of government grants including the disclosure requirements related to government grants and government assistance. However this standard does not deal with the following aspects:

• Government assistance in the form of tax related benefits such as income tax credits, tax breaks, orreduced tax rates.
• Benefits in the form of, government participation in the ownership of the entity
• Government grants which are covered under IAS 41
• Treatment of government grants due to the changing price levels.
• Provision of general infrastructure

Definitions

Government

It is defined as government, government agencies acting on behalf of government and other similar local, national or international bodies.

Government Grants

These are assistance by the government in the form of transfers of economic resources to an entity,as a result ofentity’s past or future compliance with certain specified conditions relating to the operating activities of the entity.  However, it does not include thoseforms of government assistance which cannot be reliably measured in monetary termsand transactions with government which are not distinguishable from the normal trading transactions of the entity.

Government Assistance

These are actions by the government undertaken to provide economicbenefits to an entity or range of entities which qualify certain conditions. These do not have exact value placed upon them in monetary terms.

Grants related to Assets

Thegovernment grants which are available for the construction, acquisition or purchase of certain assets are called grants related to assets. It may be having some certain conditions attached to it regarding the nature, use or location of the asset.

Grants related to Income

These are government grants other than grants related to assets, and are normally available for development or improvements. Such as grant for improvement in working conditions for employees, grant for the creation of job vacancies, and grant for the training of the staff.

Forgivable Loans

These are the loans whose repayment has the potential to be waived by the lenderunder certain prescribed conditions.

Recognition of Government Grants

Government grants are only permitted to be recognized when it is reasonablycertain that:

(a) Grant will be received and
(b) The entity will satisfy the predetermined conditions related to the government grant

Approaches for the Recognition of Government Grant

There are two broad approaches to the accounting for government grants:

• Capital Approach
• Income Approach

1. Capital Approach

Under this approach, government grant is recognized outside the profit or loss, as part of the equity in the statement of financial position. The supporters of capital approach have the following arguments in favor of this approach:

(a) Government grants are financing components therefore, should be treated as suchin the statement of financial position as part of equity.

(b) Government grants are not earned, so, it is not appropriate to recognize these in profit or loss because these represent an incentive provided by governmentwithout related costs.

2. Income Approach

Under this approach, government grantis recognized in statement of profit or loss using appropriate method over the periods in which the entity recognizes the related costs, for which the grant is intended tocompensate. The supporters of Income approach have the following arguments in favor of this approach:

(a) Government grant should not be recognizeddirectly in equity because these are received from a source other than equity participants, but should be recognized in profit or loss in the relevant periods using appropriate method.

(b) The entity earns government grantby complying with predetermined conditions attaching to it and meeting the related obligations. Therefore, it should berecognized in statement of profit or loss using appropriate method over the periods in which the entity recognizes the related costs, for which the grant is intended tocompensate.

Notes:

• This standard supports the use of income approach and requires that government grant should be initially recorded as deferred income and it should berecognized in statement of profit or loss using appropriate method over the periods in which theentity recognizes the related costs, for which the grant is intended tocompensate.

• The manner in which a grant is received does not affect the accounting treatment of the government grant, it will be accounted for in thesame manner as specified in this standard.

 

Measurement of Government Grant

If government grant satisfies the recognition criteria, it will be measured as follows:

1) In Case of Government Grant in Cash

If government grant is in the form of cash, it will be measured at the amount of cash received or receivable.

2) In Case of Non-monetary Government Grant

If the government grant is in the form of non-monetary asset such as free of cost land, license or other non-monetary resources, it will be measured either at fair value of asset or nominal cost of such asset.

Amortization of Government Grant

This standard requires that government grant should be initially recorded as deferred income and it should then be amortized in the statement of profit or loss at the end of each reporting period, using appropriate method, in which the entity recognizes the related costs for which the grant is intended tocompensate as follows:

1. Grant related to Asset

If the government grant is available for the construction, acquisition or purchase of an asset, it will be amortized as follows:

• If it is depreciable asset, it will be amortized in the statement of profit or loss in the periods and proportion as that asset is depreciated.

• If it is non-depreciable asset, it will be amortized in the statement of profit or loss over the life of any obligation attached to that asset such as the grant of a land may be requiring the construction of a building over it, in this case the grant recognized may be amortized over the life of the building.

2. Grant related to Income

If the government grant is available for the general improvements or developments, it will be amortized in the statement of profit or loss following the pattern of expenses in the relevant periods.

3. Other Points:

• Sometimes governmentgrants are received as part of a package,and have number of conditions attached to it. In such cases, the entity needsto identify the conditions and should determine theperiods over which the grant will be earned. It may be appropriate to amortize partof a grant on one basis and remaining part on another.

• If the government grant becomes receivable as a compensation for an expense orloss,which has already been incurred, for the purpose of immediate financial reliefto the entity with no future related costs, it will be recognized in statement of profit or loss ofthe period in which it becomes receivable.

 

Presentation of Government Grant

This standard permits two methods for the presentation of government grant either it is grant related to asset or grant related to income, these are:

• Gross Up Method
• Net Method

Gross Up Method

Under this method, government grant is initially recognized at its gross amount separately as deferred income in the statement of financial position. It is then amortized to statement of profit or loss using appropriate method over the relevant periods.  Any unamortized balance of government grant will remain as deferred income in the statement of financial position at the end of reporting period.

Net Method

Under this method, government grant is deducted from the cost of related asset or expense and then it is amortized to statement of profit or loss in the form of reduced depreciation charge or expense.

Both methods are regarded as acceptable for the presentation of government grant either it is grant related to asset or grant related to income. 

Repayment of Government Grant

If the entity has not been able to meet the predetermined conditions attached to the government grant, it may become repayable and will be accounted for as a change inaccounting estimate as per IAS 8. It will be treated as follows:

• If the government grant was recognized using the gross up method, first the entity should de-recognize any unamortized government grant and it will be classified as payables. Any difference between the unamortized balance of government grant and grant repayable will be recognized immediately in profit or loss.

• If the government grant was recognized using the net method, first the entity should restate the carrying amount of asset by theamount of government grant repayable. And the difference between cumulative depreciation that would have beento date in the absence of the grant and existing depreciation will be recognized immediately in profit or loss as incremental depreciation.

Government Assistance

These are the actions by the government undertaken to provide economicbenefits to an entity or range of entities which qualify certain conditions. These do not have exact value placed upon them in monetary terms such as free provision of technical advice or financial guarantees.

As the government assistance does not have exact value placed upon them, therefore these are only disclosed in the notes to the accounts.

Disclosures

This Standard requires the entity to disclose the following matters:

• The presentation method adopted by the entity for the government grants in the financial statements
•  The nature of government grants recognized in the financial statements
• Other forms of the government assistance received by the entity, from which entity has obtained benefits
• Any unfulfilled conditions related to the grant which has been recognized.

 

Worked Example

Example 1 (Grant related to Asset)

AB Ltd purchased an energy saving plant for $100,000 on 1 January 2009, having useful life of 5 years with a residual value of $10,000. The entity received a government grant equal to 20% of the cost of the asset, on the condition that plant must be used at least for period of 4 years otherwise a repayment will arise on sliding scale basis i.e. 75% of the grant will be repayable if the asset is sold in the first year and it will diminish by 25% for subsequent years up to year 4. AB Ltd has no intention to sell plant in first four years.

Required:

How the plant and the related government grant will be accounted for in the financial statements of AB Ltd for the year ended 31.12.2009 using

i) Gross Up Method

ii) Net Method

Solution:

i) Gross Up Method

Statement of Profit or Loss	31.12.09
	$’000
Depreciation Expense (W1)	(18)
Amortization of Government Grant	4
Total Charge	(14)

 

Statement of Financial Position	31.12.09
	$’000
Assets:
Non-Current Assets:
Plant ($100 - $18)	82
Non-Current Liabilities:
Govt. Grant ($16- $4)	12
Current Liabilities:
Govt. Grant	4

 

(W1) Depreciation Expense = ($100 - $10) / 5 years = $18

(W2) Receipt of Govt. Grant = ($100 × 20%) = $20

         Under gross up method govt. grant is recorded as deferred income separately and it will be amortized using appropriate method.

   Cash a/c   $20
   Deferred income a/c   $20

(W3) Amortization of Govt. Grant at 31.12.09

As the grant relates to the depreciable asset it will be amortized in the way as asset will be depreciated in the relevant periods as($20 / 5 years) = $4

                    Deferred Income a/c   $4
         Profit or Loss a/c   $4

The remaining balance of unamortized govt. grant of $16($20 - $4) will remain as deferred income in the statement of financial position and will be amortized in the relevant periods. However, it will be classified in to current and non-current liability.

 

ii) Net Method

Statement of Profit or Loss	31.12.09
	$’000
Depreciation Expense (W1)	(14)

 

Statement of Financial Position	31.12.09
	$’000
Assets:
Non-Current Assets:
Plant [($100 - $$20) - $14(W1)]	66

 

(W1) Depreciation Expense = [($100 - $20) - $10] / 5 years = $14

(W2) Receipt of Govt. Grant = ($100 × 20%) = $20

        Under net method govt. grant will be deducted from the cost of the asset and asset will be recognized at net cost $80($100 - $20). It is not recorded separately as:

 

Cash a/c   $20
     Plant a/c   $20

(W3) As the govt. grant has been deducted from the cost of asset, therefore there is no need of separate amortization of govt. grant

 

Example 2 (Grant related to Income)

AB Ltd received a grant of $500,000 from provincial government for creating job vacancies, for the individuals in the nearby area,and maintaining them for a period of 3 years.The entity has prepared an expense forecast in respect of this project which is as follows:

	$’000
Recruitment cost in Y1	50,000
Expected Salary Expense:
Y1	250,000
Y2	275,000
Y3	300,000

Required:
How the receipt of government grant will be accounted for in the financial statements of AB Ltd?

Solution:

The grant is available for developments rather than for the construction or acquisition of an asset therefore, it is grant related to income.

This standard requires that government grant should be initially recorded as deferred income and it should be recognized in statement of profit or loss using appropriate method over the periods in which the entity recognizes the related costs, for which the grant is intended tocompensate. Therefore, it will be accounted for as follows:

As this is grant related to income, therefore, it will be amortized following the pattern of expenses as follows:

1. The Receipt of Govt. Grant

Cash a/c   $500,000
           Deferred Income a/c   $500,000

 

2. Amortization of Govt. Grant at the end of Y1

[$500,000 × ($50,000 + $250,000) / ($50,000 + 250,000 + 275,000 + 300,000)]

Defer Income a/c   $171,429
   Profit or Loss a/c   $171,429

 

3. Amortization of Govt. Grant at the end of Y2

$500,000 × $275,000 / ($50,000 + 250,000 + 275,000 + 300,000)

Defer Income a/c   $157,142
   Profit or Loss a/c   $157,142

 

4. Amortization of Govt. Grant at the end of Y3

$500,000 ×$300,000 / ($50,000 + 250,000 + 275,000 + 300,000)

Defer Income a/c   $171,429
  Profit or Loss a/c   $171,429