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IAS 20: Accounting for Government grants and Disclosure of Government Assistance Objective of IAS 20: The objective of IAS 20 is to prescribe the accounting for, and disclosure of, government grants and other forms of government assistance.

Scope: IAS 20 applies to all government grants and other forms of government assistance. However, it does not cover government assistance that is provided in the form of benefits in determining taxable income. It does not cover government grants covered by IAS 41 Agriculture, either. The benefit of a government loan at a below-market rate of interest is treated as a government grant. These grants can be of any time some of the examples are as follows: • Grants • Forgivable loans • Capital grants • Revenue grants General principles: IAS 20 follows two general principles when determining the treatment of grants: Prudence: Grants should not be recognised until the conditions for receipt have been complied with and there is reasonable assurance the grant will be received. Accruals: Grants should be matched with the expenditure towards which they were intended to contribute.

Definitions: IAS 20 Accounting for Government Grants and Disclosure of Government Assistance defines the following terms: Government refers to government, government agencies and similar bodies whether local, national or international. Government grants are assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. They exclude assistance that cannot be valued and normal trade with governments. Government assistance is action by government designed to provide an economic benefit specific to an entity or range of entities qualifying under certain criteria' e.g. the grant of a local operating licence. It does not include indirect help such as infrastructure development. Grants related to assets are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term assets. Grants related to income are government grants other than those related to assets – known as revenue grants.

Recognition: The government may offer financial support to a company to assist with: • Subsidizing general expenditure; for example, contributing to employee costs, to • Encourage a company to locate its operations in an area of high unemployment • The acquisition or construction of an asset. Assistance to an entity from the government, in the form of cash grants or in any other form of assistance, must be accounted for in the entity’s financial statements. A government grant is recognised only when there is reasonable assurance that (a) The entity will comply with any conditions attached to the grant and (b) The grant will be received. The grant is recognised as income over the period necessary to match them with the related costs, for which they are intended to compensate, on a systematic basis. Non-monetary grants, such as land or other resources, are usually accounted for at fair value, although recording both the asset and the grant at a nominal amount is also permitted. Even if there are no conditions attached to the assistance specifically relating to the operating activities of the entity (other than the requirement to operate in certain regions or industry sectors), such grants should not be credited to equity. A grant receivable as compensation for costs already incurred or for immediate financial support, with no future related costs, should be recognised as income in the period in which it is receivable. The general principle is to account for grants and assistance by matching the grant income to the related cost. There are two types of grants: (a) Revenue/Income grant: For example, a government may pay a cash grant towards the cost of retraining employees of an entity, so that they acquire new skills (b) Capital grant: For example, an entity may be given a government grant towards the cost of building a new asset, such as a factory in an area of high unemployment (a) Revenue grant: Journal entry: Dr. Receivables (Government Grant) Cr. Income Revenue grant can be credited in income statement and reported separately as other income or it can be deducted from related expenses. If amount received is lower or higher than it should be presented as receivables and payables. Example: A company receives a grant from a government department to assist it with a programme of staff retraining. The programme is expected to last for 18 months. In this situation, the grant should be expensed to profit or loss over the same 18 month period as the associated retraining costs are incurred.

Example: A grant is paid to a company to allow it to settle its outstanding accounts payable and prevent it from going into liquidation. As the expense of the purchase has already been incurred, the grant should be released to profit or loss in full in the period the grant is received. Illustration 2: Salary Expense: $300000 Grant is 30% of labour cost Solution: Salary expense Dr: 300000 Bank Cr: 300000 Grant: Deferred Income Dr: 90000 P&L Cr: 90000 (i) Directly deducted from expenses: If the grant is paid when evidence is produced that certain expenditure has been incurred, the grant should be matched with that expenditure. Journal entry: Dr. Bank/Cash/Receivables for grant Cr. Expenses (ii) Recognised revenue separately: If the grant is paid on a different basis, e.g. achievement of a nonfinancial objective, such as the creation of a specified number of new jobs, the grant should be matched with the identifiable costs of achieving that objective. Journal entry Dr. Bank/Cash/Receivables for grant Cr. Income Revenue grant presentation Presentation as credit in the statement of profit or loss: Supporters of this method 'claim that it is inappropriate to net income and expense items, and that separation of the grant from the expense facilitates comparison with other expenses not affected by a grant'. Deduction from related expense: It is argued that with this method, 'the expenses might well not have been incurred by the entity if the grant had not been available, and presentation of the expense without offsetting the grant may therefore be misleading'.

Illustration 7: An entity is given $300,000 on 1 January 20X1 to keep staff employed within a deprived area. The entity must not make redundancies for the next three years, or the grant will need to be repaid.

By 31 December, 20X1, no redundancies have taken place and none are planned. The grant should be released over three years, meaning that $100,000 is taken to the statement of profit or loss each year. This can be shown as a separate line in the statement of profit or loss or deducted from administrative expenses (or wherever the staff costs are charged). As $100,000 has been released to the statement of profit or loss, the remaining $200,000 will be held in deferred income, to be recognised over the next two years. Of this, $100,000 will be released within the next year, so will be held within current liabilities. The remaining $100,000 will be held as a non-current liability. Repayments: When organisation breach the condition which are related to government grants organisations often has to back. In this condition it should be treated as a change in estimate under IAS 8 and accounted for prospectively. If a grant becomes repayable, it should be treated as a change in estimate. The repayment should be applied first against any related unamortised deferred credit, and any excess should be dealt with as an expense. Illustration 3: Cost of the asset: $10000 Life 2 years Grant received 40% of cost = $4000 Solution: Bank Dr: 4000 Deferred Income Cr: 4000 Amortisation of grant= 4000/2 = 2000 x 6/12 = 1000 Condition: If asset is sold within two years then full payment need to be paid and in this scenario. Repayment will be recognised as follows Deferred Income Dr: 1000 P&L Dr: 3000 Bank Cr: 4000 (b) Capital grant: These are non-monetary grants such as land or building in remote area or money towards purchase of the asset and usually account for at the fair value. Grants for purchases of noncurrent assets should be recognised over the expected useful lives of the related assets. IAS 20 provides two acceptable accounting policies for this: At initial recognition of asset, it will be recorded as: At recognition of grant

Bank Dr: xxx Deferred Income Cr: xxx To recognise revenue for the year Deferred Income Dr: xxx P&L Cr: Xxx Revenue for the year will be recognised on straight line basis for each year. Illustration 1: Machine cost $100000 Life 4 years Grant received 20% of cost Solution: Asset recognition Machine Dr: 100000 Cash Cr: 100000 Grant: Bank Dr: 20000 Deferred Income Cr: 20000 Amortisation of grant/Revenue for the year 20000/4 years = 5000 per year P&L extract Dep expense: $25000 Amortisation of grant: $5000 (i) Deduct the grant from the cost of the asset and depreciate the net cost: In this case grant received should be deducted from Non - Current assets and depreciation should be charged on reduced cost. Reversal: Increase the cost of the asset with the repayment. This will also increase the amount of depreciation that should have been charged in the past. This should be recognised and charged immediately. Journal entry: Dr. Property, Plant and Equipment Cr. Cash Dr. Depreciation Cr. Property, Plant and Equipment

(ii) Treat the grant as deferred income and release to profit or loss over the life of the asset: Treat the grant as deferred income and transfer the portion to revenue income each year till the life of Non – Current Assets i.e. matching grant to expenditure. Reversal: Firstly, debit the repayment to any liability for deferred income. Any excess repayment must be charged against profits immediately. Or (a) Income-based grants: Firstly, debit the repayment to any liability for deferred income. Any excess repayment must be charged to profits immediately. (b) Capital-based grants deducted from cost: Increase the cost of the asset with the repayment. This will also increase the amount of depreciation that should have been charged in the past. This should be recognised and charged immediately. (c) Capital-based grants treated as deferred income: Firstly, debit the repayment to any liability for deferred income. Any excess repayment must be charged against profits immediately. Example: A company receives a grant of $300,000 towards the acquisition of a machine costing $500,000. The machine has a useful life of five years. Once again, the grant should be matched against the associated cost. There are two acceptable accounting approaches in this situation. Option 1: Deduct the grant from the asset cost so that the asset is recorded at $200,000, being the net cost to the company. Option 2: Record the asset at its full cost of $500,000 and take the grant to the statement of financial position as deferred income. The deferred income is then released to profit and loss over the useful life of the asset. The effect is to reduce the depreciation charge. Both approaches have the same effect on profit or loss and net assets. • In the example above, if Option 1 is chosen and the asset has no residual value, the cost of the asset is recorded at $200,000 and there will be an annual depreciation charge of $40,000 for five years. • If Option 2 is chosen, the cost of the asset is recorded at $500,000 and there will be an annual depreciation charge of $100,000 for five years. In addition, deferred income of $300,000 is recorded, and this will be released (as realised income) to profit and loss at the rate of $60,000 each year for five years. The net effect is to charge a net amount of $40,000 ($100,000 - $60,000) to profit or loss each year. Note: problems with both methods of accounting It can be argued that both of these approaches are theoretically unsound, because they are inconsistent with the principles in the IASB Framework. • Deducting the grant from the cost of the asset is not in accordance with the principle of recognising assets at the ‘cost’ to the entity.

• Treating the grant as deferred income uses an element in the financial statements (‘deferred income’) that is not recognised in the IASB Framework. The IASB has expressed its dissatisfaction with the treatment of government grants as a liability (deferred income) when no liability exists, but a revision to IAS 20 is not planned in the near future. Government assistance: As implied in the definition set out above, government assistance helps businesses through loan guarantees, loans at a low rate of interest, advice, procurement policies and similar methods. It is not possible to place reliable values on these forms of assistance, so they are not recognised.

Disclosure of government grants:   

Accounting policy adopted for grants, including method of balance sheet presentation Nature and extent of grants recognised in the financial statements Unfulfilled conditions and contingencies attaching to recognised grants

Illustration – Government grants: On 1 June 20X1, Clock received written confirmation from a local government agency that it would receive a $1m grant towards the purchase price of a new office building. The grant becomes receivable on the date that Clock transfers the $10m purchase price to the vendor. On 1 October 20X1 Clock paid $10m in cash for its new office building, which is estimated to have a useful life of 50 years. By 1 December 20X1, the building was ready for use. Clock received the government grant on 1 January 20X2. Required: Discuss the possible accounting treatments of the above in the financial statements of Clock for the year ended 31 December 20X1. Solution: Government grants should be recognised when there is reasonable assurance that: • The entity will comply with any conditions attached, and • It is reasonably certain that the grant will be received. The only condition attached to the grant is the purchase of the new building. Therefore, the grant should be accounted for on 1 October 20X1. A receivable will be recognised for the $1m due from the local government. Clock could then choose to either: (a) Reduce the cost of the building by $1m: In this case, the building will have a cost of $9m ($10m – $1m). This will be depreciated over its useful life of 50 years. The depreciation charge in profit or loss for the year ended 31 December 20X1 will be $15,000 (($9m/50 years) × 1/12) and the building will have a carrying value of $8,985,000 ($9m – $15,000) as at 31 December 20X1. (b) Recognise deferred income of $1m.

In this case, the building is recognised at its cost of $10m. This will be depreciated over its useful life of 50 years. The depreciation charge in profit or loss for the year ended 31 December 20X1 will be $16,667 (($10m/50 years) × 1/12) and the building will have a carrying value of $9,983,333 ($10m – $16,667) as at 31 December 20X1. The deferred income will be amortised to profit or loss over the building’s useful economic life. Therefore, income of $1,667 (($1m/50) × 1/12) will be recorded in profit or loss for the year ended 31 December 20X1. The carrying value of the deferred income balance within liabilities on the statement of financial position will be $998,333 ($1m – $1,667) as at 31 December 20X1....