Finance & Accounting

Accounting Treatment of Government Grants as per AS 12

A venture’s receipt of government grants is crucial for the preparation of financial statements for two reasons. First, an appropriate accounting strategy is required if a government grant has been received. Second, it’s a good idea to say how much the business has benefited from a grant like this over the reporting period. This makes it easier to compare an organization’s financial statements online to those of other businesses and to those from previous periods. The present article shall discuss the Accounting Treatment for Government Grants as per AS 12.

Meaning of Grants

Grants can be defined as assistance in cash or kind by the Government to an eligible grantee without expecting the firm to pay back. Government Grant does not include any technical aid which provides services instead of money or any other aids in the form of revenue sharing, loans, loan guarantees, interest subsidies, insurance, or direct appropriations. These grants can have different terms, too, like – subsidies, cash incentives, duty drawbacks, etc. A thorough knowledge of the accounting treatment for Government Grant as per AS 12 is integral for individual/ entities.

Approaches to Accounting Treatment of Government Grants  

The approaches to Accounting Treatment of Grants are discussed below- 

Capital Approach versus Income Approach   

 The accounting treatment of government grants can be treated in one of two general ways: the “income approach,” in which a grant is treated as income over one or more periods, and the “capital approach,” in which a grant is treated as part of the funds of shareholders. 

• Capital Approach 

Under this, the grant is treated as part of shareholders’ endowments. Many government grants are such that they are given with reference to the total funding in an agreement or by way of contribution towards its capital outlay, and no repayment is ordinarily expected in the case of such grants. And therefore, they are expected to be credited directly to shareholders’ funds. Government grants cannot be recognized in the profit or loss statement, as they are not earned but represent an incentive provided by the Government without related costs. 

• Income Approach  

Grants from the Government are, in most cases, reasoned and justified. The ventures earn them through due compliance and by completing intended obligations. As a result, these grants can be treated as income and matched with the costs they are intended to cover. Since income tax and other taxes are deducted from income, it is safe to say that government grants can be included in the profit and loss statement as an extended component of fiscal policies. The “income approach” requires that government grants be identified in the profit and loss statement in a methodical and rational manner over the necessary time periods to match the costs associated with them.

• Advantages of “capital approach” for Accounting Treatment:  

The advantages of capital approach for accounting treatment are enlisted below –

1. A lot of government grants are in the form of promoters’ contributions, which means that they are given in proportion to the total amount invested in a business or as a contribution to the total amount spent on capital, and there is typically no expectation of repayment for these grants. As a result, this ought to be credited directly to the funds of shareholders^[1]. 
2. Government grants should not be included in the profit and loss statement because they are not earned but rather an incentive provided by the Government without associated costs. 

• Advantages of “income approach” for accounting treatment:  

The advantages of income approach for accounting treatment are –

1. Grants from the Government are rarely free. They are earned by the business through compliance with their conditions and fulfilment of anticipated obligations. As a result, they should be added to income and compared to the expenses that come with them, which the grant is supposed to cover. 
2. Since income tax and other taxes are added to income, it makes sense to include government grants in the profit and loss statement because they are an extension of fiscal policies. 
3. When grants are credited to shareholders’ funds, there is no correlation between how the grant is treated in accounting and how the grant’s related expenditure is treated in accounting. 
4. It is generally accepted that the specific grant’s nature should be used as the basis for accounting for government grants. It is appropriate to treat grants as a component of shareholders’ funds if they share characteristics with promoter contributions. In the case of other grants, the income approach might be more appropriate. 
5. It is essential to the “income approach” that government grants be properly and methodically accounted for in the profit and loss statement over the appropriate time frames in order to match the costs associated with them. According to Accounting Standard (AS), Disclosure of Accounting Policies, government grants should not be recognized as income on a receipts basis because this is inconsistent with the accrual accounting assumption. 
6. Since it is typically possible to determine the time periods over which an organization recognizes costs or charges related to such grant, the ones that recognize specific expenses are included in an organization’s income in the same period as the relevant expenses. 

Recognition of Grants from the Government  

• Grants from the Government that the Company is eligible for are taken into consideration for inclusion in the accounts: 
• When there is a reasonable assumption that the business will adhere to the conditions;  
• When the company has earned these benefits, and it is reasonably certain that the final payment will be made. 

The mere fact that a grant has been received does not necessarily imply that the grant’s conditions have been met or will be met.  

1. Even though the actual amount of these earned benefits may be settled and received after the end of the relevant accounting period, an appropriate, prudently estimated amount is credited to income for the year. 
2. A government grant-related contingency treated in accordance with Accounting Standard (AS) 4, Events Occurring after the Balance Sheet Date, arises after the grant has been recognized. In some cases, a grant from the Government is given to a business to provide  it immediate financial support, not as an incentive to make a specific purchase. These grants might only be available to a single business, or they might not be available to all businesses.  
3. According to Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items, and Changes in Accounting Policies, these circumstances may necessitate applying the grant to income during the period in which the company is eligible to receive it—if appropriate, as an extraordinary item). 
4. An organization may be able to collect government grants as compensation for losses or expenses incurred during a previous accounting period. 
5. According to Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items, and Changes in Accounting Policies, such a grant is recognized as an extraordinary item in the income statement of the duration in which it becomes receivable. 

Non-Monetary Government Grants  

Non-monetary assets like land or other resources may be provided at concessional rates as part of government grants. In these situations, it is common practice to account for such assets at their purchase price. A nominal value is recorded for free non-monetary assets.

Presentation of Grants

It is important to be aware of the following aspects regarding the presentation of grants.

Presentation of Grants for Specific Fixed Assets  

Grants for Specific Fixed Assets are government grants whose primary condition is that a business qualifying for them must purchase, construct, or otherwise acquire such assets. Other terms may be attached that limit the kind of assets, where they can be found, or how long they can be owned or held. 

• There are two acceptable alternatives for presenting grants—or the appropriate portions of grants—pertaining to specific fixed assets in financial statements. 
• In one approach, the grant is shown as a deduction from the asset’s gross value when calculating its book value. As a result, a lower depreciation charge is applied to the grant over the useful life of a depreciable asset in the profit and loss statement. When the asset has a nominal value on the balance sheet, it represents the entire or nearly complete cost of the asset. 
• Under the alternative method, grants for depreciable assets are treated as deferred income that is rationally and methodically recognized in the profit and loss statement over the asset’s useful life. Depreciation on related assets is typically deducted over the time periods and in proportions that correspond to this allocation to income. This method credits grants for non-depreciable assets to the capital reserve because non-depreciable assets typically do not affect income. However, if a grant associated with a non-depreciable asset necessitates the fulfillment of particular obligations, the grant is added to income concurrently with the expense of fulfilling those obligations. In the meantime, the deferred income is appropriately accounted for in the profit and loss account. For instance, in the case of a company, it is shown with a suitable after “Reserves and Surplus” but before “Secured Loans.”  
• The acquisition of assets and the receipt of related grants can significantly alter an organization’s cash flow. Even if the grant is deducted from the associated asset for the purpose of balance sheet presentation, such movements are frequently disclosed as distinct items in the financial position statement in order to demonstrate the gross investment in assets. 

Presentation of Grants Related to Revenue 

Grants related to revenue may be presented as a financial standing in the profit and loss statement, either as a separate credit or as a general heading like “Other Income.” They can also be deducted when reporting the associated expense. Proponents of the first method argue that it is inappropriate to separate grants from expenses and that doing so makes it easier to compare them to other expenses that are not affected by grants. For the second approach, it is argued that the company might not have needed to spend the money if presentation 10 and the grant were not available.  

Presentation of Grants of the Nature of Promoters’ Contribution  

 When government grants are of the nature of promoters’ Contribution, i.e., they are given in reference to the total financing in an undertaking or as a contribution towards its total capital outlay (such as the central investment subsidy scheme), and there is typically no expectation of repayment, the grants are treated as a capital reserve, and they cannot be distributed as a dividend or considered deferred income. 

Refund of Government Grants  

The aspects related to Refund of government grants are discussed herein under

• Grants from the Government can sometimes be refunded if certain conditions still need to be met. According to Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items, and Changes in Accounting Policies, a government grant that becomes refundable is considered an extraordinary item. 
• The amount that can be refunded for a revenue-related government grant is first deducted from any unpaid deferred credit that is still attached to the grant. If the amount refundable is greater than any deferred credit, or if there is no deferred credit, the amount is immediately added to the profit and loss statement. 
• The refundable portion of a government grant for a specific fixed asset is recorded by either increasing the asset’s book value or decreasing the capital reserve, or delayed income balance by the refundable portion, as necessary.  
• When a grant that is similar to a promoter’s contribution becomes refundable to the government, either in part or in full, if certain conditions are not met, the amount that the government can recover is taken out of the capital reserve in the first alternative, which occurs when the asset’s book value rises.

Points to Remember 

The below mentioned points must be remembered in respect of accounting treatment of government grants

• Before there is a reasonable assurance that the company will adhere to the associated conditions and that the grants will be received, government grants should not be recognized. 
• When determining the assets’ book value, government grants for specific fixed assets ought to be deducted from their gross value on the balance sheet. When the grant associated with that fixed asset equals or is close to equal to the total cost of the asset, the asset must be visible in the balance sheet at a nominal value. Government grants for particular fixed assets as reflected in the balance sheet as a removal from the gross value of the resources when calculating their book value. Government grants for depreciable fixed assets, on the other hand, may be treated as deferred income that should be recognized in the profit and loss statement in the same proportions as depreciation on those assets over the asset’s useful life and over the periods of time that depreciation is incurred. Under this approach, grants for non-depreciable assets should be credited to the capital reserve. However, if a grant for a non-depreciable asset necessitates the fulfillment of particular obligations, the grant should be added to income during the same time frame as the expense of fulfilling those obligations. In the financial statements, the deferred income balance should be disclosed separately. 
• In order to match government grants with the costs they are meant to offset, they should be recognized in the profit and loss statement in a methodical manner over the necessary time periods. 
• These grants should be reported separately under “other income,” or they should be deducted from the related expense. 
• Government grants that are similar to promoter contributions ought to be credited to the capital reserve and regarded as a component of the funds available to shareholders. 
• The acquisition cost of non-monetary assets that receive concessional government grants should be taken into account. If a non-monetary asset is given away for free, its nominal value should be recorded. 
• Government grants that are receivable as reimbursement for expenses or losses suffered in a previous accounting period or for the purpose of providing immediate monetary support to the enterprise with no further related AS 12 costs should be recognized and revealed in the profit and loss statement of the period in which they are receivable in accordance with Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items, and Changes in Accounting Policies.
• Accounting Standard (AS) 4, contingencies and events occurring after the Balance Sheet Date, should be followed when dealing with a government grant-related contingency that arises after the grant has been recognized. 
• According to Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items, and Changes in Accounting Policies, refundable government grants ought to be accounted for as an extraordinary item. 
• The amount that can be refunded for a grant related to revenue should first be applied to any unpaid deferred credit for the grant. The refund amount should be added to the profit and loss statement if it is more significant than any deferred credit or if no deferred credit exists. A grant involving a specific fixed asset’s refundable amount should be recorded by either increasing the asset’s book value or decreasing the refundable amount divided by the capital reserve or deferred income balance.
• Depreciation on the asset’s revised book value should be provided prospectively over the asset’s remaining useful life in the first option, which involves increasing the asset’s book value. 
• The capital reserve should be depleted of government grants that are refundable promoter contributions. 

 Disclosure  

The following points must be disclosed during the accounting treatment of government grant

• The accounting method used  government grants  , including how the financial statements are presented; 
• The kind and amount of such grants that are shown in the financial statements. This includes grants of non-monetary assets that are given at a discount or for free. 

Conclusion 

The accounting treatment of Government Grants as per AS 12 makes it convenient and efficient for the companies to maintain their balance sheets. Such treatment can be treated in two methods – via capital approach and income approach, therefore the calculations depend on the type of grant received by the company, and the approach followed for accounting treatment. 

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