Accounting Standard 12: Government Grants Overview

PRESENTATION ON ACCOUNTING STANDARD 12 ORGANISED BY ON AUG 05, 2008 AT ONGC Presented by: CA Verendra Kalra

ACCOUNTING STANDARD 12 OVERVIEW INTRODUCTION EXCLUSIONS ILLUSTRATIONS SIGNIFICANCE DISCLOSURES AS 12 REFUND DEFINITIONS RECOGNITION ACCOUNTING 2 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 INTRODUCTION AS-12 came into effect in respect of accounting periods commencing on or after 1.4.1992, but has become mandatory for accounting period commencing on or after 1.4.1994. The statement deals with the accounting for government grants. 3 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 EXCLUSIONS FROM THE AS The Accounting Standard does not deal with: Government assistance other than in the form of government grants. i.e. tax holiday in backward area, tax exemption in notified area Government participation in the ownership of the enterprise. i.e. investment by the Government as equity 4 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 MEANING OF GOVERNMENT GRANTS Government Grants are assistance by the Govt. in the form of cash or kind to an enterprise in return for past or future compliance with certain conditions Government assistance, which cannot be valued reasonably, is excluded from Government Grants Those transactions with Government, which cannot be distinguished from the normal trading transactions of the enterprise, are not considered as Government Grants.These are sometimes called as subsidies, cash incentives, duty drawbacks etc. 5 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 MEANING OF GOVERNMENT GRANTS Government refers to government, government agencies and similar bodies whether local, national or international. 6 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 SIGNIFICANCE OF THE AS The receipt of government grants by an enterprise is significant for preparation of the financial statements because: If a government grant has been received, an appropriate method of accounting is necessary It is desirable to give an indication of the extent to which the enterprise has benefited from such grant during the reporting period 7 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 TYPES OF GOVERNMENT GRANTS Monetary Grants Non Monetary Grants Eg:Grants in the form of assets such as land, Eg: Grants related to depreciable fixed assets plant & machinery etc. 8 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 APPROACHES TOWARDS TREATMENT OF GOVERNMENT GRANTS Capital Approach Income Approach The grant is treated as a part of the shareholder s The grant is taken as income for one or more funds periods 9 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ARGUMENTS IN SUPPORT OF CAPITAL APPROACH There are many arguments as to which approach is the correct accounting treatment of the government grants. Following are the arguments in support of capital approach - Many government grants are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay and no repayment is ordinarily expected. Therefore, these should be credited directly to shareholders funds. 10 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ARGUMENTS IN SUPPORT OF CAPITAL APPROACH It is inappropriate to recognize government grants in the profit and loss statement, since they are not earned but represent an incentive provided by government without related costs. Government grants are rarely gratuitous. The enterprise earns them through compliance with their conditions and meeting the envisaged obligations. Therefore, they should be taken to income and matched with the associated costs which the grant is expected to compensate. 11 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ARGUMENTS IN SUPPORT OF INCOME APPROACH As income tax and other taxes are charges against income, government grants should also be dealt in the profit and loss statement, as they are an extension of fiscal policies. In case grants are credited to shareholder s funds, no correlation is done between the accounting treatment of the grant and the accounting treatment of the expenditure to which the grant relates. 12 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ACCOUNTING TREATMENT OF GOVERNMENT GRANTS Accounting for government grant should be based on the nature of the relevant grant. Grants which have the characteristics similar to those of promoter s contribution should be treated as part of shareholder s funds. Income approach may be more appropriate in the case of other grants. 13 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ACCOUNTING TREATMENT OF GOVERNMENT GRANTS In case of Income approach, Government grants should be recognized in the profit and loss statement on a systematic and rational basis over the periods necessary to match them with the related costs. Income recognition of government grants on a receipt basis is not in accordance with the accrual accounting assumption. 14 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 RECOGNITION OF GOVERNMENT GRANTS Government grants are considered for inclusion in accounts: Where there is reasonable assurance that the enterprise will comply with the conditions attached to them, and o Where such benefits have been earned by the enterprise and it is reasonably certain that the ultimate collection will be made o 15 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 RECOGNITION OF GOVERNMENT GRANTS Mere receipt of a grant is not necessarily a conclusive evidence that conditions attaching to the grant have been or will be fulfilled An appropriate amount in respect of such earned benefits, estimated on a prudent basis, is credited to income for the year even though the actual amount of such benefits may be finally settled and received after the end of the relevant accounting period. This means that grants are recorded on accrual basis. 16 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 RECOGNITION OF GOVERNMENT GRANTS A contingency arising after the grant has been recognized, is treated in accordance with Accounting Standard (AS) 4, Contingencies and Events Occurring After the Balance Sheet Date. In certain circumstances, a government grant is awarded for the purpose of giving immediate financial support to an enterprise rather than as an incentive to undertake specific expenditure. In this case, the grant can be taken as income in the period in which the enterprise qualifies to receive it, as an extraordinary item 17 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 RECOGNITION OF GOVERNMENT GRANTS Government grants may become receivable by an enterprise as compensation for expenses or losses incurred in a previous accounting period. Such a grant is recognized in the income statement of the period in which it becomes receivable, as an extraordinary item If the government grants take the form of non-monetary assets, such as land, given at concessional rates, then such assets are accounted for at their acquisition cost. 18 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 RECOGNITION OF NON-MONETARY GOVERNMENT GRANTS Non-monetary assets given free of cost are recorded at a nominal value. 19 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Example 2 Suppose an asset with Rs.10 lakhs fair value is supplied by Government at - Concessional rate of Rs.3 lakhs, the accounting entry will be- Fixed Asset Dr. 3,00,000 To Bank 3,00,000 (If it is depreciable fixed asset depreciation will be charged on Rs.3 lakhs). 20 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Free of Cost, the accounting entry will be- Fixed Asset Dr. 1.00(nominal value) To Profit and loss account 1.00 (Asset will be shown at nominal value in the books till remains with the organization. When it is disposed it will be written off to profit and loss account). 21 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 GRANTS RELATED TO SPECIFIC FIXED ASSETS Sometimes, government grants related to specific fixed assets have conditions like an enterprise qualifying for them should purchase, construct or otherwise acquire such assets or they may restrict the type or location of the assets or the periods during which they are to be acquired or held. There are two methods for presentation of such grants related to specific fixed assets in financial statements. 22 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 METHOD 1 FOR SPECIFIC FIXED ASSETS GRANTS The grant is shown as a deduction from the gross value of the asset concerned in arriving at its book value. The grant is thus recognized in the profit and loss statement over the useful life of a depreciable asset by way of a reduced depreciation charge. Where the grant equals the whole, or virtually the whole, of the cost of the asset, the asset is shown in the balance sheet at a nominal value. 23 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 METHOD 2 FOR SPECIFIC FIXED ASSETS GRANTS The grants related to depreciable assets are treated as deferred income which is recognized in the profit and loss statement on a systematic and rational basis over the useful life of the asset, for example, in the proportions in which depreciation on related assets is charged. Grants related to non-depreciable assets are credited to capital reserve, as there is usually no charge to income in respect of such assets. However, if certain obligations are to be fulfilled, the grant is credited to income over the same period over which the cost of meeting such obligations is charged to income. The deferred income is to be disclosed in the balance sheet as Deferred Govt. Grants after Reserves but before Loans. 24 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 GRANTS RELATED TO SPECIFIC FIXED ASSETS The purchase of assets and the receipt of related grants can cause major movements in the cash flow of an enterprise. For this reason and in order to show the gross investment in assets, such movements are often disclosed as separate items in the statement of changes in financial position regardless of whether or not the grant is deducted from the related asset for the purpose of balance sheet presentation 25 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 GRANTS RELATED TO REVENUE Government grants related to revenue should be recognized on a systematic basis in the profit and loss statement over the periods necessary to match them with the related costs which they are intended to compensate. Such grants should either be shown separately under 'other income' or deducted in reporting the related expense. 26 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 GRANTS IN THE NATURE OF PROMOTER S CONTRIBUTION Where the government grants are of the nature of promoter s contribution, they are treated as capital reserve which can be neither be distributed as dividend nor considered as deferred income 27 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Example 1 Suppose a fixed asset is purchased for Rs. 20 lakhs, and government grant received towards it is Rs. 8 lakhs. The asset is depreciable with Rs. 2 lakhs residual value and 4 years life, the accounting entries will be- If it is a non-depreciable asset and no obligation are attached, then- Bank Account Dr. 8,00,000 To Fixed assets/Capital Reserve 8,00,000 28 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Example 1 If it is a non-depreciable asset and there is an obligation to incur expenses over 4 years, then- Bank Account Dr. 8,00,000 To Deferred Government Grant 8,00,000 (The deferred grant will be written off to profit and loss account in 4 years i.e. Rs2 lakhs each year). 29 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Example 1-choice1 If it is a depreciable asset, then there are two choices, Credit the grant to fixed assets- Bank Account Dr. 8,00,000 To Fixed Assets 8,00,000 (The book value is reduced to Rs.12 lakhs. The estimated scrap value is Rs.4 lakhs and life is 4 years, hence depreciation to be charged on the asset every year will be Rs.2 lakhs). 30 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION [Depreciation = (12 - 4)/4 = 2] Net approach distorts the value of the asset and shows a comparatively lower asset base and higher return, which may mislead investors. 31 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Example 1-choice 2 Credit the grant as deferred income- Bank Account Dr. 8,00,000 To Deferred government grant 8,00,000 (The book value of asset is Rs.20 lakhs, residual value is Rs.4 lakhs and life is 4 years, hence depreciation to be charged on Rs.4 lakhs per annum for 4 years). Deferred government grant Dr. 2,00,000 To Profit and Loss 2,00,000 32 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION (The grant has to be recognized in profit and loss account over the life of asset in proportion to depreciation. Depreciation is Rs4 lakhs per annum for 4 years, hence grant to be written off will be Rs.2 lakhs per annum for a year). 33 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 REFUND OF GOVERNMENT GRANTS When certain conditions are not fulfilled, government grants becomes refundable. A government grant that becomes refundable is treated as an extraordinary item. Refund of grants related to revenue o The amount refund should be adjusted against any unamortized deferred government grants , if any. o The remaining balance amount of refund should be charged to Profit and Loss Account. 34 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 REFUND OF GOVERNMENT GRANTS Refund of grants in nature of promoter s contribution o Where a grant which is in the nature of promoter s contribution becomes refundable on non-fulfillment of some specified conditions, recoverable by the government is reduced from the capital reserve. the relevant amount 35 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 REFUND OF GOVERNMENT GRANTS Refund of grant related to specific assets: o The refundable amount should be recorded by increasing the book value of the asset. Here the depreciation on the revised book value is provided prospectively over the residual useful life of the asset, or o The refundable amount should be recorded by reducing the capital reserve, or the refundable amount should be adjusted with unamortized deferred income, as may be appropriate. 36 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Example 3 A fixed asset purchased for Rs.20 lakhs, government grant is received Rs.8 lakhs (useful life is 4 years, residual value Rs.4 lakhs).Grant becomes refundable in the 3rd year to the extent of Rs.6 lakhs. The accounting treatment under different alternatives will be- Non-Depreciable fixed asset o Fixed Asset/ Capital Reserve Dr. 6,00,000 To Bank 6,00,000 37 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Example 3 Depreciable fixed asset o Fixed Asset Dr. 6,00,000 To Bank 6,00,000 (The balance of fixed asset a/c after 2 years depreciation was Rs.8 lakhs and now it will become Rs.14 lakhs. Assuming same residual value and remaining life of 2 years, Rs.5 lakhs depreciation will be charged in remaining 2 years). 38 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 ILLUSTRATION Deferred Government grant Dr.4,00,000 o Profit and loss Account Dr.2,00,000 To Bank 6,00,000 (Deferred grant a/c will become nil. The fixed asset will continue to be depreciated at Rs.4 lakhs p.a.). 39 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 DISCLOSURES The following disclosures are to be made in the financial statements: The accounting policy adopted for government grants, including the methods of presentation in the financial statements, and The nature and extent of government grants recognized in the financial statements, including grants of non-monetary assets given at a concessional rate or free of cost. 40 ACCOUNTING STANDARD 12

ACCOUNTING STANDARD 12 RELEVANCE As per point 3 of Schedule 27 of the previous year s audited financial statements the following disclosure was made: Government grants for acquisition of fixed assets are initially treated as Capital Reserve and are subsequently recognized as income in the P & L on a systematic basis over the useful life of the assets in the proportion in which depreciation on those assets is charged. As per Schedule 2 of Reserves & Surplus an amount of Rs. 25.97 million is being recognized as addition made to Government grants during the year. 41 ACCOUNTING STANDARD 12

Thank You 42 ACCOUNTING STANDARD 12