Section 19 – Government Grants

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Section 19-Government Grants

Section 24 deals with the recognition, measurement and disclosure requirements for government grants.

Scope

Extract from FRS 105 – Section 19.1 – 19.2

19.1 This section speciﬁes the accounting for all government grants.

19.2 Government grants exclude those forms of government assistance that cannot reasonably have a value placed upon them and transactions with government that cannot be distinguished from the normal trading transactions of the micro-entity.

OmniPro comment

Appendix I of FRS 105 defines a government grant as ‘assistance by government in the form of a transfer of resources to an entity in return for past or future compliance with specified conditions relating to the operating activities of the entity’.

It is clear from the above that government grants are only covered by Section 19. Old GAAP/FRSSE was broader in its application as it covered the treatment for government assistance that are available in determining taxable profits. Section 19 does not deal with how research and development tax credits should be treated. Under old GAAP entities had a policy choice to set the research and development tax credit against administrative expenses or the entity could post the credit to the tax line in the profit and loss account.

Given that research and development tax credits can be repaid in cash to the entity where there is no taxable profits to utilise the tax credit and given the detailed requirements to be met before a research and development tax credit can be claimed this may suggest that this would meet the definition of government assistance and therefore could be accounted for under Section 19 instead of Section 24-Income tax. If on the other hand some other forms of investment credit had very few requirements, was not taxable and could not be reclaimed in cash if no taxable profit existed then this would indicate that it would come within the scope of Section 24 and therefore would be posted as a credit to the tax line in the profit and loss. This will mean significant judgement will be required in determining the way in which these should be treated.

Recognition and measurement

Extract from FRS 105 – Section 19.3 – 19.4

19.3 Government grants, including non-monetary grants, shall not be recognised until there is reasonable assurance that:

(a) the micro-entity will comply with the conditions attaching to them; and

(b) the grants will be received.

19.4 A micro-entity shall measure grants at the fair value of the asset received or receivable.

OmniPro comment

See application of 19.3 below:

Example 1: Recognition as a receivable

Company A has been approved to receive a government grant of CU50,000 to contribute towards the cost of employing 20 staff on a new department opened by the company. Approval was obtained during year 1. A condition as part of the grant is that the entity must create a non-distributable reserve equal to the amount of the grant to be received and the employees must be kept on for a minimum of 3 years. At the end of year 1 the company has employed the 20 employees but at year end has not created the non-distributable reserve. The company has sufficient distributable reserves to allow for the recognition of the non-distributable reserve. The company will receive the grant when the claim is made by the company. During year 2, the non-distributable reserve was created and the formal claim was made to the government authority.

Given that the company has met the employee number requirement and all that had to be done was to create the non-distributable reserve and the company has the reserves to do this, it is reasonable for the company to assume that the conditions of the grant will be complied with and the grant will be received. In this case it may be appropriate to recognise the CU50,000 as a receivable at the end of year 1. Whether this income can be recognised in the profit and loss or deferred on the balance sheet will depend on whether cost has been incurred in excess of the grant. If it is incurred then it should be released to match the costs incurred.

Fair value

A government grant should be recognised at fair value of the asset received or receivable. It would normally be the amount of cash received but it may also include non-cash benefits e.g. land.

Fair value as defined in Appendix I of FRS 105 is ‘the amount for which an asset could be exchanged, between knowledgeable, willing parties in arm’s length transaction.

There are instances where governments will provide some non-cash items such as licences, if this is the case, then the licenses should be recognised at their fair value together with the associated liability for the repayment of the grant under certain conditions if applicable.

Measurement

Extract from FRS 105 – Section 19.6 – 19.10

19.6 A micro-entity shall classify government grants either as a grant relating to revenue or a grant relating to assets.

19.7 Government grants relating to revenue shall be recognised in income on a systematic basis over the periods in which the micro-entity recognises the related costs for which the grant is intended to compensate.

19.8 A government grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of giving immediate ﬁnancial support to the entity with no future related costs shall be recognised as income in proﬁt or loss in the period in which it becomes receivable.

19.9 Government grants relating to assets shall be recognised in income on a systematic basis over the expected useful life of the asset.

19.10 Where part of a government grant relating to an asset is deferred it shall be recognised as deferred income and not deducted from the carrying amount of the asset.

OmniPro comment

As per above, the accruals model recognises the grant so as to match it with the costs incurred. So for revenue type grants such as training grants, the grant could be recognised in income in any of the following ways:

Matched against direct training costs
Taken over a period of time against salary for the employees expected to benefit from the training
Taken systematically over a straight line basis
Taken when cash is received

As can be seen there will be judgement required as to which best meets the company requirements. It is vital that the company applies the policy chosen consistently and discloses this in the accounting policies.

Example 2: Accruals model – revenue grant

Company A has been approved to receive a government grant of CU50,000 to contribute towards the cost of employing 20 staff for a new department opened by the company. Approval was obtained during year 1. A condition as part of the grant is that the employees must be kept on for a minimum of 3 years and the entity must create a non-distributable reserve equal to the amount of the grant to be received. The cost of the employees for each of the three years remain the same.

Under the accruals model, it may be appropriate to recognise the CU16,667 (CU50,000/3 yrs) in income each year so as to match the costs.

If we assume that the wage cost would increase by 10% per annum, then the release of the grant would be lower in year 1 than in year 2 and year 3 as higher costs are incurred in those years. Here the grant received would be recognised in proportion to the years cost over the total cost over the three years if this type of policy is chosen.

Example 3: Accruals model – revenue grant

Company A obtained a grant for the cost of relocation. This grant is repayable if the company moves within 3 years.

Underthe accruals method, Company A would recognise the grant income in year one so as to match the costs charged for relocation.

If at the end of year one it was not reasonable to assume that the grant would be fully collectible or all conditions had been met then a receivable could not be recognised for the grant even though the costs were incurred. If in year 2, a grant was received, the full grant would be recognised in year 2. This would be included prospectively no prior year adjustment is required as it was a change in estimate. Based on facts and circumstances at the end of year 1 it was not reasonable the grant would be received.

Example 4: Accruals model – capital grant – depreciable asset

Company A received a grant of CU100,000 towards the cost of constructing a factory. A condition of the grant is that the Company continues to utilise the manufacturing plant for a period of 20 years. The useful life of the plant itself is 50 years. Under the conditions of the grant the amount repayable if the 20 year condition is not met is reduced for every year the company stays in the factory.

In this case, the amount to be recognised each year will be based on the 50 year life as this is the life that the asset is depreciated over. Hence there is a matching of the depreciation charge on the property with amortisation of the grant. The total grant to be released each year is CU2,000 (CU100,000/50yrs). The journals required are:

	CU	CU
Dr Bank	100,000
Cr Deferred Revenue/Grant Liability		100,000

Being journal to recognise receipt of the funds

	CU	CU
Dr Accumulated Amortisation on Grant Liability	2,000
Cr Grant Amortisation – Admin Expenses		2,000

Being journal to recognise the release of the grant each year for 50 years.

Note the CU2,000 release per year should be included in the same line item in the profit and loss account as where the deprecation was charged.

If the above was a grant on land, which is non-depreciable, it is likely that this should be released over the terms of the building constructed on it.

Example 5: Accruals model – capital grant

In this particular case, judgement will have to be made as to whether in substance this is a capital grant or a revenue grant. All facts would have to be reviewed. However, given the large grant and the fact that it is principally towards the cost of the plant, in this particular case it would be treated as a capital grant and accounted for accordingly.

Classification in the profit and loss

It would be usual for revenue grants to shown in the ‘Other operating income’ line in the profit and loss account. However it may be appropriate to net the grant against the costs to which they relate and instead disclose the grant credited in the notes to the financial statements. In the financial statements of an FRS 105 set of financial statements it would be shown in the line ‘other income’.

For capital grants, the amortisation of the grant would usually be posted within the same line item as the depreciation was posted on the asset to which it relates.

Repayments of grants

Extract from FRS105: Section 19.5

19.5 Where a grant becomes repayable it shall be recognised as a liability when the repayment meets the deﬁnition of a liability.

OmniPro comment

The repayment of a grant liability is accounted for as a change in estimate and as a result is adjusted prospectively. No prior year restatement is required. Where the debit in the profit and loss is classified depends on whether it is so large to be called exceptional in nature, if so it may be shown as an exceptional item. See example below illustrating how the repayment of a grant should be accounted for:

Example 6: Repayment of grant – capital grant – accruals model

Company A received a grant of CU100,000 towards the cost of constructing a factory. A condition of the grant is that the Company continues to utilise the manufacturing plant for a period of 20 years. If not then the full amount of the grant full is amount repayable. The useful life of the plant itself is 50 years. Under the conditions of the grant the amount repayable if the 20 year condition is not met.

At the end of year 10, the company made a decision to close the manufacturing plant. The NBV of the grant at the end of year 10 is CU80,000 (CU100,000/50yrs * 40yrs).

As at the end of year 10, the repayment of the grant meets the definition of a liability as Company A has a present contractual obligation to repay the grant as a result of a past event (that being the receipt of the grant) that can be reliably measured.

Under the accruals model the journals required for the recognition of the liability is:

	CU	CU
Dr Profit and Loss	20,000
Cr Deferred Revenue/Grant Liability (CU100,000 less carrying amount of grant liability at end of year 10 of CU80,000)		20,000

Being journal to recognise liability for the repayment of the grant

Example 7: Repayment of grant – revenue grant – accruals model

Company A received a grant of CU50,000 for relocating to a premises that is situated in a disadvantaged location. The condition of the grant dictates that the Company must remain in the premises for a minimum of 3 years and if not the grant is fully repayable.

At the end of year 2, the company moved out.

As at the end of year 2, the repayment of the grant meets the definition of a liability as Company A has a present contractual obligation to repay the grant as a result of a past event (that being the receipt of the grant) that can be reliably measured reliably.

Under the accruals model the journals required for the recognition of the liability is:

	CU	CU
Dr Profit and Loss	50,000
Cr Deferred Revenue/Grant Liability		50,000

Being journal to recognise liability for the repayment of the grant which was previously recognised in the P&L

Transition exemptions

FRS 105 provides no exemptions with regard to accounting for government grants so retrospective adjustments will be required.

Given that old GAAP/FRSSE only permitted the accruals model, there will be no transition adjustments for entities transitioning from old GAAP/FRSSE.

FRS 102 on the other hand gave two options, to either apply the performance model or the accruals mode. Therefore where an entity adopted a policy of applying the performance model, then a transition adjustment may be required.

Principal transition adjustments

1) Adoption of a policy of recognising grants on a accruals basis from the performance model basis as performance basis not permitted under FRS 105 (applicable to entities transitioning from FRS 102 only)

As stated above, where an entity is transitioning from FRS 102 to FRS 105 and applied the performance model approach under FRS 102 to account for government grants, the company will need to apply the accruals model under FRS 105 retrospectively as the performance model is not permitted under FRS 105.

Example 8: Adoption of the accruals model from the performance model – revenue grant (applicable for entities transitioning from FRS 102)

Company A’s date of transition is 1 January 2015. The company received a revenue grant on 30 December 2014 of CU10,000 for the cost of employing 10 employees. A condition of the grant states that the employees must be kept on up to 31 December 2016. Under FRS 102, Company A applied the performance model such that the grant liability at 1 January 2015, 31 December 2015 and 2016 was CU10,000, CU10,000 and CUnil respectively. Assume the grant was taxable when released in 2014 and the tax rate is 10%

Under FRS 105, the accruals model must be utilised. If this model was utilised the full CU10,000 would have been recognised in 2015 on the basis that the conditions of the grant were likely to be achieved and that the CU10,000 grant was set against the first years cost of the employees (assume no costs incurred from 30 December 2014 to 1 January 2015 hence could not be released in 2014 year).

A transition adjustment would be required as follows:

At 1 January 2015

No adjustment required

Year ended 31 December 2015

	CU	CU
Dr Deferred Revenue/Grant Liability	10,000
Cr Other Income in Profit and Loss		10,000

Being journal to derecognise the grant liability under FRS 105 as the conditions for the accruals model has been met

Dr Corporation Tax in P&L

1,000

Cr Corporation Tax on balance sheet

(CU10,000*10%)

1,000

Being journal to reflect corporation tax for tax to be paid over a 5 year period so as to show the tax charge as what it would have been had FRS 105 applied from inception

Year ended 31 December 2016 assuming the above journals are posted to reserves

	CU	CU
Dr Other Operating Income	10,000
Cr Deferred Revenue/Grant Liability		10,000
Dr Corporation Tax on balance sheet (CU1,000/5 yrs) Cr Corporation Tax in P&L	200	200

Being journal to reverse the release of the grant liability recognised under FRS 102 under performance model as this was already released to P&L in transition adjustment above under FRS 105

The tax journal here reflect the additional deduction for 1/5th of the sale not previously taxed up to 31/12/15 under FRS 102 which has therefore fallen out on transition to FRS 105. Note this assumes that the tax journal posted will include the transition tax adjustment for the CU200 when it is finally recognised. If there was no corporation tax in 2016, then the CU200 would still be released as a debit to the P&L as it would be no longer payable to the tax authorities. As no deferred tax can be recognised under FRS 105 it cannot be held as deferred tax on the balance sheet as a timing difference. The remaining CU800 (CU1,000-CU200) will still be included as a liability at the year end in the corporation tax nominal and released over the remaining 4 yrs.

Note a similar adjustment would be required if there was a grant received prior to the date of transition which was released under FRS 102 under the performance model.

Example 9: Adoption of the performance model – capital grant (applicable for entities transitioning from FRS 102)

Company A received a grant of CU100,000 towards the cost of constructing a factory 10 years prior to transition. Transition date is 1 January 2015. A condition of the grant is that the Company continues to utilise the manufacturing plant for a period of 20 years. The useful life of the plant itself is 50 years.

Under FRS 102, the performance model was adopted. Therefore the carrying amount of the grant under the performance model at the date of transition was CU50,000 (i.e. CU100,000/20 yrs being length of performance condition * 10 yrs being number of years left to the expiration of the performance condition= CU50,000). This is being amortised at CU5,000 per annum.

As the performance model is not permitted under FRS 105, a transition adjustment is required to show the grant based on the accruals model as required by FRS 105.

Under the accruals model the NBV of the grant liability at the transition date should be CU80,000 (CU100,000/50yrs*40yrs). The amortisation to be recognised each year is CU2,000 (CU100,000/50 yrs).

Assume the factory did not qualify for capital allowance purposes and therefore there is no tax impact.

On transition to FRS 105 the following adjustments would be required:

	CU	CU
Dr Profit and Loss Reserves (CU80,000-CU50,000)	30,000*
Cr Deferred Revenue/Grant Liability		30,000

Being journal to reflect correct opening balance utilising the accruals model

Journal required for year ended 31 December 2015 assuming journals above are carried forward

Dr Profit and Loss – operating expenses

(CU5,000-CU2,000)

3,000

Cr Deferred Revenue/Grant Liability

3,000*

Journal required for year ended 31 December 2016 assuming journals above are carried forward through reserves.

The same journals will be required as 31 December 2015 above.

If in the above example there was capital allowances claim on the asset, then under FRS 102, deferred tax would have been recognised on this. If this was the case the deferred tax on this would have to be derecognised as Section 24 does not permit deferred tax to be recognised on the balance sheet.

2) Government grants recognised when it is reasonable all conditions for the grant will be complied with compared to old GAAP where all the conditions had to be complied with (Applicable for entities transitioning from FRSSE/old GAAP only – not applicable for entities transitioning from FRS 102)

Example 10: Reasonable that the conditions for the grant will be complied with (Applicable for entities transitioning from FRSSE/old GAAP only – not applicable for entities transitioning from FRS 102)

Company A’s date of transition is 1 January 2015. The company did not recognise a revenue grant on 31 December 2014 as all the conditions had not been complied with and therefore it could not be recognised under old GAAP/FRSSE however it was reasonable that all the conditions would be complied with. The grant was received during the 31 December 2014 year and was recognised at that date. Under FRS 105 this would have been allowed to be recognised as an asset on 1 January 2015. The grant was a revenue grant of CU10,000 for the cost of carrying out research. There were no conditions to be complied with on receipt of the grant as the work was performed. Under FRS 105, Company A should have recognised the full CU10,000 on the basis that the conditions of the grant were likely to be achieved and that the CU10,000 grant was set against the cost of the work. Assume the grant was taxable when released in 2015 and the tax rate is 10%

A transition adjustment would be required as follows:

At 1 January 2015

	CU	CU
Dr Receivable for Government Grant	10,000
Cr Profit and Loss Reserves		10,000

Being journal to recognise the receivable for the grant and the associated income

Dr Profit and Loss Reserves

(CU10,000*10%)

1,000

Cr Corporation Tax Liability

1,000

Being journal to reflect Corporation tax for tax to be paid on this grant in the future which would have been payable had FRS 105 applied from incecption.

31 December 2015 journals assuming the above journals were posted to reserves etc

	CU	CU
Dr Other Income	10,000
Cr Receivable for Government Grant		10,000

Being journal to derecognise the receivable for the grant and set it against the grant recognised in the P&L under old GAAP/FRSSE as it has been recognised on transition under FRS 105 in the above journal

	CU	CU
Dr Corporation Tax Liability	1,000
Cr Corporation Tax in P&L		1,000

Being journal to reverse Corporation tax on the grant receipt as it was taxed in 2014 under FRS 105.

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