Grant accounting: What you need to know
Many companies receive grants for all sorts of different things, for example when a company wants to expand and set up in a deprived area, the company may receive a grant from the government to entice it to create employment opportunities, explains Steve Collings.
This article will consider the accounting for government grants in light of some ambiguities that have cropped up for some practitioners.
Government grants – overall principles
Government grants are covered by SSAP 4 Accounting for Government Grants. This is a fairly old standard, issued in April 1974 and revised in July 1990 following the issue of ED 43 in 1988 whose proposals it broadly adopted. SSAP 4 recognises that the term “government” is widely defined and as a consequence does not just include the national government as we know it, but its scope extends to government agencies and non-departmental public bodies. In addition, its scope also covers the EC and other EC bodies, together with other international bodies and agencies.
The FRSSE (effective April 2008) also deals with government grants within the Fixed assets and goodwill section at section 6.
There are generally two forms of grant which need accounting consideration:
- Revenue based grants
- Capital based grants
As accountants, we are all familiar with the principles of the matching concept. SSAP 4 states that government grants need to be recognised in the profit and loss account so as to match them with the expenditure towards which they are intended to contribute. For revenue based grants, these will be written off to the P&L account as and when the relevant expenditure has been incurred; for capital based grants the grant will be recognised in the profit and loss account over the life of the asset to which it relates (i.e. matched with the relevant depreciation charges).
An important point to note is that when a client receives a government grant, it cannot be recognised in the profit and loss account until the conditions for the grant’s receipt have been complied with, and there is reasonable assurance that the grant will be received. If a client does not comply with the conditions of the grant’s terms, then the grant-making body will more than likely have the right to recover all, or part, of the grant. To accord with the prudence concept, clients and their accountants need to understand that just because there is a possibility that a grant may have to be repaid at some point in the future, this “possibility” cannot mean indefinite deferral from the profit and loss account. Clients and accountants need to consider if there is a likelihood that any breach of the grant’s terms will occur (or already has occurred) and if this is the case, or is likely to be the case, then provision should be made for the liability.
SSAP 4 recognises that the tax treatment of different types of grant can be polarised. At one end of the spectrum, some grants may be totally free of any tax consequences, whereas at the other end of the spectrum, some grants are taxed as income on receipt.
Many accountants may well consider that if a grant is taxable on receipt, the entire grant should be credited to the profit and loss account on receipt (i.e. accounting treatment to follow the tax treatment). SSAP 4 does not take this view; instead SSAP 4 recognises that the tax treatment of a grant cannot determine the accounting treatment of the grant. SSAP 4 concludes that if accountants simply follow the tax treatment and write off the whole grant to the profit and loss account, there are occasions when doing so will result in an “unacceptable departure from the principle that government grants should be matched with the expenditure to which they are intended to contribute” [SSAP 4 paragraph 7]. Care should be taken to ensure that any credits of grants to the profit and loss account are done in the correct accounting period. Where timing differences do occur between a tax charge and the recognition of the related credit of the grant in the profit and loss account this will trigger deferred tax issues and therefore the provisions in FRS 19 Deferred Tax will need consideration.
When a grant relates to a fixed asset, SSAP 4 recognises that there are two potential balance sheet treatments available to entities:
(a) to treat the amount of the grant as deferred income which is credited to the profit and loss account by instalments over the expected useful economic life of the related asset on a basis consistent with the depreciation policy
(b) to deduct the amount of the grant from the purchase price or production cost of the related asset, with a consequent reduction in the annual charge for depreciation
You must be extremely careful with the accounting treatment here - particularly for limited companies. Consider the following illustration:
An incorporated company purchases a fixed asset for £60,000 cash and receives a government grant towards the cost of this asset for £20,000. The useful economic life of the fixed asset is 10 years with zero residual value at the end of this life. The directors have said that for simplicity they are simply going to go for option (b) and credit the grant against the cost of the asset, so the bookkeeping entries will be:
On initial recognition
DR fixed asset additions £60,000
CR cash at bank £60,000
Being initial recognition of the new fixed asset
DR cash at bank £20,000
CR fixed asset additions £20,000
Being receipt of grant
(£60,000 minus £20,000) / 10 years £4,000 per annum
Under this option, the grant is recognised in the profit and loss account by way of reduced depreciation charges. This treatment is also recognised in IFRS (specifically IAS 20 Accounting for Government Grants and Disclosure of Government Assistance).
SSAP 4 recognises that this treatment (along with option (a)) are capable of giving a true and fair view. The problem with this treatment (option (b)) is that offsetting the grant against the cost of the asset is prohibited under the Companies Act because the statutory definitions of “purchase price” and “production costs” do not make any provision for any deduction from that amount in respect of a grant. As a result, incorporated entities must recognise any unamortised grant(s) as a liability within the balance sheet as ‘deferred income’.
Therefore, in the Figure 1 scenario, the entries in the books must be in accordance with option (a):
On initial recognition
DR fixed asset additions
CR cash at bank
DR cash at bank
CR deferred income
DR depreciation charge P&L
CR accumulated depreciation
Grant release over the life of the asset (10 years)
DR deferred income
CR grant income P&L
You will note that we still end up at the same place as option (b) at paragraph 15 to SSAP 4, but instead of netting off the grant against the cost of the asset and recognising the grant in the profit and loss account by way of a reduced depreciation charge, we are essentially showing everything gross.
Revenue based grants
SSAP 4 requires any revenue based grants to be recognised in the profit and loss account in the same period as the expenditure to which the grant relates. The standard also recognises that in some cases a client may receive a grant for immediate financial support or assistance, or for the reimbursement of costs which have been previously incurred, without any conditions attached or a requirement to incur further costs. In addition, the standard also recognises that sometimes grants may be received by clients to finance general activities over a specified period, or to compensate for loss of income. When a client receives such grants on these bases, the grant should be recognised in the profit and loss account in the period they are paid or if the grant does not specify an accounting period, they should be recognised in the profit and loss account in the period in which they become receivable.
Paragraph 14 to SSAP 4 also requires that if a client is required to repay a government grant (either in whole, or in part), the full amount to be repaid (after taking account of any unamortised deferred income relative to the grant) will be charged to the profit and loss account as soon as it becomes repayable.
The following disclosures should be made within the financial statements relating to grants:
- The accounting policy adopted
- The period(s) over which the grants are credited to the profit and loss account
- Where the results for the period have been affected materially by amounts credited in respect of government grants, and/or where the results of future periods are expected to be affected materially by the recognition in the P&L of grants already received, disclosure should be made of the effects on the results, or the financial position of the client
- Where the client has received government assistance (other than grants) that has had a material effect on the results for the period, the nature and, where measurable, the effects of the assistance should be disclosed. Paragraph 19 cites examples of consultancy and advisory services, subsidised loans and credit guarantees
Steve Collings is audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘The AccountingWEB Guide to IFRS’ and ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.