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.

Tax treatment

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.

Accounting treatment

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.

Continued...

» Register now

The full article is available to registered AccountingWEB members only. To read the rest of this article you’ll need to login or register.

Registration is FREE and allows you to view all content, ask questions, comment and much more.

Comments

Thanks for this    3 thanks

zas | | Permalink

How timely! Just preparing accounts for a client (ltd co) who received a capital grant. Very good article. Once again, thank you for posting it.

There's another way

smallbeancounter | | Permalink

Interesting article. None of those techniques suits me and I do it differently. One of my businesses is in tourism and the company has received 3 grants since starting in 1993, from the Rural Development Commission, from the County Council, and from the District Council. All grants were for capital expenditure and are non-repayable. Until recently I ran the bookkeeping system for the business and I'm not a qualified accountant so I always go for the simple common sense approach. After thinking about how the grants actually work and checking that capital grants are not included in trading income for corporation tax (the current rules are at http://www.hmrc.gov.uk/manuals/bimmanual/BIM40451.htm) I decided they have got nothing whatsoever to do with the profit and loss account and should never be shown there in any form whatsoever. The profit and loss account is supposed to show trading activities, but capital grants have nothing whatsoever to do with trading. To treat them as a trading receipt is to misunderstand their nature completely. Therefore I put them in the bottom half of the balance sheet. The receipt of the cash is recognised in the Assets & Liabilities section of the balance sheet because of its effect on the bank balance, and it is recognised in the Funding section by a separate item with a Note which records the history of all grant receipts and a comment that they are all non-repayable. Nobody has ever challenged this in the past and if they ever do my response will be, "See you in court!". I bet my explanation will be easier for a judge to understand than one of those ghastly jargon-stuffed FRS thingamajigs. 

Oooooh

Ayesha Bham | | Permalink

Timely for me also! One of our clients had just received a large grant so I've printed this off ready .
@smallbeancounter I think your treatment is very dubious. How can you put the credit side to the reserves part of the balance sheet ? If the grant relates to assets you credit it to the profit and loss account to match the depreciation. Do you put the depreciation to reserves as well or just not depreciate?

Reply to Ayesha Bham

smallbeancounter | | Permalink

 

 

Ayesha asked: ‘How can you put the credit side to the reserves part of the balance sheet ? If the grant relates to assets you credit it to the profit and loss account to match the depreciation. Do you put the depreciation to reserves as well or just not depreciate?’

I put the credit side to the reserves for two reasons.

First, and most importantly,  a grant is a gift. That's what a grant means in this context. I'm too lazy to dig out the OED and type out their definition, so these are off the internet:- To confer, give, or bestow. A gift [of legal rights or privileges] - http://legal-dictionary.thefreedictionary.com/grant; Bounty, contributiongift, or subsidy - http://www.businessdictionary.com/definition/grant.html.  The important consequence of the fact that a capital grant is a gift is that it should not form part of the trading income of the company. It actually takes effect as an introduction of capital, which happens to be gratuitous instead of being in return for the issue of shares or debentures etc. I am strengthened in this view by the tax treatment. If you study http://www.hmrc.gov.uk/manuals/bimmanual/BIM40451.htm  you will notice the very clear distinction between Revenue Grants, Capital Grants, and Undifferentiated Receipts. I am discussing (and my earlier comment related exclusively to) capital grants. HMRC say: ‘Grants, which meet capital expenditure, are normally not trading receipts.’ And they are not taken into account for corporation tax.  They reduce qualifying capital expenditure for capital allowance purposes but that doesn’t make them a trading (or revenue) item. The way I understand accounts is that the P&L shows trading activity over a period of time and the balance sheet shows a snapshot of assets and liabilities (and thus the net capital) at a moment in time. If I am right and a capital grant is a gift of capital it is an increase in the capital of the company and should be shown on the balance sheet. It is only if I am wrong, and a capital grant is part of trading activity, that it properly finds a home on the P&L. And if I am wrong, so are HMRC and so is the tax treatment of capital grants. The minute you put a capital grant on the P&L, as a lump sum or as a series of tranches to match depreciation charges over a period of time, you are in effect saying that it is a trading receipt – and what follows from that is that it ought to be taxed.

The second reason goes back to the thinking behind SSAP 4 which is the assumption 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, and SSAP4 says this should be done by matching with the relevant depreciation charges. Ayesha is saying the same thing. But that’s wrong-headed because it means you do have to show them in the P&L (because that’s where the depreciation appears) and for the reasons I have given the P&L is the wrong place to put them.

I anticipate that Ayesha will say that you must match the grant to the depreciation, otherwise you must put the depreciation to reserves, but I ask, why? The capital grant comes in as capital and goes to reserves (matched by the consequent impact on the cash position), and that’s all you have to do with the grant. The asset which is purchased using the grant money is depreciated, and the depreciation goes on the P&L in the usual way, but I don’t think that means the grant has to pop up on the P&L to match the depreciation, nor do I think that the depreciation has to pop up in the reserves to match the grant. And my reason is the one I keep repeating: a capital grant has no place in a P&L whatsoever and therefore finding a way to put it there is just an artifice. What you should be doing is fighting the urge to put it on the P&L, because it doesn’t belong there.

 

Very odd    1 thanks

Ayesha Bham | | Permalink

I don't think you are correct and I think you may completely misunderstand the accounting entries for grant income. Of course it goes onto the Profit and loss. What you are implying is that the accounting law itself is wrong. That just cannot be the case and as the article itself says the tax treatment does not dictate accountancy treatments.
I won't comment further on this because your "method" just is not right. Its quite scary if I am honest.

for simplebeancounter    1 thanks

geoffwolf | | Permalink

Your reply hits the nail on the head where you say that for Capital Allowances you deduct the grant from the cost of the asset.

As you cannot claim capital allowances on the grant it is in effect being taxed. For  tax computational purposes you adjust the profit but Ayeesha is absolutely correct that the receipt of the grant reaches reserves by way of the P & L Account in tranches equivalent to depreciation.

I'm enjoying this

smallbeancounter | | Permalink

 

I'm enjoying this.

@Ayesha - 'What you are implying is that the accounting law itself is wrong.' Which law are you referring to?

@geoffwolf - 'Ayeesha is absolutely correct that the receipt of the grant reaches reserves by way of the P & L Account in tranches equivalent to depreciation.' This is where you and SSAP4 both go wrong. Because the receipt of a capital grant is in effect the introduction of capital into the business it is analogous to the sale of shares and should go directly to reserves. Getting it into the reserves by way of the P&L is misleading.

Bottom line – I suspect we are never going to agree, because you both think that a capital grant is a kind of revenue and therefore must appear somewhere on the P&L, and I think it is capital and should never appear on the P&L. 

Eh?

WhichTyler | | Permalink

@simplebeancounter

If you follow your approach (and with no other transactions), you will end up with a 'capital' reserve (in perpetuity, akin to a share premium account) equal to the amount of the grant and a negative p&l reserve (due to the full depreciation going through the P&L). Is that how you show the reserves?

Except

mackthefork | | Permalink

Where the grant is for assets which do not attract capital allowances, the grant is still taxed on receipt.  It is frightening that people saying FRSs and SSAPs are wrong headed are out there and responsible for preparing financial statements and tax computations for real businesses, I'm sure there are a hundred horrors stories created every day as a result.  Almost makes you think they should ban unqualifieds altogether.

MtF

 

SSAP 4 clearly outlines the correct treatment

mackthefork | | Permalink

""Bottom line – I suspect we are never going to agree, because you both think that a capital grant is a kind of revenue and therefore must appear somewhere on the P&L, and I think it is capital and should never appear on the P&L.  """" 

""

The grant is amortised into P&L along the same lines as the underlying asset is depreciated, therefore satisfying the matching concept, which is key to the fundamental value of the financial statements, without it profit is mainly a matter of opinion, as it largely was in the past, and until very recently in the USA.

MtF

 

 

SSAP 4    1 thanks

Kelly10 | | Permalink

Newbie, so ready to be shot down!

In fact, pretty confident on this one as unfortunately smallbeancounter there is actually a prohibition on the direct credit to reserves of grant income within SSAP 4. "SSAP4 does not allow grants received to be credited directly to reserves in any circumstances" and a case with London Underground Ltd in 2000 confirmed that this was the case and resulted in the company subsequently reclassifying all capital grants received from their so called 'capital grant reserve' to deferred income to agree with the matching concept that many have mentioned above.

Hopefully see you guys again

 

K10

"It is frightening that    1 thanks

smallbeancounter | | Permalink

"It is frightening that people saying FRSs and SSAPs are wrong headed are out there and responsible for preparing financial statements and tax computations for real businesses".

FRSs and SSAPs are as capable of being wrong as any other artefact of human intelligence. They only acquire binding force if and when they are approved by a court, and even judges get things wrong sometimes which is why we have an appeals system. Sensible discussion of where accounting rules might be wrong is useful. In a democracy it is disastrous if people feel they cannot speak out against things which they believe are wrong. Following the flock like an unthinking sheep is not a good policy. 

In the particular case of grant income I am clearly in a minority of one. When we received our first grant it seemed to me that capital was being put into the company from outside and I treated it as such. But I won't pursue that argument further.

By the way, I did our own accounts for many years because I lost confidence in accountants. I won't bore you with the reasons but I have built up a successful solvent business which employees people and I make no apology for being unqualified. We have no debt whatsoever apart from the money we owe our suppliers during the month, and all suppliers are paid on the dot at the end of each month. In some years we have had nil creditors in the annual accounts. The only shareholders are me and my wife. Therefore even if I am making errors nobody is going to be harmed by them. My accounts are dead easy to understand and have hardly any notes, which contrasts with the accounts prepared by professional accountants for another company on whose board I am a non-executive director. My colleagues on that board sometimes complain that they cannot fully understand the accounts and usually end up asking how much money is in the bank since that has become the only measure they trust, the accounts being so difficult to understand.

Sally26's picture

This is the reason I read these comments !

Sally26 | | Permalink

Real people grappling with real issues and being open and straight forward in their disagreements. I like it and thank you all !

I did not get qualified because I like to operate like the little bean and be free to account in a meaningful way for my clients. They know this and they like it. I think that life is grey.....  black and white is very useful but sometimes grey can sometimes say it better.

Sally

Question: recognising tuition fee & course grants

IIdemudia | | Permalink

Pls can someone tell me how this is accounted for in P&L and Balance sheet? As this relates to tuition fee for the director, I have added it in the top half of the balance sheet after sales revenue as grant fee. The money money has already been used in part payment of the fees. Hence I have shown the total cost of the course fees as an admin expense since the company is paying for the course on behalf of the staff - the director.

 

Thanks

IIdemudia