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Thanks for this
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
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
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
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, contribution, gift, 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
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
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.
Except
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
I'm enjoying this
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.
SSAP 4 clearly outlines the correct treatment
""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
Eh?
@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?
SSAP 4
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
"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.
This is the reason I read these comments !
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
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
Thanks for the post. Providing support to the government agencies with its extending scope is a good thing but I think your way of expressing is something quite unfamiliar and unacceptable. It fulfills central financial accounting providing administration support services. Many funding individuals make grants to companies to encourage growth and development. But it should be treated correctly. I read you disclosure of grants and to some extent your points are acceptable.
Grants received for Capital Assets (No AIA or capital allowance)
My client received grant for property addition and improvements as we are not claiming any allowance for expenditure (AIA or capital allowance) and no deductible expenditure in income statement for corporation tax purpose. Will that grant received for expenditure be tax free or company has to pay Corporation tax on grant income.
Hope anyone can help...
Thanks
I am just researching the same problem
Did you have any luck finding out if the grant is classed as taxable income if no expenses or allowance are been claimed
Thanks
I have been working with a start up who have received a grant toward development of an App which would ultimately become their asset - and they may not depreciate - how should the rules be applied in this instance?
My initial thoughts were to reduce the value of the asset and therefore any subsequent depreciation - however after reading your answer I can see this is not technically correct? Any advice appreciated.
I have a question; im posed with an issue relating to a charity im doing some temp work for, they have grants which are in effect budgets allocated to projects they pay for on behalf of organisations. I am faced with two contradictory facts; i need to see what invoices are outstanding at any time and also the grant totals outstanding at the end of the year; sage allows me to see either the grant as an invoice but then payments will not reflect invoices or whats due of just posting the invoices against the organisation as a supplier will not show me the grant outstanding; do i really need to keep a manual set of grant accounts alongside sage or is there a way or dealing with everything at once? I thought maybe credit limit as balance but im not sure? anyone have any thoughts?
Good afternoon Can you please advise if the Grant funds in the balance sheet should be used in the current liabilities to calculate the current ratio
thank you