FRS 102: Government grants
It is not unheard of for companies to receive grants to help them set up operations (for example in a deprived area) to encourage employment opportunities or for companies to receive grants to help them with day-to-day expenses (such as new start-up grants) or to help with the cost of a fixed asset, explains Steve Collings.
FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland deals with government grants in Section 24 and while some of the concepts are largely the same as in current SSAP 4 Accounting for government grants, FRS 102 introduces the ‘performance model’ which is not available under SSAP 4. There are also some additional accounting issues relating to government grants that should be considered by firms of accountants.
Section 24 itself is a very short section and 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 worth mentioning that the ways in which government grants are accounted for has been the subject of much debate over the years and the FRC has intimated that it will revisit this area in the future with the objective of overhauling the ways in which grants are accounted for.
Section 24 does not deal with government assistance provided to an entity in the form of benefits which are available in determining taxable profit (or loss), or are determined or limited on the basis of income tax liability. Section 24 defines ‘government assistance’ as:
“...action by government designed to provide an economic benefit specific to an entity or range of entities qualifying under specified criteria”.
Examples of such assistance are tax holidays, investment tax credits, accelerated depreciation allowances and reduced income tax rates and users are directed to Section 29 Income Tax for issues pertaining to taxation.
Recognition and measurement
Before a grant (which also includes non-monetary grants) can be recognised in an entity’s financial statements, there must be reasonable assurance that:
- the entity will comply with the conditions attaching to them
- the grants will be received
The term ‘reasonable assurance’ is not defined in FRS 102, although it should be taken to mean the same as ‘probable’ which is defined in the glossary to FRS 102 as ‘more likely than not’.
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Grants will be initially recognised at the fair value of the asset received (or receivable) to comply with paragraph 24.5 and if any of the grant becomes repayable, the reporting entity must recognise a liability at the point in time the repayment meets the definition of a liability.
The performance model
Under the provisions in SSAP 4, only the accrual model is permitted for the recognition of grants. However, FRS 102 introduces a new concept of the ‘performance model’ which is not recognised in SSAP 4 or the international equivalent, IAS 20.
If an entity adopts the performance model it recognises grants as follows:
- a grant is recognised in income when the grant proceeds are received (or receivable) provided that the terms of the grant do not impose future performance-related conditions*
- if the terms of a grant do impose performance-related conditions* on the recipient, the grant is only recognised in income when the performance-related conditions* are met
- any grants that are received before the revenue recognition criteria are met are recognised in the entity’s financial statements as a liability
*performance-related conditions are defined in the Glossary as “A condition that requires the performance of a particular level of service or units of output to be delivered, with payment of, or entitlement to, the resources conditional on that performance.”
The accrual model
This is probably the most familiar model to accountants and FRS 102 requires grants accounted for under the accrual model to be classified as a grant relating to revenue (revenue-based grant) or a grant relating to assets (capital-based grants). There are four methods of accounting for grants under the accrual model, depending on whether they are revenue or capital-based grants:
- grants relating to revenue are recognised in profit and loss on a systematic basis over the periods in which the entity recognises the related costs for which the grant is intended to compensate
- grants that are received in respect of expenses or losses already incurred by the entity are recognised in profit and loss in the period when the grant becomes receivable
- capital-based grants are recognised in profit and loss on a systematic basis over the useful economic life of the asset (usually to match the associated depreciation charge)
- grants relating to an asset which are deferred are recognised as a liability (deferred income) and are not deducted from the carrying value of an asset
The final bullet point addresses an issue that was not explicitly dealt with in SSAP 4. SSAP 4 offers a choice of accounting for a capital-based grant (as does IAS 20). Under SSAP 4 an entity can either recognise the deferred portion of the grant within liabilities as deferred income, or it can offset the grant against the cost of the related asset. If the reporting entity were to choose the latter accounting method, the grant would be recognised within profit or loss by way of reduced depreciation charges (as the cost-base used to calculate depreciable amount would be lower). However, the issue here is that Companies Act 2006 prohibits such treatment (although as I have previously reported, entities that do not apply the Companies Act 2006 when preparing their financial statements (sole traders and partnerships for example) may well be able to offset grants against the cost of asset to which the grant relates). This is illustrated as follows:
A company purchases a new machine for £100,000 (funded out of cash) and the directors have assessed the useful economic life (UEL) to be five years with a nil residual value at the end of this UEL. The company’s accounting policy in respect of depreciation is to charge a full year in the year of acquisition and none in the year of disposal and the company received a government grant in respect of this machine for £30,000. The grant has been recorded as follows:
DR cash at bank £30,000
CR plant and machinery £30,000
Being receipt of capital-based government grant
The annual depreciation charge would therefore be calculated as:
|Less government grant||(£30,000)|
The depreciation charge would be £70,000/five years = £14,000 per annum.
Under the provisions in FRS 102, paragraph 24.5G prohibits the above treatment relating to government grants, so the following would occur:
Cost = £100,000
Depreciation = £100,000/five years = £20,000 per annum
£30,000 released over five years = £6,000 per annum
Net effect on profit and loss account
Depreciation charge £20,000
Government grant released (£6,000)
Overall net charge to P&L £14,000
Effect on balance sheet
Deferred income within 1 year £6,000
Deferred income more than 1year £18,000
So you can see that there is no overall difference on the charge to the P&L account (it is still taking an overall hit of £14,000), it is just that FRS 102 (and Companies Act 2006) requires all amounts to be shown gross and not netted off.
The disclosures required in respect of government grants are as follows:
- The accounting policy adopted for grants in accordance with paragraph 24.4
- The nature and amounts of grants recognised in the financial statements
- Unfulfilled conditions and other contingencies attaching to grants that have been recognised in income
- An indication of other forms of government assistance from which the entity has directly benefited
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’.