FRS 102: How to account for grants
FRS 102 becomes mandatory for accounting periods starting on or after 1 January 2015. Steve Collings considers accounting for grants under the new GAAP.
Government grants are defined in the glossary to FRS 102 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. Government refers to government, government agencies and similar bodies whether local, national or international.”
The scope of Section 24 does not extend to government assistance which an entity receives in the form of benefits which are available in arriving at taxable profit (or loss) or are determined or limited on the basis of income tax liability. Paragraph 24.3 cites examples of income tax holidays, investment tax credits, accelerated depreciation allowances and reduced income tax rates. Any aspects relating to income tax are dealt with in Section 29 Income Tax.
Recognition and measurement
The overarching principle contained in Section 24 is that an entity must not recognise grants (including non-monetary grants) until there is reasonable assurance that the entity will adhere to the conditions which are attached to the grant. In addition, there must be reasonable assurance that the grant will be received by the entity in order to recognise the grant in the financial statements. Once these conditions are met, the entity then has two accounting policy choices to recognise the grant:
- The performance model
- The accrual model
The performance model
The performance model is a new concept in Section 24 which is not available under SSAP 4 Accounting for government grants. The performance model works by recognising grant income when the grant’s performance-related conditions are met. Certain grants are given by government without any conditions attached (for example to compensate for a loss of income) and where grants are unconditional, they should be recognised within income when they are receivable. The model works as follows:
- A grant that does not impose specified future performance-related conditions on the recipient is recognised in income when the grant proceeds are receivable
- A grant that imposes specified future performance conditions on the recipient is recognised in income only when the performance-related conditions are met
- Grants received before the revenue recognition criteria are satisfied are recognised as a liability
Company A has experienced a period of rapid expansion over the last couple of years and has a year-end of 31 December 2015. In October 2015 it opened up a new production plant in an area of high unemployment in an attempt to be seen to encourage individuals back into work. It has employed 100 members of staff and has entered into negotiations with the government to reclaim some of the costs incurred in training these new employees. The directors have calculated they may be entitled to £5,000 worth of compensation for training these new employees and then offering them permanent employment.
In February 2016, the government agreed to the grant claim and gave the company the grant. The financial director has recognised the grant in the financial statements for the year-end 31 December 2015 on the basis that the directors were confident the claim would be successful.
The grant should not be recognised in the 31 December 2015 financial statements because the claim was not approved until the following February. Therefore, the grant should be recognised in the 31 December 2016 financial statements. Until the claim is approved by the government, it is not certain whether the grant will be received, thus fails the recognition criteria in paragraph 24.3A(b) in FRS 102.
When conditions are attached to a grant, the grant can only be recognised in income when those conditions have been met. Therefore, it follows that until the performance conditions are met the grant must be recognised as a liability and released to income as and when the performance conditions are met.
Company B Limited has agreed to expand in a deprived area of the country in order to entice employment opportunities and has therefore agreed to construct a new production plant in the area. The company has entered into negotiations with the government for a setup grant amounting to £100,000. There are performance-related conditions attached to the grant which state that:
- Company B must ensure its production plant complies with all planning and environmental legislation
- It must maintain a workforce of at least 100 individuals, all of whom must be employed on the commencement of trading
- Production must commence on or before 31 December 2015
The grant was received by Company B on 1 February 2015.
Until the performance-related conditions are met by Company B, the grant must be recognised as a liability. If it is assumed that the performance-related conditions are met by the company by 31 December 2015, the liability can be derecognised and the grant recognised in income. If, on the other hand, the grant conditions are not met by 31 December 2015, then a liability is still recognised until the conditions are met.
Any grants which become repayable are recognised as a liability when the repayment meets the definition of a liability. In the above example, it may be the case that the company has to repay some/all of the grant if the conditions attached to the grant are not met - for example if the production plant did not start trading on or before 31 December 2015. In such cases, part or all of the grant that is due for repayment must be recognised as a liability.
Company C Limited receives a government grant on 1 January 2016 which contains certain conditions. One of those conditions is that the company must maintain a certain number of employees on its workforce throughout a three-year period. If the company fails to maintain the minimum number of employees the grant is repayable in full.
Conditions are complied with
When the conditions are complied with and the company maintains the number of employees specified in the grant conditions then the grant is recognised in income as it becomes non-repayable - for example on a straight-line basis over the three-year period.
Conditions are not complied with
If the company fails to comply with the conditions attached to the grant then a liability is recognised for amounts repayable. Any repayment is then applied to the unamortised balance with any excess being recognised in profit or loss as an expense.
The accrual model
The accrual model is probably the most familiar with accountants because the accounting treatment is essentially carried over from SSAP 4. There are four methods of accounting for grants under the accrual model:
- Grants relating to revenue are recognised in income on a systematic basis over the periods in which the entity recognises the related costs for which the grant is intended to compensate
- A 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, is recognised in income in the period in which it becomes receivable
- Grants relating to assets are recognised in income on a systematic basis over the expected useful life of the asset
- Where part of a grant relating to an asset is deferred, it shall be recognised as deferred income and not deducted from the carrying amount of the asset
The first thing that a company has to do is to consider whether the grant relates to revenue, or whether it relates to an asset.
Grants which relate to revenue are recognised in income in the period the related costs are incurred by the entity for which the grant is intended to compensate. For grants which are received by the entity for compensation for expenses or losses which have already been incurred, the grant is recognised in income when it is received or receivable.
Asset-based grant (or capital-based grant)
Grants which relate to assets are recognised in income on a systematic basis over the useful life of the asset.
Company D Limited purchases an asset at a cost of £100,000 in cash. The useful expected life of the asset is 10 years at which point the residual value is assessed to be £20,000. The company’s depreciation policy is to depreciate the asset on a straight-line basis over its expected useful life. The government has agreed to a grant of £35,000 and this was received on 1 December 2015. The company’s year-end is 31 December 2015 and the depreciation policy is to charge a full year’s depreciation in the year of acquisition of assets but no depreciation is charged in the year of disposal.
On initial recognition of the grant
DR cash at bank £35,000
CR deferred income £35,000
On initial recognition of the asset
DR property, plant and equipment additions £100,000
CR cash at bank £100,000
DR depreciation charge (income statement) £8,000 ([£100,000 - £20,000] / 10)
CR accumulated depreciation £8,000
DR deferred income £3,500 (£35,000 / 10)
CR income statement (grant income) £3,500
Falling due within one year £3,500
Falling due after more than one year £28,000
A key point to emphasise where asset-based grants are concerned is that the grant must not be offset against the cost of the asset. Paragraph 24.5G prohibits such a treatment.
Company E Limited receives a government grant on 1 January 2015 amounting to £100,000 for the creation of a new production plant for which there are conditions attached. It’s year-end is 31 December 2015 and the company uses the accruals model for accounting for its grants. All conditions attached to the grant are met by 31 December 2015 and the directors have assessed this grant as being a capital-based grant as it relates directly to the construction of the production plant.
This is an example of where the accruals model and the performance model are very different in terms of accounting treatment. If the company were to use the performance model, then it could recognise the entire £100,000 in income as the performance-related conditions have been met by 31 December 2015. However, the company has adopted the use of the accruals model and therefore the grant will be recognised in income on a systematic basis over the asset’s useful life.
Grants may not necessarily be made in cash. They can take other forms (for example land) and this can often pose problems in terms of valuation. Paragraph 24.5 says that an entity shall measure grants at the fair value of the asset received or receivable. The glossary to FRS 102 defines fair value as:
“The amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged, between knowledgeable, willing parties in an arm’s length transaction. In the absence of any specific guidance provided in the relevant section of this FRS, the guidance in paragraphs 11.27 to 11.32 shall be used in determining fair value.”
Company E Limited operates a chain of fish markets across the country and has a year-end date of 31 December. It has to apply to the government every five years to obtain a fishing licence and on 1 January 2015, the company received a non-transferable five-year licence to catch 15 tonnes of fish per annum. There are strict conditions attached to the grant relating to the fishing quota and if the company exceeds the quota, there are substantial penalties that can be levied by the government.
The fishing licence is a government grant because the grant gives the company the right to remove up to 15 tonnes of fish per annum and it is received on the basis of the conditions attached to the grant (that the company will not exceed the quota contained in the grant). If the fair value of the grant is assessed to be £250,000 then this will be recognised as an intangible asset on the balance sheet (statement of financial position) and will be amortised over a five-year period.
Under the performance model, the grant of £250,000 will be recognised in income in the period it which it becomes receivable. The grant is non-transferable and will not be revoked as there are no future performance conditions.
Under the accrual model, the grant will be recognised as a liability and released to profit or loss over the life of the intangible asset (five years) in order to match the amortisation charge.
There is more flexibility under FRS 102 where grants are concerned because of the new concept of the performance model. While SSAP 4 permits the offsetting of a grant against the cost of an asset, companies legislation prohibited such a practice and FRS 102 is now explicit in that offsetting grants against the cost of an asset is prohibited and therefore for some entities (such as public benefit entities), there will be a change in accounting practice as a result of this prohibition.
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’.