Accounting For Government Grants under IAS 20

IAS 20 deals with accounting and disclosure of government grants and government assistance.

Government, according to the standard, refers to government, government agencies and similar bodies, whether local, national or international.

Government Grants are assistance by government in the form of transfer of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity.

* The government grants can be monetary or non-monetary.

Example:

AV Ltd wants to set up a factory in a rural district. The government provides a cash assistance (monetary) as well as land at subsidised price (non-monetary).

Manner of recognition of government grants:

IAS 20 suggests that Government grants, including non-monetary grants, should not be recognised until there is a reasonable assurance that:

1. The entity will comply with the conditions attaching to them; and

2. The grant will be received.

* The grant may be received before the conditions have been met. However, the above two conditions should be met in totality. If there is likelihood that the conditions won’t be met, the government grant cannot be recognised.

Example:

AV Ltd has set up a factory in a rural area. The government announces a grant of $5 million to the companies setting up factories in the area similar to the one set up by AV Ltd. The grant is received by AV Ltd.

Also, the government also wants that the companies are required to install necessary equipment’s to ensure that the pollution levels do not increase to a significant level. AV Ltd believes that it would not be able to install the pollution control equipment’s at the site.

In the above situation, government grant cannot be recognised and will be treated as a liability (for cash received). In other words, the money received by AV Ltd is required to be returned back to government, since the conditions attached thereto would not be met.

Types of grants:

Grants related to income: (Revenue Grants)

These grants may be presented:

• Either as income (under ‘Other Income’ heading); or

• As a deduction from related expense

The IASB accepts either treatment, subject to being followed in a consistent manner.

Grants related to assets (Capital Grants)

Grants related to assets are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term assets. Subsidiary conditions may also be attached restricting the type or location of the assets or the periods during which they are to be acquired or held.

These grants may be presented as:

• deferred income; or

• deduction from asset

Deferred income approach:

This method recognises the grant as a deferred income (liability). The deferred income is recognised an income over the useful life of the asset. To the extent the deferred income is not recognised, it is shown as a liability (current and non-current) in the statement of financial position (SOFP).

Deduction from asset approach:

Under this approach, the amount of government grant is reduced from the cost of the asset. As a result, the asset’s carrying amount is reduced, and therefore, depreciation charge is reduced automatically.

Grants received for non-depreciable assets:

These grants would have specific terms and conditions with regard to their use. For grants received for land, usually the grant is written off over the useful life of the factory or building constructed on the land.

Non-monetary grants

When government gives the grants in non-monetary form (land, etc), these assets may be recognised at their fair value, or the nominal value (price paid).

Example:

AV Ltd received a plot of land for setting up a cottage industry to generate employment under labour intensive production. AV Ltd had paid $20,000 for the land as costs of registration. The market value of the plot of land is estimated as $1 million.

AV Ltd may recognise the above land either at nominal value or at the market price.

For recording at nominal value:

Debit Land Account $20,000

Credit Cash Account $20,000

For recording at market value:

Debit Land Account $1,000,000

Credit Cash Account $20,000

Credit Grant Account $980,000

Note: Grant received without any condition is directly taken to Income statement.

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Non Current Assets Held For Sale: Recognition

Recognition Criteria Under IFRS 5

IFRS 5 provides that the asset under consideration must be available for immediate sale in its present condition subject to terms that are usual and customary for sales of such assets and its sale must be highly probable.

Immediate sale

Example:

AV Ltd owns a building where it runs its branch sales office. Due to change in business operations, the building is not required by AV Ltd. The building is agreed to be sold in its present condition to the buyer. However, some of the furniture is still lying in the building. Also, staffs needs to be transferred to other location. These activities would take around 2 weeks’ time.

Considering the above example, we notice that the building is considered as an asset held for sale. 2 weeks’ time in above case is usual and customary before the actual transfer of building happens. Hence, the asset is shown as a non-current asset held for sale.

Example:

AV Ltd owns a building where it runs its branch sales office. Due to change in business operations, the building is not required by AV Ltd. The building is agreed to be sold in its present condition to the buyer. However, AV Ltd seeks some time to identify a new building where it can transfer the staff and shift the belongings. In this situation, the first building is not held for sale, since it is not available for immediate sale. It would only happen once the replacement building is present. Although, disclosures with regard to the agreement entered into with buyer should be given.

Example:

AV Ltd intends to sell its manufacturing unit. However, there are a few orders accepted by AV Ltd which need to be completed, before the unit can be sold. In this case, the unit is not considered as available for immediate sale.

Example:

AV Ltd would like to sell the property it owns. However, to ensure more revenue by sales, it conducts renovation and repairs. The property, in this case, is not considered as available for immediate sale, until these repairs are complete.

Meaning of Highly Probable:

• An appropriate level of management must be committed to sell the asset or disposal group;

• The asset is being actively marketed;

• An active program to locate a buyer and complete plan must have been initiated;

• The sale should be expected to qualify for recognition as a completed sale within 1 year;

• It is unlikely that any significant changes to the plan will be made or that the plan will be withdrawn.

A sale is not considered as highly probable if the management is not committed to a selling plan.

Condition 1

The matter has been placed at the Board (decision-makers) and there is a consent / approval to sell the asset under consideration.

Condition 2

Active marketing for selling the asset has initiated already. This would mean that the outside parties are aware of the intention of the company that an asset or a unit is available for sale. Appointment of a selling agent or advertisement to sell the asset would be a common basis to meet the condition.

Example:

AV Ltd owns a building in Mumbai. Considering a surplus to its requirements, AV Ltd decides to sell the building. An advertisement has been placed in all leading newspapers to sell the building on ‘as is’ basis. In this case, the sale of building is presumed to be meeting the definition of highly probable.

Condition 3

Marketing for sale of asset is done close to the fair value of the asset. A higher price may be quoted, where the expectations are that negotiations to conclude the price at fair value will be there.

Condition 4

It is reasonably certain that the sale would be completed in 1 years’ time from the date of classification to hold for sale. Market conditions, past experience etc. are a factor in determining to identify if the sale is considered as recognised to be completed in one year’s time.

Condition 5

No circumstances indicate that the sale plan is likely to be withdrawn, or the intentions are likely to change.

Example:

AV Ltd’s management approves plan for sale of a plant. All efforts are put in place to identify the buyer, marketing is done, etc. However, a sudden increase in bank interest rates is keeping buyers away to put their money into purchases of such assets. The buyers are difficult to find. Global factors like inflation, lower demand for industrial output and local factors like trade unions issues restricting sale of units have resulted in management reconsidering the decision to sell the plant.

In the above case, the plant cannot be considered to be held for sale purposes.

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Finance Lease: Indicators under IAS 17

Finance lease:

A lease that transfers substantially all the risks and rewards incidental to ownership of the asset to the lessee. Title may or may not be transferred.

The standard provides that the substance of the agreement is to be understood. Legal form is not essential for determining whether a lease is an operating lease or finance lease.

IAS 17 mentions several indicators where a lease normally would be considered as finance lease.

Indicator 1: The lease transfers ownership of the asset to the lessee by the end of lease term

AV Ltd leases an asset to T Ltd. The lease term is 10 years. At the end of 10 years, T Ltd would take the asset from AV Ltd. The ownership, as specified under the agreement, will transfer from AV Ltd to T Ltd. This means that the risks and rewards incidental to ownership of the asset would belong to T Ltd. This is an example of finance lease.

Indicator 2: The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised

AV Ltd leases an asset to T Ltd. The lease term is 10 years. As per the lease agreement, T Ltd has an option to buy the asset for $500. The value of the asset is expected to be close to $100,000 at the end of lease term. It is reasonably certain at the time of agreement that T Ltd is going to exercise the option to buy the asset.

This again transfers substantially the risks and rewards incidental to ownership to the lessee. Hence, this would be an example of a finance lease.

Indicator 3: The lease term is for the major part of the economic life of the asset even if title is not transferred.

AV Ltd leases a car to T Ltd for a lease term of 10 years. The useful life of the car is 12 years. Since a significant part of the useful life of the car is used by the lessee, substantially the risks and rewards incidental to the ownership of the car are assumed to be automatically transferred to the lessee. This would be considered as a finance lease. The fact remains that the building has not been sold by the lessor.

Indicator 4: At the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.

AV Ltd leases a building to T Ltd for a period of 50 years. The lease rentals are $50,000 per annum. Present value of these lease rentals come to $495,750 considering a discount rate of 10%. The fair value of the machine is $496,000.

In the above case, the underlying assumption is that T Ltd has bought the building and is making the payment on the basis of instalment. It is as good as acquiring a loan amounting to the fair value of the asset (building) and making the payment to the lessor.

The risks and rewards incidental to the ownership are assumed to have been transferred to the lessee, and the lease would be a finance lease.

Indicator 5: The leased assets are of such a specialised nature that only the lessee can use them without major modifications.

AV Ltd is in aviation industry. It owns and also has on lease few aircrafts. Further, AV Ltd has taken on lease several buses to ferry passengers to and from the aircraft to the airport. These buses have been customised by the manufacturer to meet the requirements of AV Ltd. The colour, design of seats, paint, etc are all customised to symbolize AV Ltd’s airlines.

These buses cannot be used for any other purpose or by any other airlines unless major changes are done to these buses. In a manner, the airlines company would be assumed to have taken these buses under finance lease, since the risks and rewards associated with the ownership pertain to the lessee.

Indicator 6: If the lessee can cancel the lease, the lessor’s losses associated with cancellation are borne by the lessee

AV Ltd has taken an office premises on lease for 10 years. After 3 years, AV Ltd wants to cancel the lease since the region in which he operates is not generating enough revenue for him. It approaches G Ltd, the lessor and requests for cancellation of lease agreement.

G Ltd agrees upon a condition that any losses (due to the office remaining idle, or diminution in the value of the office premises

Indicator 7: Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equaling most of the sales proceeds at the end of the lease);

Indicator 8: the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent

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