The following article will go over the key concepts for obtaining competent (C) grade in government grant AOs in CPA Canada PEP and CFE exams under IFRS.
In Part 2 (to be posted later), we will look at a similar example for ASPE.
The best way to understand how to solve government grant AOs is to look at an example. In green color below I walk you through the example and in black color I explain the technicals. Let’s take a look.
Example
In January 20×0, the government provided a $20,000 grant to Company ABC to purchase new manufacturing equipment. At the time, the equipment was purchased for $100,000, and has a useful life of 10 years. To retain the grant, Company ABC must meet specific production criteria for the next 5 years. In the last few years, Company ABC has met this production criteria.
Definition
A government grant is defined as a type of assistance by the government in the form of a transfer of resources (monetary or non-monetary) to the entity. This could be for past or future compliance with specific conditions related to the entity’s operating activities.
This differs from government assistance in which economic benefits are provided indirectly through action, for example free marketing or business advice. (Note that ASPE 3800 uses the term “government assistance” to refer to both government grants and government assistance. On the other hand, IAS 20 distinguishes these two and provides different rules for government grants vs. government assistance.)
In the case of Company ABC, the transaction of $20,000 represents a monetary transfer of resources for future compliance, and meets the definition of a government grant. Therefore, the definition criteria is MET.
Recognition & Measurement
Government grants should only be recognized when the following criteria are met:
- There is reasonable assurance that the entity will comply with the conditions.
- There is evidence the grant is likely to be received.
In the case of Company ABC, there is reasonable assurance of compliance with the conditions as they have been in compliance for the last few years and that can be expected to continue. The grant has also already been received. Therefore, recognition criteria are MET.
There are two approaches for measuring government grants:
- Income approach
- Capital approach
Under income approach, the grant is recognized in P&L depending on nature. Under capital approach, the grant is treated as a capital transaction and credited to equity. The capital approach is not used (per IAS 20, para. 12), so we’ll follow the income approach.
Income Approach – Grants for Current or Past Period Expenses
These should be recognized in the P&L immediately as revenue. This can be shown separately or netted against the corresponding expense.
Income Approach – Grants for Future Period Expenses
These should be deferred and amortized as the expenses are incurred (i.e. deferred revenue).
In the case of Company ABC, the transfer of resources don’t relate to the expenses (ie, it’s for capital equipment, not to cover their expenses), therefore the Income Approach would not make sense. Since it relates to the purchase of an asset, the Capital Approach is appropriate.
Income Approach – Grants for PPE
There are two acceptable methods for presenting these.
- Reduce the PPE balance and amortize based on this new carrying amount.
Under this first option, Company ABC would deduct the grant from the equipment costs and recognize the grant as income by reduced depreciation expense. The initial entry would be:
Dr. Cash $20,000
Cr. Equipment $20,000
At year-end, depreciation would be recorded as follows:
Dr. Depreciation expense $8,000 ($100,000 – $20,000 = $80,000 / 10 years)
Cr. Accumulated depreciation $8,000
Note: Without this grant, the depreciation recorded would had been $10,000 ($100,000 / 10 years)
- Record a deferred liability account and amortize on the same basis as PPE.
Under option 2, Company ABC would recognize the grant as a liability and amortize the income over the life of the equipment.
The entry would be:
Dr. Cash $20,000
Cr. Deferred government grant $20,000
At year-end, the following adjustment would be made:
Dr. Deferred government grant $2,000
Cr. Revenue from grant $2,000 ($20,000 / 10 years)
Note: The impact on income is the same under both approaches, so we need to assess user needs and how they want to see the information presented.
Non-Monetary Grants
These are grants for things like land or other resources (non-monetary). These are special measurement rules, these are accounted for at fair value.
Forgivable Loans
If the government provides a forgivable loan, it can be treated as a government grant as long as there is reasonable assurance the entity will comply with the terms for the forgiveness of the loan.
Repayment of Grant
In the case where conditions are broken and the grant must be repaid to the government, this treatment will dependent on how the initial grant was recognized.
In the case of Company ABC, assume as of the end of 20X2, the conditions of the grant will be broken. The government now requires the entire $20,000 grant to be returned.
Repayment – Grants Related to Income/Expenses
This repayment will be treated prospectively as a change in estimate. Profit or loss should immediately be recognized for the extent in which the repayment exceeds the deferred credit for the grant.
For example, if a grant of $2,000 was received to offset salary expenses, but only $500 had been incurred, a deferred balance of $1,500 would exist. If the government required $1,800 to be repaid, there would be a loss of $300 ($1,800 – $1,500) to recognize immediately.
Repayment – Grants Related to PPE
Repayment for a grant related to an asset should be treated by increasing the carrying amount of the asset or reducing the deferred income balance by the amount repayable, dependent on which method was initially used.
If a deferred liability was set up initially under the Capital Approach option 1, the amortization expense will get reversed as the loan is to be repaid.
For Company ABC, the entry would be:
Dr. Deferred Revenue $14,000
Dr. Loss $6,000 ($20,000 – ($20,000 / 10 years) x 3 years)
Cr. Cash $20,000
If the grant was initially set to reduce the carrying amount of the asset, the additional depreciation that would have been recognized had the grant not been recorded, should be recognized immediately as profit or loss.
For Company ABC, the entry would be:
Dr. Equipment $20,000
Dr. Loss $6,000 ($2,000 depreciation x 3 years)
Cr. Accumulated Amortization $6,000
Cr. Cash $20,000
Conclusion
In determining which method is right for the company, you should assess the nature of the grant, the user needs for the presentation and overall case facts. For more information on government grants under IFRS, review IAS 20 or get my technical FR summaries.
