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August 2012

GAPS in GAAP — Account ing for Government Grant

By Dolphy D’Souza, Chartered Accountant
Reading Time 5 mins
Government Grants are common in India and therefore accounting for Government Grant could have a significant impact on financial statements. Firstly, whether there is a grant or not; and if there is a grant whether the same is a fixed asset-related grant, revenue grant or promoters contribution will have to be decided. If the grant is a revenue grant, then its immediate impact is recorded in the P&L account, if the grant is a fixed asset grant, the grant income is released systematically to the P&L account in proportion to the depreciation on the related fixed asset. Alternatively, the grant is reduced from the amount of fixed asset capitalised, which will have the same P&L effect. Government grant in the nature of promoter’s contribution is treated as equivalent of shareholders fund and credited to the capital reserve. Needless, to say, the accounting will not only have a significant impact on the financial statements, but will also have a significant incometax impact, including MAT computation. Therefore the manner in which the government grant is accounted for becomes critical.

 In this article the author discusses an EAC opinion on the issue of whether a sales tax exemption under a scheme of the government is a grant or not. This article does not discuss the issue on the nature of the grant, whether fixed asset-related or revenue grant or promoters contribution. The issue of whether sales tax exemption scheme is a grant came to the Expert Advisory Committee (EAC) of the ICAI for an opinion (EAO-VOL-20-05). In the said fact pattern, the company was entitled to sales tax exemption over a period of three years, subject to an upper monetary limit. The upper limit was computed based on the additional investment in plant, machinery and building required for expansion. The EAC considered the definition of government grant in AS-12 Accounting for Government Grants.

As per paragraph 3.2 ‘government grant’ is defined as “Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government, which cannot be distinguished from the normal trading transactions of the enterprise”. The EAC felt that sales tax exemption is not assistance in cash or kind and is therefore not a government grant within the meaning of this term under AS-12.

 As such AS-12 is not applicable to sales tax exemption. However, there was no further elaboration on this point. The EAC further noted the definition of Revenue in AS-9 Revenue Recognition and was of the view that the entire sales proceed of the company constitutes revenue. It is immaterial whether the sale proceeds result from sales at normal prices or at higher than normal prices that the unit is able to charge due to sales tax exemption.

 In the author’s view, sales tax exemption is a government grant for the following reasons:

(1) It is a sacrifice by the government for achieving a particular social objective (e.g., dispersion of industry). The upper limit on the grant is clearly quantified. It may not be possible to quantify the sales tax exemption for the entire period of grant upfront; nonetheless, it is possible to quantify the amount of exemption included in each sales transaction. The grant is provided subject to fulfilment of certain conditions.

(2) The manner in which a grant is received does not affect the accounting method to be adopted in regard to the grant. Thus a grant is accounted for in the same manner, whether it is received in cash or as a reduction of a liability to the government.

(3) Government grants exclude assistance provided by the government which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the entity. Examples of these assistance are free technical or marketing advice and the provision of guarantees, etc. Sales tax exemption is a scheme granted by the government, subject to fulfilment of conditions relating to investment and operation in underdeveloped areas. Sales tax foregone by the government is in substance a transfer of resources by the government to the company.

In accordance with the EAC opinion, the grant will be included in the revenue amount. Going by the author’s view, the grant would be included in other income if it is concluded that it is a revenue-related grant. If the grant is concluded to be a fixed assetrelated grant it would be presented as deferred income and released over time in proportion to the depreciation of the relevant asset. Alternatively it would be reduced from the fixed asset, which would have the same impact.

As can be seen the accounting and presentation of the grant will not only have a significant impact on the financial statements, but also on the tax and MAT computation. This is therefore an issue, the ICAI would need to reconsider.

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