023: How to match a government grant with costs for which the grant compensates?
IFRS Question 023: How to recognize grant income in profit or loss?
I work for a real estate development company and we got a grant from international organization to support social housing.
The conditions are that we build an apartment house, we will operate it and we will rent the apartments to financially disadvantaged people for rental fees that are much lower than the market rent for 10 years.
The grant has a few purposes: to compensate us for lower rental income during 10 years and to contribute to our capital expenditure.
How and when can we account the grant income in profit or loss?
IFRS Answer 023
There is no definitive answer in the standards.
Often you need to apply your experiences, knowledge of the situation and judgment to develop the best method of accounting.
Here, we have more issues to consider.
Before we start analyzing it, let me remind you one of the basic rules of the standard IAS 20 Accounting for Government Grants and Disclosure of Government Assistance.
Rules for grant accounting
You should recognize any grant only when:
- You are sure enough that you will meet the conditions attached to the grant, and
- When you are reasonably sure that you will receive them.
That’s the paragraph 7 of IAS 20.
When you meet both conditions, you will recognize the grant itself.
Well, you debit the grant receivable and credit the deferred income – with some exceptions.
The specific journal entry depends on timing of the cash receipt.
In some cases, the grant is provided to compensate past expenses and really, you should book it directly in profit or loss.
That’s the initial recognition of the grant receivable.
What about the subsequent step – matching the grant with the expenses that it compensates?
IAS 20 paragraph says 12 that the government grants shall be recognized in profit or loss on a systematic basis over the periods in which the entity recognizes as expenses the related costs for which the grants are intended to compensate.
When you receive the cash from the grant, it does NOT automatically mean that you recognize it in profit or loss.
In fact, this is the matter of your own judgment and selection of the most appropriate policy to match the expenses with the grant income.
Sometimes, it is very clear and straightforward.
For example, you can get the grant to compensate the expenses for cleaning the environment in the certain year. Thus, you recognize the grant as an income in that year.
In other cases, it can be quite difficult to come up with the most appropriate matching principle.
Let me describe the two main issues here.
Issue #1: Identify the purpose of the grant and split.
Sometimes, the purpose is just one.
But sometimes, the grant can have more purposes – like in today’s question.
Sometimes, the grant conditions will tell you which portion of the grant is provided for certain purpose.
For example, you can receive the grant of 1 mil. EUR, thereof :
- EUR 800 000 to support your capital expenditures and
- EUR 200 000 to compensate the training costs for new employees.
In other case, the grant may NOT have this specification.
It can just say: you will receive 1 mil. EUR and it is to compensate your capital expenditures and training costs of new employees – see, it does NOT specify the amounts for individual purposes.
If this is the case, then you need to come up with some method to split the grant amount into these 2 elements, because the time of recognizing the grant income in profit or loss will be different.
You may split it, for example, based on total costs spent for individual elements.
In today’s question, this is also crucial to do.
The grant was for capital expenditures and to compensate the lower rent. So, you must first separate individual elements of the grant.
Issue #2: Select the most appropriate method to match the grant income with the associated costs
This is sometimes very difficult and judgmental.
Let’s take for example the case from today’s question.
The company is going to build the real estate to earn rental income.
By definition, this is the investment property and the company should apply IAS 40 Investment property to accounting for the apartment house.
Thus, there are 2 options:
- Apply cost model under IAS 16, or
- Apply fair value model.
Option #1: Cost model is applied
If you apply the cost model under IAS 16, then there are 2 options for recognizing the grant:
- Either you deduct the grant from the cost of an asset; or
- You keep it at deferred income.
In any case, you will recognize the grant income related to capital expenditure elementover the asset’s useful life, either within reduced depreciation charge or as an income on a systematic basis.
And, it is appropriate to recognize the grant element related to lower rental income compensation over the term of 10 years, in line with the lower rental expenses received.
Option #2: Fair value model is applied
If you apply the fair value model, then there’s no depreciation charged, but you revalue the investment property to its fair value at the end of the reporting period.
So, you can deduct the grant amount from the cost of an asset, but at the end of the reporting period, you will have to revalue the investment property to fair value and as a result, the change will include the full grant.
Effectively, the grant will be recognized in profit or loss immediately.
This is acceptable.
The reason is that IAS 20 does not address the situation when the grant is for investment property at fair value, but for guidance we can look to agricultural standard IAS 41.
It says that the grants related to biological assets at fair value less cost to sell are recognized in profit or loss immediately when the grant becomes receivable.
This is fully consistent with the suggested treatment for investment property at fair value model.
The second component of the grant – compensating the lower rental income – can be recognized in profit or loss over the term of 10 years when lower rental fees are received.
Finally, let me remind you that these methods are probably the most appropriate, but it depends on your own situation. There is no definitive one black or white answer.
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