Accounting for Grants

Definitions The following terms are used in this Standard with the meanings specified: Government refers to government, government agencies and similar bodies whether local, national or international. 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. Explanation The receipt of government grants by an enterprise is significant for preparation of the financial statements for two reasons. Firstly, if a government grant has been received, an appropriate method of accounting therefore is necessary. Secondly, it is desirable to give an indication of the extent to which the enterprise has benefited from such grant during the reporting period. This facilitates comparison of an enterprises financial statements with those of prior periods and with those of other enterprises. Grants for nonprofits typically come from private foundations, donors or governmental agencies. Government grants: The majority of grants from governmental agencies are considered conditional grants because they involve an exchange transaction. In most cases the governmental agency is responsible to the community to provide the service. With their grant to the nonprofit they contract with the nonprofit to perform the service for them. Exchange transactions are not recorded as contributions and are typically considered unrestricted revenue. The terms of the grant agreement generally guide the recording of revenue. Non-government grants are most often considered contributions. This is because the grantor is not receiving any benefit in exchange for the grant. Grant awards that are considered contributions are to be recorded when the promise is made, which is often the date of the award letter. These grants can be considered unrestricted or temporarily restricted base on the terms of the grant agreement.
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Exceptions: Grants are considered conditional when:

The donor has a condition on the grant that is dependent on some future event that has a more than remote chance of not occurring. The grantor has a right to call back the grant. The exception clause rarely applies to non-government grants, so it is important to have your auditor or accountant review the grant documents to help determine if the grant is an exception. Contracts/Agreements many grant awards require signing a contract or agreement specifying the conditions required for the grant award. It is very important the contract terms are carefully read and understood. These terms often include: o Expenses that can or cannot be spent with grant funds. o The budget for the grant award, which describes what can or cannot be spent for each budget line item. o The contract period, which is the period of time expenditures can be made from grant funds. o Reporting requirements of program and financial results. o How to submit reimbursement requests for reimbursement grants. Reimbursement grants are grants that require an organization to make the expenditures before receiving grant funds for those expenditures. Advancement grants are grants that release grant funds before expenditures are made. Monitoring grants is very important for the nonprofit. A nonprofit could lose their ability to obtain further grants if program activities, grant funds expended and reporting requirements are not aligned with the requirements of the grant. o Program activities should be documented and reviewed to ensure they are the activities stated in the grant contract. o Expenses should be tracked to ensure they are allowable expenses as stated in the grant contract. Also a nonprofit cannot apply the same expense to more than one grant.

o Many grants require reporting of program activity along with financial activity for specified periods during the grant. These reports should be reviewed by someone in authority to ensure they are accurate and timely filed. Federal Awards: Federal awards include, but are not limited to, direct or indirect grants, contracts and loans from the federal government. A direct award is received directly from a federal governmental agency. An indirect award is a federal award received through another agency, including state, county, city and even other nonprofits. It is important to inquire of the awarding agency if the award is considered a pass-through federal award. Internal controls over federal awards provide: o Reasonable assurance operations are effective and efficient. o Financial reports are reliable. o All applicable laws and regulation are complied with. Financial and program management requirements: o Activities allowed or un-allowed are generally stated in the grant contract and also include any laws or regulations pertaining to the federal award program. o Allowable costs are the costs allowed as specified in the grant. o Generally costs must be: Reasonable for the performance of the grant. Be consistent with the organizations and federal policies and procedures. Be treated in accordance with generally accepted accounting principles (GAAP). Not be included as a cost in any other federal grant. Be adequately documented. Cash management relates to federal funds received in advance. The nonprofit must have procedures in place to reduce the time between when the funds are received and when they are used. Eligibility relates to the eligibility requirements of those receiving services from the program funded by the grant. Matching relates to the amount stated in the contract the nonprofit must contribute with their funds towards the project.
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Level of effort relates to the level of service to be provided as stated in the grant. Earmarking relates to the stated minimum or maximum amount of percentage of the programs funding that must be used for specified activities. Program income relates to the program income required to be earned by the nonprofit from grant activities. An example of program income is the amount charged to the participants in the program. Period of availability of federal funds relates to the grant period stated in the grant contract. Expenses cannot be charged to the grant that have occurred outside of the grant period. Property standards relates to property management of property acquired with federal grants. Procurement standards relates to specific procurement standards required for purchases of property with federal grant dollars. Reporting requirements relates to the required program and financial reporting as stated in the grant. Subrecipient Monitoring relates to the requirements of the nonprofit if they pass federal funds on to another nonprofit to assist in the performance requirements of the grant.

Capital Approach versus Income Approach Two broad approaches may be followed for the accounting treatment of government grants: the capital approach, under which a grant is treated as part of owners/accumulated funds, and the income approach, under which a grant is taken to income over one or more periods. Those in support of the capital approach argue as follows: Many government grants are in the nature of promoters contribution, i.e., they are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay and no repayment is ordinarily expected in the case of such grants. These should, therefore, be credited directly to owners/accumulated funds. It is inappropriate to recognize government grants in the Income and Expenditure account, since they are not earned but represent an incentive provided by government without related costs. Arguments in support of the income approach are as follows:

Government grants are rarely gratuitous. The enterprise earns them through compliance with their conditions and meeting the envisaged obligations. They should therefore be taken to income and matched with the associated costs which the grant is intended to compensate. As income tax and other taxes are charges against income, it is logical to deal also with government grants, which are an extension of fiscal policies, in the Income and Expenditure account. It is generally considered appropriate that accounting for government grant should be based on the nature of the relevant grant. Grants which have the characteristics similar to those of promoters contribution should be treated as part of Owners/accumulated funds. Income approach may be more appropriate in the case of other grants. It is fundamental to the income approach that government grants be recognized in the Income and expenditure account on a systematic and rational basis over the periods necessary to match them with the related costs. Income recognition of government grants on a receipts basis is not in accordance with the accrual accounting assumption. In most cases, the periods over which an enterprise recognizes the costs or expenses related to a government grant are readily ascertainable and thus grants in recognition of specific expenses are taken to income in the same period as the relevant expenses.

Recognition of Government Grants Government grants available to the enterprise are considered for inclusion in accounts: (i) Where there is reasonable assurance that the enterprise will comply with the conditions attached to them; and (ii) Where such benefits have been earned by the enterprise and it is reasonably certain that the ultimate collection will be made. Mere receipt of a grant is not necessarily a conclusive evidence that conditions attaching to the grant have been or will be fulfilled. An appropriate amount in respect of such earned benefits, estimated on a prudent basis, is credited to income for the year even though the actual amount of such benefits may be finally settled and received after the end of the relevant accounting period. In certain circumstances, a government grant is awarded for the purpose of giving immediate financial support to an enterprise rather than as an incentive to undertake
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specific expenditure. Such grants may be confined to an individual enterprise and may not be available to a whole class of enterprises. These circumstances may warrant taking the grant to income in the period in which the enterprise qualifies to receive it, as an extraordinary item if appropriate. Government grants may become receivable by an enterprise as compensation for expenses or losses incurred in a previous accounting period. Such a grant is recognized in the income statement of the period in which it becomes receivable, as an extraordinary item if appropriate.

Non-monetary Government Grants Government grants may take the form of non-monetary assets, such as land or other resources, given at concessional rates. In these circumstances, it is usual to account for such assets at their acquisition cost. Non-monetary assets given free of cost are recorded at a nominal value.

Presentation of Grants Related to Specific Fixed Assets Grants related to specific fixed assets are government grants whose primary condition is that an enterprise qualifying for them should purchase, construct or otherwise acquire such assets. Other 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. Two methods of presentation in financial statements of grants (or the appropriate portions of grants) related to specific fixed assets are regarded as acceptable alternatives. Under one method, the grant is shown as a deduction from the gross value of the asset concerned in arriving at its book value. The grant is thus recognized in the Income and Expenditure account over the useful life of a depreciable asset by way of a reduced depreciation charge. Where the whole, or virtually the whole, of the cost of the asset, the asset is shown in the balance sheet at a nominal value. Under the other method, grants related to depreciable assets are treated as deferred income which is recognized in the Income and Expenditure account on a systematic and rational basis over the useful life of the asset. Such allocation to income is usually made over the periods and in the proportions in which depreciation on related assets is charged.
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Grants related to non-depreciable assets are credited to capital reserve under this method, as there is usually no charge to income in respect of such assets. However, if a grant related to a non-depreciable asset requires the fulfillment of certain obligations, the grant is credited to income over the same period over which the cost of meeting such obligations is charged to income. The deferred income is suitably disclosed in the balance sheet pending its apportionment to Income and Expenditure account. The purchase of assets and the receipt of related grants can cause major movements in the cash flow of an enterprise. For this reason and in order to show the gross investment in assets, such movements are often disclosed as separate items in the statement of changes in financial position regardless of whether or not the grant is deducted from the related asset for the purpose of balance sheet presentation.

Presentation of Grants Related to Revenue Grants related to revenue are sometimes presented as a credit in the income and expenditure account, either separately or under a general heading such as Other Income. Alternatively, they are deducted in reporting the related expense. Supporters of the first method claim that it is inappropriate to net income and expense items and that separation of the grant from the expense facilitates comparison with other expenses not affected by a grant. For the second method, it is argued that the expense might well not have been incurred by the enterprise if the grant had not been available and presentation Presentation of Grants of the nature of Promoters contribution Where the government grants are of the nature of promoters contribution, i.e., they are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay (for example, central investment subsidy scheme) and no repayment is ordinarily expected in respect thereof, the grants are treated as capital reserve

Refund of Government Grants Government grants sometimes become refundable because certain conditions are not fulfilled. A government grant that becomes refundable is treated as an extraordinary item the amount refundable in respect of a government grant related to a specific fixed asset is recorded by increasing the book value of the asset or by reducing the capital reserve or the deferred income balance, as appropriate, by the amount refundable. In the first alternative, i.e., where the book value of the asset is increased, depreciation on the revised book value is provided Where a grant which is in the nature of promoters contribution becomes refundable, in part or in full, to the government on non-fulfillment of some specified conditions, the relevant amount recoverable by the government is reduced from the capital reserve. Disclosure The following disclosures are appropriate:

(i) The accounting policy adopted for government grants, including the methods of presentation in the financial statements; (ii) The nature and extent of government grants recognized in the financial statements, including grants of non-monetary assets given at a concessional rate or free of cost. Main Principles Government grants should not be recognized until there is reasonable assurance that (i) the enterprise will comply with the conditions attached to them, and (ii) the grants will be received. Government grants related to specific fixed assets should be presented in the balance sheet by showing the grant as a deduction from the gross value of the assets concerned in arriving at their book value. Where the grant related to a specific fixed asset equals the whole, or virtually the whole, of the cost of the asset, the asset should be shown in the balance sheet at a nominal value. Alternatively, government grants related to depreciable fixed assets may be treated as deferred income which should be recognized in the income and expenditure account on a systematic and rational basis over the useful life of the asset, i.e., such grants should be allocated to income over the periods and in the proportions in which depreciation on those assets is charged. Grants related to nondepreciable assets should be credited to capital reserve under this method. However, if a
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grant related to a non-depreciable asset requires the fulfillment of certain obligations, the grant should be credited to income over the same period over which the cost of meeting such obligations is charged to income. The deferred income balance should be separately disclosed in the financial statements. Government grants related to revenue should be recognized on a systematic basis in the income and expenditure account over the periods necessary to match them with the related costs which they are intended to compensate. Such grants should either be shown separately under other income or deducted in reporting the related expense. Government grants of the nature of promoters contribution should be credited to capital reserve and treated as a part of capital/ accumulated funds. Government grants in the form of non-monetary assets, given at a concessional rate, should be accounted for on the basis of their acquisition cost. In case a non-monetary asset is given free of cost, it should be recorded at a nominal value. Government grants that are receivable as compensation for expenses or losses incurred in a previous accounting period or for the purpose of giving immediate financial support to the enterprise with no further related costs, should be recognized and disclosed in the Income and expenditure account of the period in which they are receivable, as an extraordinary item if appropriate. Government grants that become refundable should be accounted for as an extraordinary item. The amount refundable in respect of a grant related to revenue should be applied first against any unamortised deferred credit remaining in respect of the grant. To the extent that the amount refundable exceeds any such deferred credit, or where no deferred credit exists, the amount should be charged to Income and Expenditure account. The amount refundable in respect of a grant related to a specific fixed asset should be recorded by increasing the book value of the asset or by reducing the capital reserve or the deferred income balance, as appropriate, by the amount refundable. In the first alternative, i.e., where the book value of the asset is increased, depreciation on the revised book value should be provided prospectively over the residual useful life of the asset.
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Government grants in the nature of promoters contribution that become refundable should be reduced from the capital reserve.

Why Bother Reporting Receipts of Government Grants? The receipt of government assistance by an enterprise may be significant for the preparation of the financial statements for two reasons. Firstly, if resources have been transferred, an appropriate method of accounting for the transfer must be found. Secondly, it is desirable to give an indication of the extent to which the enterprise has benefited from such assistance during the reporting period. This facilitates comparison of an enterprise's financial statements with those of prior periods and with those of other enterprises. Recognition of Government Grants Government grants should only be recognized if the organization is reasonably sure that: (a) the enterprise will comply with the conditions attaching to them; and (b) the grants will be received. Credit Capital or Credit Income? IAS 20 paragraphs 13 - 15 discuss two potentially alternative ways of accounting for Government Grants: 13. the capital approach, under which a grant is credited directly to capital/accumulated fund, and the income approach, under which a grant is taken to income and expenditure account over one or more periods. The Standard then goes on to discuss the arguments in favour of crediting Capital/accumulated fund with the value of the Government Grant and then the arguments in favour of crediting the Income accounts with the value of the government grants: There is no allowed alternative treatment of Government Grants: they MUST be Credited to Income
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Government grants should be recognized as income over the periods necessary to match them with the related costs which they are intended to compensate, on a systematic basis. They should not be credited directly to Capital/accumulated fund. Accounting Treatment of Government Grants IAS 20 goes on to say that Government grants must be recorded in accordance with the principles of IAS 1: that is, they must be recognized in accordance with the accruals principle and not on the receipts basis unless "no basis existed for allocating a grant to periods other than the one in which it was received." grants in recognition of specific expenses are recognized as income in the same period as the relevant expense. Example An organization receives a grant of $30 million to defray environment costs over a period of five years. Environment costs will be incurred by the organization as follows: Year 1 2 3 4 5 Total Cost ($m) 1 2 3 4 5 $15

We apply the grant, notice it is for $30 million not only $15 million as follows:

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year 1 2 3 4 5 Total

Cost ($ m) $30 x (1/15) = 2 $30 x (2/15) = 4 $30 x (3/15) = 6 $30 x (4/15) = 8 $30 x (5/15) = 10 $30

Also from paragraph 17 of IAS 20: "grants related to depreciable assets are usually recognized as income over the periods and in the proportions in which depreciation on those assets is charged." Example In the case of an asset costing, say, $200 million that is to be depreciated on the straight line basis over a period of ten years that attracts a Government grant of $100 million, the provision for depreciation of the asset will, quite simply, be $200 million/10 years = $20 million per year Similarly, the organization will recognize Government grant along side the depreciation provision and it would amount to $100 million/10 years = $10 million per year Note also that if, for example the Government had given the grant on condition that the recipient complied with certain conditions then the organization must disclose these conditions for as long as the conditions apply. Paragraph 19 of IAS 20 says that "Grants are sometimes received as part of a package of financial or fiscal aids to which a number of conditions are attached." Let's consider an example to illustrate this point:
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Example Imagine we are given a plot of land by a Government department in return for providing guaranteed employment to local people as they work with on improving the facilities on that land. The budget for the work says that the total cost of the work is to be $60 million, to be spent as follows: Year 1 $10 million Year 2 $10 million Year 3 $40 million The fair value of the land at acquisition is $120 million. In accordance with Paragraph 19, we need to recognise the fair value of the land, ie the value of the grant, over the duration of the conditions attaching to the grant:

Year 1 2 3 Total

Grant recognised (million) $120 x (10/60) = $20 $120 x (10/60) = $20 $120 x (40/60) = $80 $120

Non Monetary Government Grants If a government grant is made in a form other than cash, IAS 20 says " it is usual to assess the fair value of the non-monetary asset and to account for both grant and asset at that fair value (paragraph 23).

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Presentation of Grants Related to Assets Government grants related to assets, including non monetary grants at fair value, should be presented in the balance sheet either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset. Two methods of presentation in financial statements of grants (or the appropriate portions of grants) related to assets are regarded as acceptable alternatives. One method sets up the grant as deferred income which is recognized as income on a systematic and rational basis over the useful life of the asset. Example 1: deferred income option Set up the grant as deferred income: eg a $3 million grant is awarded that is to be used to buy for $9 million a dilapidated building in 2000 that is estimated to have a useful life of 3 years. The deferred income account will behave as follows: Recognition as income

Date 2000 31 Dec 2000 31 Dec 2001 31 Dec 2002

Open/Balance b/d 3 3 2 1

Balance c/d 3

1 1 1

2 1 0

The other method deducts the grant in arriving at the carrying amount of the asset. The grant is recognized as income over the life of a depreciable asset by way of a reduced depreciation charge. Example 2: grant deducted from carrying value

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Date 2000 31 Dec 2000 31 Dec 2001 31 Dec 2002

Open/Balance b/d 9 6 4 2

Depreciation 3 2 2 2

Balance c/d 6 4 2 0

* this deduction of $3 million represents the total value of the Government grant being offset against the total value of the building. The purchase of assets and the receipt of related grants can cause major movements in the cash flow of an enterprise. For this reason and in order to show the gross investment in assets, such movements are often disclosed as separate items in the cash flow statement regardless of whether or not the grant is deducted from the related asset for the purpose of balance sheet presentation. Presentation of Grants Related to Income Grants related to income are sometimes presented as a credit in the income statement, either separately or under a general heading such as "Other income"; alternatively, they are deducted in reporting the related expense. Again, we believe that paragraphs 30 and 31 should be consigned to an appendix as they present arguments supporting the alternatives here rather than anything constructive Disclosure The following matters should be disclosed: (a) the accounting policy adopted for government grants, including the methods of presentation adopted in the financial statements; (b) the nature and extent of government grants recognized in the financial statements and an indication of other forms of government assistance from which the enterprise has directly benefited; and (c)

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unfulfilled conditions and other contingencies attaching to government assistance that has been recognized. Transitional Provisions An enterprise adopting the Standard for the first time should: (a) Comply with the disclosure requirements, where appropriate; and (b) either: (i) Adjust its financial statements for the change in accounting policy in accordance with IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies; or (ii) Apply the accounting provisions of the Standard only to grants or portions of grants becoming receivable or repayable after the effective date of the Standard.

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