CA Inter Adv Accounting — Suggested Answers — May 2022

Accounting Treatment of Government Grants under AS 12 — Accounting for Government Grants

AS 12 (Issued by ICAI) recognises two broad approaches to accounting for government grants: the Capital Approach (credit to capital/reserves) and the Income Approach (recognise in P&L over relevant periods). The standard permits both approaches for grants related to depreciable assets, while mandating specific treatments in other cases.

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(i) Government Grant of 40% towards Machinery worth ₹25 Crores

Grant Amount = 40% × ₹25 Crores = ₹10 Crores

This is a grant related to a depreciable fixed asset (Machinery). Under AS 12, para 14, two alternative treatments are permissible:

Method 1 — Deduction from Asset Cost (Asset Method):
The grant is deducted from the gross value of the asset to arrive at its book value. Depreciation is then charged on the net book value of ₹15 Crores over the useful life of the asset.

Journal Entries:
Dr. Machinery A/c ₹25 Crores
Cr. Bank A/c ₹15 Crores (own funds paid)
Cr. Government Grant Receivable/Bank A/c ₹10 Crores (grant portion)

Balance Sheet Presentation: Machinery shown at ₹15 Crores (net of grant).

Method 2 — Deferred Income Method:
Machinery is recorded at its full cost of ₹25 Crores. The grant of ₹10 Crores is credited to a Deferred Government Grant Account (treated as deferred income) and transferred to the Profit & Loss Account on a systematic and rational basis over the useful life of the Machinery.

Journal Entries:
Dr. Machinery A/c ₹25 Crores | Cr. Bank A/c ₹25 Crores
Dr. Bank/Government A/c ₹10 Crores | Cr. Deferred Government Grant A/c ₹10 Crores

Each year: Dr. Deferred Government Grant A/c (proportionate) | Cr. P&L A/c

Balance Sheet Presentation: Machinery at ₹25 Crores; Deferred Grant shown under "Other Long-Term Liabilities" (reducing annually).

Both methods are acceptable under AS 12. The enterprise must apply the chosen method consistently.

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(ii) Capital Subsidy of ₹150 Lakhs for Plant in Backward Region

Plant Cost = ₹300 Lakhs; Subsidy Received = ₹150 Lakhs

This grant is in the nature of a promoters' contribution / central investment subsidy given with reference to the total investment in an undertaking set up in a notified backward region. Under AS 12, para 17, such grants:
- Are given as a contribution towards the total capital outlay (not tied to a specific condition requiring periodic compliance)
- Do not require repayment ordinarily
- Are treated as capital receipts

Treatment: The subsidy of ₹150 Lakhs must be credited to Capital Reserve and retained as such. It shall neither reduce the cost of the Plant nor be treated as income.

Journal Entry:
Dr. Bank A/c ₹150 Lakhs
Cr. Capital Reserve A/c ₹150 Lakhs

The Plant is recorded at its full cost of ₹300 Lakhs and depreciation is charged on ₹300 Lakhs over its useful life. The Capital Reserve is not available for distribution as dividend.

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(iii) ₹50 Lakhs Received for Arsenic Free Water Supply Project

This grant of ₹50 Lakhs is received from the Government for setting up a project for supply of arsenic free water in a notified area. Since the grant is specifically for setting up infrastructure/capital expenditure for the project (a social welfare / public health initiative), the treatment depends on the nature of assets acquired:

If the ₹50 Lakhs is used for acquiring a depreciable asset (e.g., treatment plant, machinery for water purification):
Apply either Method 1 (deduct grant from asset cost) or Method 2 (deferred income recognised over asset life), as discussed in point (i) above, in accordance with AS 12, para 14.

If the grant is for a specific purpose / non-refundable welfare contribution with no specific asset tied to it, and it represents a compensation for expenses already incurred or for the purpose of giving immediate financial support with no future related costs, then under AS 12, para 19, the grant should be recognised as income in the period it is received, subject to reasonable assurance that the enterprise will comply with the conditions and the grant will be received.

Most appropriate treatment (exam standpoint): Since the grant is for "setting up" (capital nature) a water supply project, the ₹50 Lakhs should be treated as a capital grant related to the project assets and either deducted from the cost of the related assets or treated as deferred income recognised over the life of those assets, consistent with AS 12, para 14.

Journal Entry (Deferred Income Method):
Dr. Bank A/c ₹50 Lakhs
Cr. Deferred Government Grant A/c ₹50 Lakhs
(Transfer to P&L proportionately over useful life of project assets)

Note: Under AS 12, a government grant is not recognised until there is reasonable assurance that (a) the enterprise will comply with the conditions attached to it, and (b) the grant will be received. Once recognised, grants are not revised retrospectively unless there is an obligation to repay, in which case repayment is treated as a revision of estimate and charged to P&L or adjusted against the unamortised deferred credit.

Summary Table:

| Item | Grant Amount | Treatment under AS 12 |
|------|-------------|----------------------|
| (i) Machinery Grant | ₹10 Crores | Deduct from asset cost OR Deferred Income over useful life |
| (ii) Backward Region Subsidy | ₹150 Lakhs | Credit to Capital Reserve (Promoters' Contribution — Para 17) |
| (iii) Arsenic Water Project | ₹50 Lakhs | Deduct from related asset cost OR Deferred Income over useful life |