Government grants: is the answer really so easy?

When the IASB first took over from its predecessor (IASC), many Board members believed that the IASB should replace IAS 20 Government Grants and Disclosure of Government Assistance. They considered that developing a replacement would be easy. The general feeling seemed that:

  • IAS 20 was (and indeed still is) an old standard. IASC published it in 1983, 6 years before IASC published its Conceptual Framework.
  • unconditional government grants do not create a liability for the recipient. So, those grants should be recognised as income immediately. They should not be recognised as liability and not be recognised by deduction from the cost of related assets.
  • accounting standards should not offer a free choice of accounting treatments.

This post deals with the following:

  • overview of IAS 20
  • is a better solution available?
  • measuring performance obligations arising from government grants
  • measuring and presenting the related asset
  • conclusion

Overview of IAS 20

The following are the main recognition and measurement features of IAS 20:

  • government grants are recognised in profit or loss ‘on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate’.
    For grants related to assets, those expenses would include depreciation.
  • Government grants related to assets are presented in the statement of financial position either:
    (a) gross, ‘by setting up the grant as deferred income’; or
    (b) net, by deducting the grant in arriving at the carrying amount of the asset.

Is a better solution available?

The IASB has not undertaken a project to replace IAS 20. This was partly because it saw work on the Conceptual Framework and on revenue recognition as prerequisites for making useful progress on accounting for government grants. Indeed, many IASB members believed that in due course its conclusions in projects on those two topics would lead automatically to answers for government grants as well.

Many of those IASB members believed that work on those projects would lead naturally to conclusions that:

  • unconditional government grants create no liability; and
  • as a result, those grants should be recognised as income immediately.

The IASB completed its projects on revenue recognition in 2014 and on the Conceptual Framework in 2018. Nevertheless, the IASB has still not undertaken a project to replace IAS 20, perhaps mainly because the Board has had other higher priorities.

Will the answer really be so easy?

It is not obvious that a project to replace IAS 20 would have the outcome that many IASB members assumed in the early 2000s, especially for grants related to assets. The Board’s work since then on revenue recognition, on liabilities and on the Conceptual Framework has underlined how important it is to identify performance obligations and recognise them. The Board now expects companies to devote much more effort to identifying performance obligations than I think Board members envisaged in the early 2000s.

Well-designed government grants do not subsidise companies just for buying (or building) assets. Typically, grants set conditions for what companies do with those assets—not just on day 1 but for all of the asset’s useful life (or for a large part of that life.) There are 3 cases to consider:

  • Case 1. The conditions require the company to repay all of the grant if it fails to meet conditions after day 1. In this case, the company has a performance obligation on day 1.
  • Case 2. The conditions let the company keep some, but not all, of the grant even if it fails to meet conditions after day 1. In this case too, the company has a performance obligation on day 1. It might be appropriate to split the grant into 2 components:
    (a) a performance obligation, to be treated in the same way as case 1; and
    (b) an unconditional grant, to be treated in the same way as case 3.
  • Case 3. The company has an unconditional right to keep all of the grant, regardless of what it does after day 1. The company has no performance obligation and so it would not be appropriate to recognise a liability on day 1.
    For government grants related to assets, I discuss briefly below whether the grant should on day 1 be recognised as income or be deducted in determining the cost of the asset. I don’t conclude on that point.
    All other government grants should on day 1 be recognised as income.

Measuring performance obligations arising from government grants

I discuss below first the initial measurement of government grants and then their subsequent measurement.

Initial measurement

In case 1, there seems little doubt that government grant would typically need to be measured at the amount of the grant received. In 2 specific cases, though, the treatment might perhaps need to be slightly different:

  • if subsequent repayments of the grant would provide too much (or too little) compensation for the passage of time and for bearing risk. This is really case 2, not case 1.
  • if the performance obligation is onerous. For onerous performance obligations, it might be appropriate to apply the principles underlying IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

In case 2, it would be necessary on day 1 to allocate the grant received between the conditional component (treated under case 1) and the unconditional component (to be covered by case 3). I would:

  • use principles underlying IFRS 15 Revenue from Contracts with Customers to determine how much of the grant is payment for satisfying conditions after day 1 (the conditional component).
  • then allocate the rest of the grant to the unconditional component.

I suspect that many IASB members in the early 2000s envisaged measuring the conditional component on day 1 using an expected value model—a model that would multiply possible future repayments of grants by the probability of repayment.

There is an important difference between such an expected value model and the revenue recognition model. The revenue recognition model would measure the performance obligation at the full amount of the grant received for that component even if the company judges that the probability of repayment is low (or has become low).  

Measurement uncertainty and cost/benefit

In case 2, the best answer might, in some instances, be to allocate all of the grant received to only one of the 2 components:

  • if allocating the grant received between the 2 components is subject to an unusually high degree of measurement uncertainty.
  • if making the measurement needed to perform that allocation would cause costs out of proportion to the benefits to users.

Subsequent measurement of the conditional component

On day 1, the performance obligation would be measured at the amount of the grant for that obligation (the whole grant in case 1, part of the grant in case 2). Because that grant—or that part of the grant—pays the company for complying with the conditions, it seems appropriate to apply the principles underlying IFRS 15 in measuring the performance obligation subsequently. The obligation would be measured at the amount of the consideration (topped up if the obligation has become onerous.)

The measurement model in IFRS 15 is an example of using cost as a measurement basis, as discussed in chapter 6 of the Conceptual Framework.

Measuring and presenting the related asset

 IAS 20 permits a free choice between 2 approaches for government grants related to assets:

  • gross accounting: recognition of a separate liability.
  • net accounting: reducing the reported cost of the asset.

Generally, accounting standards should not offer a free choice. Probably, any major amendment of IAS 20 should eliminate that choice. 

A performance obligation is a type of liability. Reducing the reported cost of the related asset by deducting the amount of the performance obligation would conceal that liability. It would also be inconsistent with normal requirements on recognition. In addition, normal requirements on offsetting would not justify offsetting a performance obligation against the asset. So, there seems no case for permitting a net presentation of a performance obligation under a government grant against the related asset.  

If a company has no obligation under a grant (case 3, or the unconditional part of case 2), it is debatable whether it is best to treat the grant received as a deduction in determining the cost of the related asset (a net treatment), or as income (gross). In its current version (2018), the IASB’s Conceptual Framework now contains much more discussion of using cost as a measurement basis, but probably not enough discussion to answer that question without more work. 

Conclusion

In the early 2000s, IASB members thought it would be easy to decide how to replace IAS 20 once the IASB had completed its projects on the Conceptual Framework and on revenue recognition. Many of them had the following answer in mind:

  • many government grants related to assets are unconditional and would be recognised immediately as income; and
  • any unconditional components of government grants would be measured on a basis that reflects the probability that repayment will ultimately be made.

What has changed since the early 2000s?

For several reasons, the IASB has not (yet) attempted to replace IAS 20. Several things have changed since that first set of IASB members thought about government grants:

  • in work on the Conceptual Framework, on revenue recognition and on liabilities within the scope of IAS 37, the Board has paid much more attention to identifying and recognising performance obligations.
  • in developing IFRS 15, the IASB confirmed that performance obligations under contracts with customers are measured at the amount of consideration received.
  • the Conceptual Framework contains a greatly enriched discussion of using cost as measurement basis. One application of a cost basis is measurement of performance obligations under IFRS 15.
  • the discussion of cost as a measurement basis might also come into play in considering how unconditional grants received are best reported on day 1: as a reduction in the cost of the related asset? Or as income?

How much would a replaced IAS 20 change?

Because of those developments, a replacement for IAS 20 might sometimes leave measurements of government grants largely the same as under IAS 20. That outcome might occur in more cases than IASB members expected in the early 2000s. Nevertheless, replacing IAS 20 might lead to worthwhile improvements:

  • removing the free choice between a gross presentation and a net presentation for grants related to assets. For performance obligations, only a gross presentation seems defensible. For unconditional grants, more work might be needed to assess whether a gross or a net presentation provides more relevant information.
  • more precise language about performance obligations would replace unhelpful and unclear language about ‘deferred income’. And this language could lead to clearer descriptions in financial statements.
  • introducing a discussion of the need to identify performance obligations would provide a clearer framework for decision both by the IASB itself (in writing a replacement for IAS 20) and by preparers (in applying the replacement Standard).  

Leave a comment

Your email address will not be published. Required fields are marked *