Expert Advisory Committee

1.44 Query:

Accounting for capital based grants.

1. A Government company is engaged in the development of dairy business. The entire share capital of the company is held by the concerned State Government. For the development of dairy business, the diaries in the various parts of the State are put up under the ownership of the company. The intention of the Government in setting up the company is to make the dairies viable units. After the dairy units become viable, they are to be transferred to co-operative unions or such other agencies as the Government may decide.

2. For the purpose of development of dairies, the company is receiving grants in various forms for acquisition of plant and machinery as per the details given in the following paragraphs.

3. Upto the year 1987-88, National Dairy Development Board was providing equipment/machineries by way of 100% grant.

4. From the year 1988-89, the scheme has been changed. Now from out of the assistance provided, 30% of the cost of the machinery is considered as grant. This assistance is provided either in cash or in kind.

5. The Government, through DDAP Agency, had transferred three dairy units with effect from 1/4/1982. The value of the assets was considered as grant from the Government to the company.

6. After the transfer of dairy units, as mentioned above, now the Government provides funds for purchase of machinery, partially as a grant and partially by way of loan.

7. In its books of account, the company is debiting the full cost of the equipment/machinery/vehicles received as grant and crediting the amount thereof to capital reserve accounts and in case of machineries partly treated as loan, such part is credited to loan account. Thus, depreciation is being provided on the full value of the equipment/machinery so acquired as per the method followed by the company, no part of the capital reserve representing depreciation for the year on such cost or part of cost of assets given by way of grant is transferred to profit and loss account of the year.

8. The auditors from the office of Comptroller and Auditor General of India, have raised the issue while auditing the accounts of the company for the year 1987-88 that the company should transfer proportionate amount out of capital reserve created on acquisition of machinery/equipment as grant, to the extent of depreciation provided on the machineries/equipments acquired out of such grants to the profit and loss account. This treatment is suggested by them in view of the treatment recommended in paragraphs 3(iv) nd 7 of the ‘Guidance Note on Accounting for Capital Based Grants’, issued by the Research Committee of the Institute of Chartered Accountants of India.

9. According to the company, the accounting method followed by it to credit the amount of grant received fully or partially towards the cost of equipment/machinery to capital reserve account and to provide depreciation on the full value of the assets so acquired without transferring the corresponding amount from capital reserve to profit and loss account, as mentioned in paragraph 7 above, is proper because of the reasons given hereunder:

(i) Since the company is considered as an agency of the Government for development of dairy business, the grants received by it are mainly in the nature of promoters’ contribution.

(ii) The object of the company is to promote and develop dairies and not to make profit. Milk is an essential commodity. Further as explained in paragraph 1 above, the company being development agency for dairies, the assets acquired from out of the amount of grant credited to capital reserve account will be transferred to co-operative unions or other agencies after they become viable. At the time of transfer of units, the assets will be transferred at their written down value along with the amount of capital reserve. It is, therefore, proper for the company not to transfer any amount from capital reserve to profit and loss account. One of the fundamental principles of accounting is conservatism. Judging from the angle of conservatism, the method followed by the company is most appropriate. Further, as explained above, assets have either been fully or partly contributed by way of promoters’ contribution. Therefore, provisions of Para 4 of Guidance Note on Accounting for Capital Based Grants will be applicable. If the company transfers the amount equivalent to depreciation provided on equipment/machinery from capital reserve to profit and loss account, its funds will be made available for distribution by way of dividends etc., which is not proper. On the other hand, by adopting the present method the funds are kept intact.

10. On the basis of the above, the opinion of the Expert Advisory Committee has been sought on the following issues:

(a) Whether the accounting method followed by the company as narrated in paragraph 7 above, regarding the treatment of grants received for acquisition of plant and machinery under various schemes, is proper.

(b) Whether the company should transfer the proportionate amount equivalent to depreciation provided on the equipment/machinery received or purchased from out of the grant and credited to capital reserve account to profit and loss account.

(c) If the answer to question (b) above is in the affirmative, whether the amount equivalent to depreciation provided in earlier years should also be transferred from capital reserve to profit and loss account or the treatment can be changed prospectively.

Opinion April 11, 1991

1. The Committee notes from the facts of the query that the main purpose of making grant for acquisition of plant and machinery is to make the diaries viable units so that, thereafter, the same can be transferred to cooperative unions and such other agencies as may be decided by the government. The Committee is of the view that it is a promotional activity in respect of the diary units developed under the scheme. The Committee is, therefore, of the view that the capital grant received by the company is of the nature of promoters’ contribution.

2. The Committee notes that paras 3(i) and 4 of the Guidance Note on Accounting for Capital Based Grants recommend as below:

“3. The following principal method of accounting for grants or subsidies are available: -

(i) The amount may be transferred to a capital reserve which should be regarded as not distributable as dividend.

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4. Where the grant or subsidy is with reference to the total investment on an undertaking or by way of contribution towards the capital outlay of the undertaking and where such contribution has the characteristics similar to those of promoters’ contribution, it may be treated as a capital receipt. In such cases the method suggested in para 3(i) may be followed. It follows from this that the amount will not be available for distribution as dividend.”

3. On the basis of the above, the opinion of the Committee on the issues raised by the querist in para 10 above, is as follows:

(a) Yes.

(b) No.

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