1.50 Query: Transfer from capital reserve created out of subsidy.
1. In the year 1980-81, a corporation capitalised an amount of Rs. 35.92 crores, representing the subsidy arising out of purchase of six ships from a shipyard in U.K., financed under the India/U.K. Mixed Project. While the contract reflected the full price of the ships, the corporation was required to pay only the net price, i.e., cost net of subsidy. The acquisition of these ships was financed out of the aid advanced by the U.K. Government and this aid was on an outright grant basis. The corporation considered it appropriate that the ships are shown in the accounts at the original purchase price, and the depreciation is charged at the gross cost so as to reflect the correct operational results in the profit and loss account, as also the correct position of fixed assets in the balance sheet. Every year, an amount equivalent to the difference between depreciation for the year calculated on the total cost of the ships and that on the net cost of the ships (i.e., after deducting subsidy), is being transferred from capital reserve to the profit and loss appropriation account. This practice of considering the depreciation on the total cost of the ships (including the amount of subsidy), for the purpose of determining the overall profitability, has been in existence since the year 1980-81. The corporation’s accounting policy also suitably amplifies the above transactions.
2. The Government Auditors from C& AG of India, have been objecting on the reflection of the amount withdrawn from the “Reserve” in the ‘Appropriation Account’ as their contention is that the amount withdrawn from the reserve should be taken above the line in the profit and loss account for arriving at the overall profitability of the corporation and not in the “Appropriation Account”.
3. The corporation submitted that having charged full amount of depreciation, credit for the amount withdrawn from the reserve can be taken in the appropriation part of the profit and loss account. By this method the entire amount of depreciation on the gross cost of the asset is being charged to profit and loss account according to the corporation, the profit and loss account would show a true and fair view of the results of operation for any year, if depreciation is charged on the gross value of assets. The corporation also invited the attention of CAG’s Auditors to para 3 of the Statement on Auditing Practices, which is quoted below: -
“In view of the definition of the expression ‘Provisions’ and ‘Reserve’ contained in the Companies Act, it follows that provisions are a necessary charge against profit and should be charged ‘above the line’ while reserves are not a necessary charge against profit and should be debited ‘below the line’.”
The corporation, therefore, submitted that as a natural corollary, the write back of reserves should be shown below the line in the profit and loss account and the concept of expression ‘below the line’ means after the determination of the profit for the year.
4. In July, 1989 the CAG’s Auditors gave the corporation a copy of their Circular No. 124/CA IV/77-75 Vol. II/CA. V/Tech. 1/80 dated 4th February, 1985 on the accounting treatment for Government grants. The querist has submitted a copy of the said circular for the perusal of the Committee. The circular mentions that the “Guidance Note on Accounting for Capital Based Grants”, published by the Institute of Chartered Accountants of India, recognises either of the following two methods of accounting of Government grants, made for acquisition of specific fixed assets: -
1. To credit the grant to specific assets for which the grant is made available.
2. To keep the amount of grant in special reserve account and to transfer proportionate part thereof annually to the profit and loss account, with respect to the life of the fixed asset for which the grant is made available.
The circular further mentions that according to para 39 of International Accounting Standard (IAS)-20 on Accounting for Government Grants and Disclosure of Government Assistance, grants relating to assets, including non-monetary grants at fair value, should be presented in the balance sheet, either by setting up the grant as a deferred income or by deducting the grant in arriving at the carrying amount of the asset.
5. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting treatment adopted by the corporation in respect of the grant is proper or not.
Opinion February 11, 1992
1. The Committee notes paragraphs 3, 6, and 7 of the ‘Guidance Note on Accounting for Capital Based Grants’, issued by Institute of Chartered Accountants of India, which recommend as under:
“3. The following principal methods 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; or
(ii) The amount may be kept in a special reserve account and an appropriate amount transferred annually to the Profit and Loss Account with reference to the period specified in the scheme of grant or subsidy; or
(iii) The amount may be credited to the specific fixed asset for which the grant or subsidy was made available; or
(iv) The amount may be kept in a special reserve and a proportionate part transferred annually to the Profit and Loss Account with reference to the life of the fixed asset for which the subsidy was made available; or……………………..
6. If the subsidy or grant is given for the acquisition of a specific fixed asset, the same may be reduced from the cost of that fixed asset as stated in para 3 (iii) above. This is a simple way of apportioning the amount of the grant or subsidy to revenue over the life of the asset through a lower depreciation charge. This method is also in conformity with that provided under the Income Tax Act for computing the actual cost of such fixed asset.
7. The method at para 3(iv) is an alternative to the method suggested in para 3(iii). Under this method, the depreciation on the fixed asset will be charged with reference to its original total cost, as against which the amount of grant or subsidy kept as a special reserve will be apportioned over the life of the asset through transfer to the Profit and Loss Account.”
2. The Committee is of the view that since the method suggested in paragraph 3(iii) of the Guidance Note is an alternative to the method suggested in paragraph 3(iv) of the Guidance Note, the impact on the current year’s profit/loss should be the same in case either of the methods is adopted.
3. The Committee further notes that the Institute of Chartered Accountants of India has issued Accounting Standard (AS) 12 on “Accounting for Government Grants”*, which comes into effect in respect of accounting periods commencing on or after 1.4.1992 and will be recommendatory for an initial period of two years. Para 14 of the Standard recommends as below:
“14. 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 recognised in the profit and loss statement 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.”
4.The Committee also notes paragraphs 21, 22 and 23 of International Accounting Standard (IAS) 20 on ‘Accounting for Government Grants and Disclosure of Government Assistance’ which are reproduced below:
“21. Two methods of presentation in financial statements of grants (or the appropriate portions of grants) related to assets are regarded as acceptable alternatives.
22. One method sets up the grant as deferred income which is recognised in the income statement on a systematic and rational basis over the useful life of the asset.
23. The other method deducts the grant in arriving at the carrying amount of the asset. The grant is recognised in the income statement over the life of a depreciable asset by way of a reduced depreciation charge.”
5.The Committee notes that para 22 of IAS 20 which is comparable to the method suggested in paragraph 3(iv) of the Guidance Note and para 14 of AS 12 also recommends that the grant is set up as deferred income which is recognised in the income statement on a systematic and rational basis over the useful life of the asset. The Committee is of the view that recognising the grant as deferred income will have the effect of increasing the profit of the company.
6. The Committee is therefore of the view that the corporation should reflect the amount transferred from the capital reserve created out of subsidy for acquisition of fixed asset in the profit and loss account for the purposes of determination of profit of the current year. The method adopted by the corporation in this regard is not correct. ______________________________ *Published in the August 1991 issue of ‘The Chartered Accountant’ (p. 149) |