Expert Advisory Committee

1.10 Query

Treatment of grant received for a particular project

1. A consultancy and engineering organisation is engaged in design, procurement, project management, technical and consultancy services for petroleum projects, refineries, oil fields, gas pipelines, offshore engineering, petrochemical complexes etc.

2. The company has set up a Research and Development Centre with internal accruals and the grant and loan received from another Agency and is carrying out the research activities to update the technology. The company has been carrying out research in the field of petrochemicals at the said Research and Development Centre and all the expenditures are being booked to the revenue. The company has also been carrying out research activities with the help of outside agencies from whom they used to receive the revenue grant aginst which expenditures were incurred and accounted for as stated above.

3. During the course of this financial year, the company has entered into Memorandum of Understanding with the Centre for High Technology (CHT), a Society registered under the Societies Registration Act of 1860, which is also a research body under the Ministry of Petroleum & Natural Gas, Government of India, to fund a project titled “Heat Transfer Enhancement By Tube Inserts”. The objectives and scope of the project are:

(a) Main objective is to acquire design engineering capability for heat transfer enhancement using wire-matrix type tube inserts.

(b) Investigation of various geometrical parameters (i.e., loop angles, interloop distance etc.) of tube inserts and fluid properties affecting heat transfer enhancement.

(d) Developing machine for the manufacture of specially designed inserts.

(e) Conducting field trails at industry level.

4. To carry out the above activities, CHT has taken the responsibility of incurring all expenditure including purchase of any capital item through the company and the company in turn will bear the cost of its manhours. For this, CHT will give grant. Any unspent amount out of the grant given by CHT to the company will be refunded back to CHT. The conditions of the MOU is that the lien on the assets acquired out of the grant of CHT shall vest with CHT in proportion of the CHT’s share of total project cost, and the benefit, if accrued out of these assets, will be shared by both the company and CHT in the ratio of 50:50. The querist has also enclosed a copy of the Memorandum of Understanding for perusal of the Committee.

5. The querist has stated that the Accounting Standard (AS) 8 on Accounting for Research and Development states that allocation of cost of research and development activities to accounting periods is determined by their relationship with the expected future benefits to be derived from these activities. In most cases, there is little, if any, direct relationship between the amount of current research and development costs and future benefits because the amount of such benefits, and the periods over which they will be received, are usually too uncertain. Research and development costs are, therefore, usually charged to expense in the period in which they are incurred.

6. The querist has stated the accounting policy of the company as below:

(a) The research and development expenditure is charged to the profit and loss account in the year in which the expenditure is incurred.

(b) Government grant of capital nature for promotion and setting up of R & D Centre is treated as capital reserve and shown separately under ‘Reserves and Surplus’.

7. The querist has sought the opinion of the Expert Advisory Committee of the Institute on the following issues:

(i) Whether such assets so generated should be recorded in the company’s books of account as a whole, and/or money received from CHT shall be shown as capital grant.

(ii) If the answer to (i) is in the negative, whether the assets so generated should be reduced from the grant received from CHT.

(iii) Alternatively, this should be treated as revenue expenditure since the outcome of the research is not known and capitalisation of assets at the very point of time will not depict true and fair view of the company’s accounts.

(iv) Whether any disclosure or change is required in the company’s accounting policy.

Opinion September 24, 1996

1. The Committee notes that the query appears to basically relate to the treatment of fixed assets acquired by the company out of the grant given by Centre for High Technology (CHT). The Committee, therefore, restricts its opinion to answering this question only.

2. The Committee further notes para 5.1 of the Memorandum of Understanding, which is stated below:

“In consideration of the work to be carried out by (the company), CHT shall pay to (the company) towards the procurement of fabricated hardware items (packing and distributors) and the cost of utilities and chemicals, based on actual expenditure subject to a maximum of Rs. 29.50 lakhs (Rupees twenty nine lakhs fifty thousand only) as per the cost estimate given in Annexure- of this MOU.”

The Committee is, therefore, of the view that the grant is given to purchase specific fixed assets, and it cannot be used for general purpose.

3. The Committee notes from the facts of the query that the company has received grant from CHT to be used, inter alia, for acquisition of assets. The fact that donor has given a ‘grant’, it is obvious that he does not intend to have ownership interest in the assets. Had he intended to have ownership interest in the assets then the amount paid to the company would not be termed as a ‘grant’, since that would have been meant to be a part or full payment of the acquisition cost of the asset.

4. The Committee also notes para 4.9 of the Memorandum of Understanding which is reproduced below:

“The lien over the assets acquired out of grant of CHT shall vest with CHT in proportion to CHT’s share over the total project cost.”

5. The Committee further notes that ‘A Dictionary for Accountants’ by E Kohler (Fifth Edition) which defines ‘lien’ as below:

“The right of the person to satisfy a claim against another by holding the other’s property as security or by seizing and converting the property under procedures provided by law.”

6. The Committee is, therefore, of the view that a lien on assets is exercised by a person who is not the owner of the assets.

7. The Committee notes that para 14 of Accounting Standard (AS) 12 on ‘Accounting for Government Grants’, issued by the Institute of Chartered Accountant of India, requires the following treatment to be made in respect of specific fixed assets acquired out of a Government grant.

“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. Grants related to non-depreciable assets should be credited to capital reserve under this method. However, if a 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.”

8. Based on the above, the Committee is of the following opinion in respect of the issues raised in para 7 of the query:

(i) The fixed assets acquired by utilising the grant should be recorded in the company’s books of account, and should be treated by either of the methods as per para 7 of the opinion.

(ii) Please see (i) above.

(iii) The grant received, to the extent utilised for generating fixed assets, cannot be treated as a revenue expenditure.

(iv) Disclosure should be made as per para 23 of Accounting Standard (AS) 12 on Accounting for Government Grants.

The company should change its relevant accounting policy to make it commensurate with the treatment suggested above. The change in accounting policy should be disclosed as per the requirements of Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India.

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