Query No. 7 Subject: Accounting treatment of subsidy received from state government for repayment of (a) loan taken for acquiring fixed assets and (b) capitalised interest[1]
A. Facts of the Case
1. A public sector company, wholly owned by a state government, was incorporated in 1975 to drill and construct tubewells and lift irrigation (L.I.) systems and to supply water through these tubewells and L.I. systems to the irrigators at subsidised rates fixed by the state government. It was principally agreed by the state government to recoup any loss sustained by the company by providing revenue subsidy. Since the company’s incorporation, the state government has been providing subsidy to it on ad-hoc basis, which has not been sufficient to meet its liabilities. The company has been making losses every year and as on 31.3.1995, its accumulated losses amounted to Rs. 115.23 crore.
2. To meet the capital costs of drilling tubewells and lift irrigation systems, the company had, with the concurrence of the state government, availed of long term credit facilities from National Agricultural Bank for Rural Development (NABARD) to the tune of Rs. 82 crore by 31st March, 1995. The company credited the term loan account on receipt of the loan amount and showed it under ‘Secured Loans’ in the balance sheet.
3. Every year, the state government has been providing subsidy for repayment of NABARD loan through budgetary provision. Upto 31.3.1995, the company had received Rs. 7,007.63 lakh from the state government towards repayment of NABARD loan. The company had considered the said subsidy as capital subsidy and shown the amount under the head ‘Capital Reserves’ in the balance sheet.
4. As per the terms and conditions of the government resolutions for providing subsidy, the company was required to utilise the subsidy to repay NABARD’s loan only and, accordingly, the company utilised the subsidy of Rs. 5,292.51 lakh to repay the said loan upto 31.3.1995.
5. According to the querist, the company had considered the amount of Rs. 5,292.51 lakh as ‘Uncommitted Reserve’ on the basis that the Capital Reserve which had been created for the specific purpose of repaying the NABARD loan had been utilised by the company for that purpose only and, therefore, the amount of Rs. 5,292.51 lakh out of the balance standing in the Capital Reserve had been adjusted against the accumulated losses of Rs. 115.23 crore as at 31.3.1995.
6. The company had also disclosed the above in the notes forming part of the accounts as on 31st March, 1995.
7. Interest paid every year on NABARD loan during the construction period had been capitalised by the company. The state government had also provided subsidy for capitalised interest every year. Upto 31.3.1995, capital subsidy for interest amounting to Rs. 478 lakh had been received by the company. As and when subsidy received from the state government for capitalised interest, it had been credited to ‘Capital Reserve Account’. Against the subsidy, the company had capitalised interest of more than Rs. 478 lakh. In 1994-95, the said amount of Rs. 478 lakh had been adjusted against accumulated losses.
8. The querist has referred to the requirement of Schedule VI to the Companies Act, 1956, that debit balance in profit and loss account should be shown after deducting ‘Uncommitted Reserves’ if any. The querist has also supplied a copy of a legal opinion obtained and relied upon by him.
B. Queries
9. Based on the above facts the querist has sought opinion of the Expert Advisory Committee on the following:
(a) Whether subsidy received for repayment of loan and credited to ‘Capital Reserve’ can be considered as ‘Uncommitted Reserve’ on its utilisation and can be set off against accumulated losses.
(b) Whether subsidy received for capitalised interest from government and credited to ‘Capital Reserve’ can be considered as ‘Uncommitted Reserve’ on its utilisation and set off against accumulated losses.
C. Points Considered by the Committee
10. The Committee notes that paragraphs 3.1, 3.2, 13 and 14 of Accounting Standard (AS) 12, ‘Accounting for Government Grants’, state as follows:
“3.1 Government refers to government, government agencies and similar bodies whether local, national or international.”
“3.2 Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the enterprise.”
“13. Government grants should not be recognised until there is reasonable assurance that (i) the enterprise will comply with the conditions attached to them, and (ii) the grants will be received.”
“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. 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.”
11. The Committee further notes that according to Part III of Schedule VI to the Companies Act, 1956, “the expression ‘Capital Reserve’ shall not include any amount regarded as free for distribution through the profit and loss account; and the expression ‘revenue reserve’ shall mean any reserve other than a capital reserve.”
12. On the basis of paragraphs 3.1 and 3.2 of AS 12 above, the Committee is of the view that the subsidy provided by the state government for repayment of loan to NABARD is in the nature of government grant. As such, the principles enunciated in AS 12 would apply in the present case.
13. The Committee is further of the view that as the subsidy has already been received and has been utilised for repayment of loan to NABARD, the conditions for recognising government grants as laid down in paragraph 13 of AS 12 are satisfied. Therefore, the subsidy received from the state government should be recognised.
14. The Committee is of the view that the subsidy received for repayment of loan taken from NABARD to meet the capital cost of drilling tubewells and lift irrigation systems is of the nature of government grant related to a specific fixed asset. Similarly, the subsidy received for payment of capitalised interest is also of the nature of a government grant related to a specific fixed asset.
15. It would be seen that AS 12 requires that government grants related to specific fixed asset should be presented in the balance sheet by showing the grant as deduction from the gross book value of the asset concerned or by presenting the grant as deferred income to be recognised in the profit and loss account on a systematic and rational basis over the useful life of the asset. AS 12 does not permit the crediting of grants of the aforesaid nature to capital reserve.
16. As the accounting treatment followed by the company is not in accordance with AS 12, appropriate adjustments will need to be made to bring the accounting treatment in line with the requirements of AS 12. To the extent such adjustments result in write-back of depreciation to profit and loss account or in transfer of an amount from deferred income to profit and loss account, they will constitute a prior period item and accordingly, they will have to be disclosed as per Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’.
D. Opinion
17. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9:
(a) The subsidy received for repayment of loan should have been credited to deferred income or deducted from the gross book value of the asset concerned. Its credit to capital reserve is not appropriate. Further, the credit to the deferred income account cannot be utilised for set off against accumulated losses.
(b) Same as (a) above.
[1]Opinion finalised by the Committee on 13.8.1998.
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