Query No. 8

Subject: Accounting treatment of government grant received from State Government for repayment of term loans/bonds.[1]

A. Facts of the Case

1. A company (hereinafter referred to as the ‘company’), is incorporated under the Companies Act, 1956. The authorised share capital of the company is Rs. 12,000 crore. The subscribed and paid-up capital is Rs. 6,987.00 crore at 31.3.2012. The entire share capital is held by the State Government and the State Financial Corporation.

2. The querist has stated that the main objective of the company is execution of the Multipurpose Irrigation Project (hereinafter referred to as ‘the project’) together with rehabilitation and resettlement of the project affected people. The company was formed in the year 1994 and commenced its business with effect from 14.1.1995. The assets of the project which were then being implemented by the Water Resources Department of the State Government along with selected liabilities were transferred to the company on 14.11.1995. Further works were carried out by the company. The project is now substantially complete. The expenditures incurred on the project have been capitalised in the books of account of the company. The project cost has been partially funded by budgetary support from the State Government and partially by borrowed funds, i.e., bonds from investors and term loans from banks and financial institutions.

3. The querist has also stated that the company does not have operational income from the core assets. As such, as per the tripartite agreement entered into between the trustees to the bondholders, the company and the State Government, having guaranteed the repayment, the State Government has been funding the debt obligation through its budgetary support. The funds are released under the nomenclature ‘for debt servicing’ as per the actual requirement furnished to the Government with the break-up of principal and interest.

4. The money released towards payment of interest component of the repayment is recognised as income in the accounts and set off against the interest paid. Component of the grants received towards principal repayment is being accounted under the head ‘Reserves & Surplus – capital reserves’, keeping in view the provisions of Accounting Standard (AS) 12, ‘Accounting for Government Grants’.

5. The accounting policy adopted by the company with regard to ‘government grants’ as related to debt servicing is reproduced below:

“Government grants received for meeting specific debt obligation are bifurcated as grants for principal and interest. The grants for meeting principal repayment are treated as capital reserves. The grants for interest payments are accounted as income.”

6. While conducting audit of the accounts of the company for the year ended 31.3.2011, the Comptroller Auditor and General (C&AG) had observed as follows:

“The company has raised external borrowings from the market against the guarantee of the State Government. Out of these borrowings, the company created assets and the same had been capitalised in the books of account. However, in the absence of operational income from its core assets, the State Government has been servicing both the installment of principal and interest. While the repayment of interest installment is being recognised as income in the accounts and set off against the finance charges paid, the principal repayment is being treated as capital reserve. As a result, as on 31.3.2011, the company had accumulated capital reserve of Rs. 3,334.75 crore. As the loan was borrowed for creation of fixed assets, the amount should have been appropriated towards fixed assets as per AS 12. However, in the absence of identification of the amount received towards specific asset, the company did not appropriate the grant amount. As the policy is in contravention of AS 12, it is requested that the company should formulate a system to identify the assets created out of each borrowing so as to enable appropriation of the grant received from the State Government for servicing the loan against the assets created out of that loan amount. The policy may also be modified suitably to appropriate such unspecified capital grant/reserve in order to present a true and fair view of the accounts.”

7. The company’s justification for adopting the accounting policy indicated in paragraph 5 above is as follows:

“7.1. The State Government was releasing funds to the company for works bills payment, debt servicing and other expenses till the year 2005-06 as contribution towards ‘Share Capital’(emphasis supplied by the querist). The company had allotted equity shares to the Government against the said releases. The company was preparing ‘Expenditure During Construction Period (pending capitalisation) Account’ up to the year 2006-07 as the project had not been substantially completed.

7.2. The company had borrowed funds through bonds and loans for project expenditure from the year 1995-96 onwards till the year 2006-07. From the year 2007-08, the Government is releasing funds for capital works as grants while earlier to this period the amount was being released as equity share capital and hence, accounted under advance against equity.

7.3. In the observations of the Accountant General, it is suggested to identify the assets created out of each borrowing and appropriate grant received from the Government for repayment of debts against each asset by deducting the same from the value of assets created. By doing so, the value of the fixed assets will become zero. There is also difference between the time of creation of assets and the repayment of the principal of the loan/Bonds. In view of the above, the company has accounted the funds received from Government for repayment of bonds and loans under capital reserve instead of advance against equity considering it as shareholders’ funds. Further, it is not possible to identify assets created against each borrowings as borrowed funds are pooled with other funds and released to project offices for payment of bills for creation of various assets and as such, the funds received from the Government for repayment of debts cannot be identified against specific assets, while the grants received for capital expenditure have been netted of against each asset.

7.4. Further, since the company is not earning any profits, the bonds/loans cannot be repaid out of own cash flows. In this scenario, the owners of the company, i.e., the State Government is replacing the debts from their own funds. Hence, the amount received from the State Government, being the promoters of the company, for repayment of principal loan amount is to be treated as contribution from the promoters. Therefore, it is rightly accounted under capital reserves, and reckoned as a part of the shareholder’s funds. The grant received from Government is in the nature of promoters’ contribution and treated as a part of shareholders’ funds as per paragraph 16 of AS 12 which states as follows:

“Government grants of the nature of promoters’ contribution should be credited to capital reserve and treated as a part of shareholders’ funds.”

 

B. Query

8. In the above context, the querist has sought the opinion of the Expert Advisory Committee with regard to the following issues:

(i) Whether the money received from the Government for servicing the principal repayment be treated at par with promoters’ contribution.
(ii) Whether the accounting policy adopted by the company, as stated in paragraph 5 above, is in violation of the provisions of AS 12.
(iii) If the above is so, what accounting policy should the company adopt for the financial year 2012-13 for accounting for grants received from the Government for repayment of principal debt?

C. Points considered by the Committee

9. The Committee notes that the basic issue raised in the query relates to accounting treatment of grant received from the year 2007-08 onwards from the State Government, which also holds majority shares in the company, for repayment of principal amount of term loans/bonds that were taken for the creation of fixed assets or construction of the project. The Committee has, therefore, considered only this issue and has not examined any other issue arising from the Facts of the Case, such as, appropriateness of recognition of expenditure incurred on the project as well as that incurred on rehabilitation and resettlement of the project affected people as the cost of the project, appropriateness of preparation of ‘Expenditure During Construction Period (pending capitalisation) Account’ till the project had not been substantially completed, accounting for grant received for repayment of interest on term loans/bonds, recognition of borrowing costs, i.e., interest on term loans/bonds borrowed for the project, etc.

10. As regards accounting for the grant/contribution received from the Government, the Committee notes that although the amount received has been described as grant but the Government holds majority of the shares of the company. Thus, the Committee is of the view that its accounting would depend on whether the amount received is in nature of grant or contribution as owner. In this context, the Committee notes paragraph 2 of Accounting Standard (AS) 12, ‘Accounting for Government Grants’, which provides the scope of AS 12 as follows:

“2. This Standard does not deal with:
(i) …
(ii) government assistance other than in the form of government grants;
(iii) government participation in the ownership of the enterprise.”

The Committee further notes clause 4.6 of the Tripartite Agreement between the company, the State government and the Trustees of the bondholders (provided separately by the querist for the perusal of the Committee), which provides as follows:

“In the circumstances recited above, the company has requested the State Government to enter into this agreement with a view to provide for various matters and contractual obligations of the State Government to make available and to provide budgetary support to the company as may be required for the purpose of facilitating and enabling, if necessary, the company to make payments of principal, interest and other charges and expenses in relation to the said Bonds. The State Government in its capacity as the majority shareholder of the company, and being the principal sponsoring party in relation to the Irrigation Projects executed, operated and maintained by the company, has agreed to enter into and execute this Agreement and has permitted the company to make certain representations in the Offer Documents.”

From the above, it is clear that the Government while giving guarantee to the bond holders for payment of interest and repayment of principal amount of the bond is acting in the capacity of the majority shareholder and principal sponsoring party for the Irrigation Project. In other words, the Government is providing financial support through budgetary allocation to the company for repayment of debt/bonds. Since the company has no operational income, the Government is contributing the money as the owner of the company. It is also evident from the Facts of the Case that the company is receiving non-refundable funds from its owner, i.e., State Government, without any consideration or reference to the total investment in the undertaking or towards total capital outlay as it generally happens when Government provides grants in the nature of promoter’s contribution under AS 12. Further, such funds provided are also not meant for the acquisition/construction /creation of any specific fixed asset or infrastructure facility which is the case of grants related to specific fixed assets under AS 12. Thus, the Government, in the extant case, being owner, is coming to assist the company to avoid failure of repayment of its dues and obligations relating to loans. Accordingly, the Committee is of the view that though, the Government may term the funds given to the company as ‘grant’, in ‘substance’, these are owner’s contribution. Hence, the funds given should not be recognised in accordance with AS 12. In this regard, the Committee notes that paragraph 17 of Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’ recognises ‘substance over form’ as one of the major considerations governing the selection and application of accounting policies. The Standard describes ‘substance over form’ as follows:

“The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form.”

From the above, the Committee is of the view that the accounting treatment should be governed by the substance of the transactions and events and not by their legal form. Accordingly, in the extant case, the funds provided by the Government should be accounted for as ‘contribution from owners’ and not as government grant.

11. For accounting treatment of contribution in the capacity of owners, the Committee notes paragraph 69(a) of the Framework for the Preparation and Presentation of Financial Statements (hereinafter referred to as the ‘Framework’, issued by the Institute of Chartered Accountants of India (ICAI) states as follows:

“(a) Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.”

From the above, the Committee is of the view that funds provided by the Government, in the capacity of owners, is a contribution from an equity participant and accordingly it should not be accounted for as ‘income’ in the financial statements of the company. It should be accounted as equity only. However, the Committee notes from the Facts of the Case that against the funds provided by the Government, no shares have been issued to the Government and accordingly, these cannot be classified as ‘Share Capital’ of the company. The Committee also notes that these funds are receipts of the company which are to be utilised by the management as per the directions of the Government for a specific purpose, viz., repayment of debts. The Committee further notes the definitions of the terms, ‘reserve’ and ‘capital reserve’ as per the Guidance Note on Terms Used in Financial Statements as follows:

Guidance Note
“14.04 Reserve
The portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for depreciation or diminution in the value of assets or for a known liability. The reserves are primarily of two types: capital reserves and revenue reserves.”

“3.10 Capital Reserve
A reserve of a corporate enterprise which is not available for distribution as dividend.”

On the basis of the above and considering the Facts of the Case, the Committee is of the view that such funds are of the nature of ‘reserve’. Since these receipts are used only for a specific purpose and are not available for distribution as dividend. Accordingly, these should be credited to ‘capital reserve’.

D.  Opinion

12.  On the basis of the above, the Committee is of the opinion on the issues raised in paragraph 8 above as under:

(i) & (ii) The contribution made by the State Government is not a government grant as discussed in paragraph 10 above and accordingly, the provisions of AS 12 would not be applicable.
(iii) The funds provided by the Government are of the nature of owner’s contribution and accordingly, these should be credited to ‘capital reserve’, as discussed in paragraph 11 above.

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[1] Opinion finalised by the Committee on 21.5.2013 and 22.5.2013.