Group 12 Assignment IAS 20 Government Grants

Q.Self Test Question 1 There are two methods which could be used to account for government grants, and the arguments for each are given in HKAS 20. (a) Capital Approach : the grant is recognized outside profit or loss. (b) Income Approach : the grant is recognized in profit or loss over one or more periods. Required: What are the different arguments used in support of each method?

Answer: Q.Self Test Question 1 1.Capital approach (a) government grants are a financing device and should be dealt with as such in the statement of financial position rather than be recognised in profit or loss to offset the items of expense that they finance. Because no repayment is expected, such grants should be recognised outside profit or loss. (b) it is inappropriate to recognise government grants in profit or loss, because they are not earned but represent an incentive provided by government without related costs.

Answer: Q.Self Test Question 1 Income approach (a) because government grants are NOT receipts from a source other than shareholders, they should not be recognised directly in equity but should be recognised in profit or loss in appropriate periods. (b) government grants are rarely gratuitous. The entity earns them through compliance with their conditions and meeting the envisaged obligations. They should therefore be recognised in profit or loss over the periods in which the entity recognises as expenses the related costs for which the grant is intended to compensate. (c) because income and other taxes are expenses, it is logical to deal also with government grants, which are an extension of fiscal policies, in profit or loss.

Q.Self Test Question 2 On 1 January 20X8, Xenon Co. purchased a non-current asset-FP for cash of $100,000 and received a grant of $20,000 towards the cost of asset. Xenon Co’s accounting policy is to treat the grant for deferred income (LIABILITY).The asset has a useful life of 5 years. Show the accounting entries to record the asset and the grant in the year ended 31 December 20X8.

Answer:Self Test Question 2 On 1 Jan 20X8: Dr. non-current asset $100,000 Cr. Cash $80,000 ($100,000-Dr.$20,000) Cr. deferred income-FP $20,000 at the year end 31Dec 20X8: Dr. Depreciation ($100,000/5) –I/S $20,000 Cr Accumulate depreciation -FP $20,000 Dr. Deferred income ($20,000/5years)-FP $4,000 Cr. Operating expense-I/S $4,000 the Net effect is am expense $16,000

Q.3 Accounting for grants related to assets A company receives a 20% grant towards the cost of a new item of machinery, which cost $300,000. The machinery has an expected life of 4 years and nil residual value. The expected profits of the company,before accounting for depreciation on the new machine or the grant, amount to $100,000 per annum in each year of the machinery life. State 1)Double entries for 4 years and 2) I/S and 3) FP for 4 years respectively and use the method: 1) reduce the cost of asset directly and 2) treat the grant as deferred income respectively.

Answer: Q3(double entry) Dr. Machinery $300,000 Cr. Cash[$300,000x(1-0.2)] $300,000 Cr. Machinery $60,000 Dr. Cash($300,000x0.2) $60,000 1 st year: Dr. Depreciation Expense ($240,000/4) $60,000(I/S) Cr. Accumulate depreciation $60,000 (FP)

Answer:Q3 (double entry) 2 nd year: Dr. Depreciation Expense($240,000/4) $60,000(I/S) Cr. Accumulate depreciation $60,000 (FP) 3 rd year: Dr. Depreciation Expense($240,000/4) $60,000(I/S) Cr. Accumulate depreciation $60,000 (FP) 4 th year: Dr. Depreciation Expense($240,000/4) $60,000(I/S) Cr. Accumulate depreciation $60,000 (FP)

Answer:Q3 (double entry) (A)Reducing the cost of the asset Year 1Year 2Year 3Year 4 Profits Profits before depreciation 100, , , ,000 Depreciation (60,000) (60,000) (60,000) (60,000) Profit 40,000 40,000 40,000 40,000 FP: Non current asset at cost 240, , , ,000 Depreciation (60,000) (120,000) (180,000) (240,000) Carrying amount: 180, ,000 60,000 0 (A)Treating the grants as deferred income

Answer:Q3 2)Treating the grant as deferred income: Year1 year2 year3 year4 total profit before grant and depreciation: 100, , , , ,000 depreciation (75,000) (75,000) (75,000) (75,000) (300,000) Grant 15, , , , ,000 Profit 40,000 40,000 40,000 40, ,000 Statement of FP: non-current asset 300, , , ,000 depreciation (75,000) (150,000) (225,000) (300,000) carrying amount 225, , ,000 0 Liability Government Grant deferred income 45,000 35,000 15,000 0 ( 300,000*0.2)-(300,000*0.2/4) (300,000*0.2)-(300,000*0.2/4x2yrs ) (300,000*0.2)-(300,000*0.2/4x3yrs )

Q.4 Exam Practice:PMT and WT Peak Medical Technology Corporation (‘PMT’) conducts research and product development for an anaesthetic injection under contract with WY Corporation (‘WY’), a pharmaceutical company. The research and development contract requires that WY pays PMT an up-front amount of $1.5 million when the contract is signed, $ 2 million upon the successful trials, and $1.5million upon the delivery of the first pilot unit of the injection. All payment are non-refundable. The total cost of completion of the project is estimated to be $3 million. PMT has invested $25 million in equipment for its research and development center, which has anticipated useful life of 8 years. Depreciation is charged on straight-line basis. In the period of acquisition, PMT has received a government grant of $10 million towards purchase of the equipment, which is conditional on certain employment targets being achieved within the next 4 years. Determine how PMT should recognize and measure the government grant by reference to the relevant accounting standards. (HKICPA May 2007)

Answer:4 Exam Practice:PMT and WT Since it is easy for the company to complete the project successfully, therefore it can be measured as a kind of income otherwise, we have to ignore the fund.

Answer:4 Exam Practice:PMT and WT (correct) Option 1: Set up deferred income :$10,000,000 and amortized it over eight years on a straight line basis. Option 2: Deduct government grant of $10,000,000 in arriving at the carrying amount of the equipment. The initial amount of the equipment would be $15m ($25m-$10m) = $15m.