Government – national, local, or beyond one’s shores, such as the EU through various schemes – often grant certain incentives to businesses, particularly when there is a strategy to promote or to provide some form of assistance to one of more specific sectors.
Some common examples might include capital
grants through which the outlay for a long term
investment is subsidised, or the subsidisation
of certain expenses, for instance where a
government or government agency covers a
proportion of apprenticeship wages. You find yourself in
the right place if you would to understand the accounting
implications of certain types of those incentives. The
below discussions are relevant both to the IFRS accounting
framework, as well as to Maltese GAAP (GAPSME).
I just start off the discussion with a fundamental accounting
concept: the accruals concept. Applying this concept
means that income is recognised when the event or
transaction giving rise to that income takes place, even if
cash is collected at a different date. Taking an example, let
us say that:
• a hotel collected cash in February, upon accepting a
booking for a 1 week stay,
• the stay takes place in June,
• one of the costs the hotel incurs is laundry, which the
hotel outsources to a third party, and on which it negotiates
a 3-month credit period with the supplier
In the above example, the hotel collected cash from its
customer in February, and will pay the laundry supplier in
September. Under the accruals concept, both the income
and the expense are recognised when the respective
services are given or received, i.e. in June. Between
February and June, the cash received from the customer is
recognised as a liability in the balance sheet (representing
the obligation towards the customer to provide
accommodation in June). Similarly, the laundry expense
will be recognised in June, and a liability will be recognised
at that date (the liability represents the obligation to pay
the supplier for a service that was already received).
by-product of the accruals concept, one also gets what is
referred to as ‘matching’, whereby the income and expenses
for activities happening in June are all matched together in
the same accounting period’s income statement, even if the
related cash is received or paid at different points in time.
‘Matching’ is also the concept that underlies the
accounting requirements for government incentives.
When a government provides some form of a subsidy, the
accounting standards’ objective is to match the subsidy in
one’s income statement to the same period in which the
subsidised cost is recognised as a cost.
Taking as an example a situation where a government
subsidises an operating cost (rather than a long term investment), such as apprenticeship wages, or the cost of providing training to personnel, or the cost of a short term rent, that subsidy is recognised in the income statement when the related expense is also recognised (i.e. when the apprentice works and earns a wage, the training is delivered, etc). Having determined the timing of when the subsidy is recognised, accounting standards allow an entity a choice on how to present that grant in the income statement. Entities may either present the grant as an offset against the expense, or alternatively present it as ‘other income’. Assuming that the unsubsidised cost is of €1,000, and the government subsidises 30% of that cost, entities may either present the net cost of €700, or may alternatively present the expense at the gross cost of €1,000, and match it with ‘other income’ of €300. Either way, given that the amounts are recognised in the same accounting period, the net accounting result is the same.
The matching concept applies equally when a government subsidises the cost of a long term investment. A key difference in this case is that long term assets are not generally expenses in the income statement when purchased; rather, the expense is spread over the period of time over which the asset will be used. Taking a simplistic example, let’s say that a restaurant purchases kitchen equipment for €10,000 and expects to be able to use the equipment over a period of 10 years (at which point in time the equipment will be scrapped and replaced). In this case, the investment of €10,000 is initially recognised as an asset, and subsequently an expense of €1,000 is recognised in the income statement in each of those 10 years. In accounting terms, that annual expense of €1,000 is called ‘depreciation’.
Extending the example to say that 30% of the cost is subsidised by a government agency, the accounting rules also allow entities a choice between:
• initially presenting the asset at the net cost of €7,000 – in this case, the annual depreciation charge over the 10 year life will amount to €700; or alternatively
• presenting the asset at the gross cost of €10,000, and presenting the subsidy of €3,000 within liabilities – in this case, the annual depreciation charge will amount to €1,000 and, following the matching concept, the subsidy of €3,000 will be recognised as income over the same 10 year life, i.e. €300 annually.
Whichever approach the restaurant adopts, the net annual cost in any given year will amount to the same €700.
It is important to bear in mind that the accounting rules also address other aspects of government assistance that are not covered in this article, such as what happens when conditions need to be satisfied in order to qualify for assistance, and it is not certain whether those conditions will actually be satisfied. Although the discussion in this article is not exhaustive, with other considerations being necessary for a complete accounting assessment – including the accounting for other forms of government assistance such as loans at a subsidised rate of interest, or tax credits – we have focused on some common types of assistance and the accounting options available.
One final consideration is that the discussion in this article is limited to accounting implications; one may also need to consider whether there may exist any tax or other implications that would also need to be addressed. That said, let’s get accounting!