Government Grant – PAS 20

Government Grant/Subsidy – it is defined as an assistance by government in the

form of transfer of resources to an entity in return for part or future compliance
with certain conditions relating to the operating activities of the entity.
 Recognition and measurement
1) When should it be recognized in the financial statements?
a. When it becomes receivable – not necessarily received, because the proper
accounting is accrual accounting, right?
b. The entity will comply with the conditions relating to the grant
 So basically, before a grant can be recognized in the financial statements, the
entity’s intention should be to comply with the requirements and the grant
should be receivable.

2) How should it be recognized in the financial statements? – Its way of recognition

depends upon the nature of the grant; does the grant relate to an asset? Or does it
relate to income?

a. Grant related to an asset – this means that the grant entails acquisition or
construction of a long-term asset (e.g., PPE, intangibles, etc.)
i. Deducted from asset – this means that the related grant is deducted
from the capitalized cost of the asset. Note: What is the effect of this?
The grant is recognized as income in such a way that future
depreciation charges are lessened.
ii. A liability is set up – in this way, a “deferred grant income” is
recognized initially. As the asset is being realized through
depreciation/amortization, the “deferred grant income” account is
being realized as well in the same manner.
Example: On January 1, 200x, a condominium corporation received 15,000,000
from the Philippine Government to construct a 5-storey building to house the
increasing number of homeless families. Assuming that the cost of construction of
the building was 25,000,000 and it’s useful life was estimated to be 20 years.
Deduction from asset approach:
Building 25,000,000
Cash 25,000,000
To recognize the cost of the building
Cash 15,000,000
 Building 15,000,000
To recognize receipt of the grant

Depreciation 500,000 ([25M – 15M] / 20 years)

Accum. Dep’n – Bldg. 500,000
To recognize depreciation
Liability set up approach:
Building 25,000,000
Cash 25,000,000
To recognize the cost of the building

Cash 15,000,000
Deferred grant income 15,000,000
To recognize receipt of the grant

Depreciation 1,250,000 (25M / 20 years)

Accum. Dep’n – Bldg. 1,250,000
To recognize depreciation

Deferred Grant Income 750,000 (20M / 20 years)

Grant Income 750,000
To realize deferred grant income
Note: Observe that under the first approach, the grant is recognized through
decreased depreciation. Under the second approach, the grant is recognized as income
as the asset is being depreciated or as the economic benefit of the asset is being
realized. It is noteworthy as well that the effect of the grant on the P/L of the company
would be the same under any approach.

b. Grant related to income – this means that the grant could be directly related
to the operation of the entity, the grant entails incurrence of expenses, or any
other activities other than the recognition of a long-term asset.
 Example: On January 1, 200x, a condominium corporation received 15,000,000
from the Philippine Government in the condition that it should let 100 homeless
families to live in one of its buildings for 5 years starting June 30, 200x.

Cash 15,000,000
Deferred grant income 15,000,000
To recognize receipt of the grant

Dec. 31, 200x when the entity prepares it FS, it should recognize grant income in its
Statement of Comprehensive income as other income.
Deferred grant income 1,500,000 ([15M /5 years] x one-half)
Grant income 1,500,000
 Grant becomes repayable – a grant can become repayable when the beneficiary
entity fails to fulfill the conditions relating to the grant.

1) Accounting for government grant that becomes repayable – the concept of

accounting for the government grant in this situation is very simple, basically, at
the time the grant becomes repayable, all income recognized in the prior
periods or all expense that should have been recognized in the prior
periods had the company did not receive the grant should be recognized
immediately.
Using the examples earlier:
1) Grant related to asset
Example: On January 1, 200x, a condominium corporation received 15,000,000
from the Philippine Government to construct a 5-storey building to house the
increasing number of homeless families. Assuming that the cost of construction of
the building was 25,000,000 and it’s useful life was estimated to be 20 years.
Deduction from asset approach:
Building 25,000,000
Cash 25,000,000
To recognize the cost of the building
Cash 15,000,000
Building 15,000,000
 To recognize receipt of the grant

Depreciation 500,000 ([25M – 15M] / 20 years)

Accum. Dep’n – Bldg. 500,000
To recognize depreciation

Assuming that the grant becomes repayable during the second year:
Building 500,000
Cash 500,000
Repayment of the grant

Depreciation 2,000,000
Accum. Dep’n – Bldg. 2,000,000
To record depreciation
Computation:
New cost 25M
Should-be AD 2.5M ([25M/20] x 2 years)
CA of AD 500k
Depreciation 2M (2.5M – 500k)

Depreciation in the future:

Depreciation 1,250,000 (22.5M/18) or (25M/20)
Accum. Dep’n – Bldg. 1,250,000
To record depreciation (back to normal)
Computation:
New Cost 25M
AD 2.5M
CA 22.5M
Liability set up approach:
Building 25,000,000
Cash 25,000,000
To recognize the cost of the building

Cash 15,000,000
Deferred grant income 15,000,000
To recognize receipt of the grant

Depreciation 1,250,000 (25M / 20 years)

Accum. Dep’n – Bldg. 1,250,000
To recognize depreciation

Deferred Grant Income 750,000 (20M / 20 years)

Grant Income 750,000
To realize deferred grant income

Assuming that the grant becomes repayable during the second year:
Deferred Grant Income 4,250,000 (5M-750k)
Loss on repayment of grant 750,000 (recognized last year)
Cash 5,000,000
2) Grant related to income – the accounting for the repayment of a grant related to
income is the same as the accounting for a grant related to an asset

Land and Building

1) Unusually capitalizable items
a. Land
i. Mortgage/assumed liabilities
 ii. Unpaid taxes (e.g., unpaid real property taxes assumed by the buyer
up to the date of acquisition)
iii. Option to buy land
iv. Payments to tenants to force them to vacate the land that is done to
prepare the land for its intended use
v. Special Assessments – Government charges for improvements done
that benefits the entity
vi. Land improvements which are not depreciable (e.g., cost of
grading, levelling, landfill, etc.) Depreciable land improvements are
capitalized to “Land improvements”
b. Building
i. Purchase
1. Mortgage/assumed liabilities
2. Unpaid taxes (e.g., unpaid real property taxes assumed by the
buyer up to the date of acquisition)
3. Payments to tenants to force them to vacate the building
ii. Constructed
1. Cost of temporary fences (Permanent fences are treated as
Land Improvements)
2. Sidewalks, Pavements, Parking lots, Driveways
a. Part of blueprint of the building – charged to
building account
b. Not part of the blueprint of the building – charged
to land improvements
3. Claims for damages – while insurance for construction
uncertainties can be capitalized as cost of the building being
constructed, claims for damages arising from certain
unfortunate events that are payable by the entity because it
lacks insurance policies, shall not be capitalized. As Valix
said, to capitalize would be tantamount to the concealment
of management negligence.
4. Ventilating systems, lighting systems, elevators
a. Installed during construction – capitalized to building
b. Installed after construction – charged to building
improvements
5. Building fixtures – cabinets, partitions, shelves
a. Immovable – charged to building
b. Movable – charged to furniture and fixtures

 PIC Interpretation - when land and an old building are acquired at a single cost
1) Acquisition cost
a. Old building is usable – allocate the cost based on fair value
b. Old building is unusable – allocate the cost only to land
 2) Usable old building is demolished immediately after acquisition or
during the same reporting period to make room for the construction of a new
building:
a. Allocated cost to the usable old building shall be treated as follows:
i. New building will be inventory – capitalize
ii. New building will be PPE or IP – recognize as loss
b. Net demolition cost - capitalize as cost of the new building
3) Usable old building was demolished during the period subsequent to the
period of acquisition to make room for the construction of a new building:
a. Allocated cost to the usable old building shall be treated as follows:
i. New building will be inventory/PPE/IP – recognize as loss
ii. Net demolition cost – capitalize as cost of the new building
For more detailed reference: http://www.picpa.com.ph/attachment/630201616634522.pdf

Machinery
1) Capitalizable costs
a. Purchase price
b. Directly attributable costs (freight, installation, testing and trial costs, etc.)
c. Initial estimate of cost of dismantling – the entity has present obligation
d. Irrecoverable taxes
2) Removal cost
a. When a machinery is moved to another location, undepreciated cost of the
old installation cost shall be expensed and the new installation cost shall be
capitalized
b. When a machinery is retired to make room for a new one, removal cost not
previously capitalized should be expensed and not be capitalized as cost of
the new machine.

Subsequent Costs of PPE

Gist – Subsequent costs shall only be capitalized if these costs will add future
economic benefit of the asset in such a way that it can increase the service potential
of the asset. Just ask yourself these two questions: 1) Is this cost necessary to bring the
asset in its present condition or location? 2) Will this cost increase the service potential
of the asset?
1) Addition - capitalized
2) Improvements or betterments – normally capitalized
3) Replacements
a. Major replacement
 i. The replaced part is separately identifiable – the CA amount of
the replaced part should be written off as a loss and the
replacement part should be capitalized.
Example: The engine of the 2 year-old BMW of entity A had to be replaced after an
accident that occurred along SLEX because the driver was taking a selfie while driving
at a speed of 80kph. The BMW was purchased for 2M that was estimated to have a useful
life of 10 years and the engine was identified to have a carrying amount of 200,000. The
cost of the new engine was 300,000.
Accumulated Depreciation 75,000 ([300,000/8 years] x 2 years)
Loss 300,000 (carrying amount)
BMW 375,000 ([300,000/8 years] x 10 years)

10 years – total useful life

8 years – remaining useful life
2 years – age of BMW
ii. The replaced part is not separately identifiable – the present
value of the replacement cost is assumed to be the cost of the
replaced part.
In this case, assume that the proper discount rate is 6% and the present value of 1 for 2
years is 0.8899; the entry would be:
Accumulated Depreciation 53,394 (300,000 x 2/10)
Loss 213,576 (300,000 x 8/10)
BMW 266,970 (300,000 x 0.8899)

b. Minor replacement – expensed outright

4) Repairs
a. Major repair - capitalized
b. Minor repair – expensed outright
5) Rearrangement costs – capitalized only when the rearrangement will increase
the service potential of the asset.

Borrowing costs – basically, the standard required capitalization of interest

expense in certain situations.
 Which interest expense? – ALL (e.g., interest expense calculated using effective
interest method, finance charge on a finance lease, other ancillary costs,
increase/decrease in interest due to forex)
 What’s the catch?

 The asset to which borrowing costs will be capitalized must be that of a

“qualifying asset”
 Qualifying asset is an asset that takes time to get ready for intended use. (e.g.,
construction of plant, intangible asset that requires extensive research and
development, etc.)
 The assets are not one of the ff:
1. Assets measured at fair value
2. Inventories manufactured on a repetitive basis
3. Assets that are ready for its intended use upon acquisition

 Types of borrowings
 General borrowing – borrowings that are used to finance the qualifying asset
and other purposes.
 Specific borrowing – borrowing solely devoted to finance the qualifying
asset.
 Accounting for borrowing cost
1. Compute the average expenditures
2. Capitalize total interest cost incurred pertaining to specific borrowing less
any investment income.
3. Deduct the principal pertaining to the specific borrowing from the average
expenditures.
4. Compute the average interest rate
5. Multiply the remaining average expenditures by the average interest rate.
Ignore any investment income earned from general borrowings and make
sure the product is not higher than the actual interest incurred.
6. In the event of completion of the qualifying asset, make sure to limit the
computation of the interest only up to the completion of the asset. For example,
the asset is completed by June 30, capitalize interest using a period of 6/12.
Average expenditures is computed just like computing the average capital. Remember
our partnership topics during our first year?
Average interest rate involves only general borrowings. It is computed by getting the
total interest expense and dividing it by the total principal.

Impairment of Assets
 Impairment – occurs when recoverable amount is less than the carrying
amount. Impairment loss is recognized in P/L.
  Recoverable amount – the higher between fair value less cost of disposal
and value in use
 Fair value less cost of disposal – this is the economic benefit of
disposing/selling the asset.
 Value in use – this is the economic benefit of continuing to use the asset.
 Hence, the higher between the two is the recoverable amount.
 As a rule, impairment should be assessed per individual asset, but when it
cannot be determined, the smallest identifiable group of assets can be
assessed collectively.
 That smallest identifiable group of assets is called the “Cash Generating
Unit”
 The procedure is to get the carrying amount of the CGU, excluding any
liability within the CGU, and then compare it to the recoverable amount of
the CGU.
 Allocate any impairment first to the goodwill and then to the other assets
within the CGU based on their carrying amount.
 However, if the recoverable amount of a specific asset is given, the carrying
amount of that specific asset (after allocation of the remaining impairment)
should not be lower than the given recoverable amount. The amount in
excess of the recoverable amount should be allocated again to the other
assets based on their original carrying amount.

 Rules on reversals of impairment

 PPE at cost model – any gain on reversal of impairment should not exceed the
“would have been” carrying amount of the asset “had there been no
impairment.” Hence, you should compute carrying amount first based on the
original cost and then compare it to the new recoverable amount. If the new
recoverable amount of the asset as a result of such reversal of impairment
exceeds the “would have been” carrying amount, use the “would have been”
carrying amount as your new carrying amount.
 PPE at revaluation model
1. Any impairment loss should be debited first to “Carrying amount” of
the revaluation surplus. By carrying amount, it means that the amount
after the appropriate realization.
2. Any gain on reversal of impairment loss should only be recognized up to
the extent of the “total impairment loss previously recognized”.
And the excess should be credited to Revaluation surplus.

Depletion – It’s like depreciating through “output of production” method in such a

way that it’s also a systematic allocation of the cost of an asset based on the production
during the year. The only difference is that the cost being allocated is the cost of the
wasting asset.

 Costs of the wasting asset

 Acquisition cost – it is the price paid to acquire the property containing the
natural resource. If there is a residual land value, it should be deducted from
the cost of the wasting asset to get the depletable amount.
 Exploration cost – these are costs incurred when the entity search for natural
resources that can be extracted. In practice, there are two ways to account for
it:
1. Full cost method – All exploration costs, whether resulted in the
discovery of a commercially viable natural resources or not, will be
capitalized.
2. Successful effort method – only those exploration costs which resulted
in the discovery of commercially viable natural resources are capitalized.
 Evaluation cost – these are costs incurred after discovering natural resources
and the entity now evaluates if these are commercially viable
 Development cost – After ascertaining that the natural resources discovered
are commercially viable, they now start extracting or exploiting the natural
resources.
 Estimated restoration cost – this is the estimated restoration cost after such
extraction is done, to which the entity has a present obligation.

 Procedure of depletion
 First is to compute for the depletion rate. This is the formula of computing the
depletion rate:
DR = Cost of wasting asset – Land RV / Expected units to be extracted
 Multiply the depletion rate to the actual units extracted during the year to get
the depletion for the year.
 Total Depletion = DR x units extracted
 Depletion charged to COS = DR x units sold
 Depletion in ending inventory = DR x units in ending inventory
 Any revision of depletion rate shall be accounted for prospectively.

 Depreciation of a tangible mining property

 Movable or can be used in other extraction projects – depreciation should be
based on the useful life of the asset.
  Immovable or can only be used in the current extraction project - depreciation
should be based on the useful life of the asset or the expected period of
extraction, whichever is shorter.

 In a period of shutdown or stoppage of mining operations

 The depreciation should be based on the useful life of the property using the
straight line method. After all, the property still depreciates, just not by use, but
through passage of time.

 Wasting asset doctrine

 Under the trust fund doctrine, the capital contributed of the owners should not
be returned prematurely to protect the interest of the creditors of the entity.
However, there is an exception to that rule when the entity is a wasting asset
entity.
 The maximum dividend that can be distributed to the owners can be computed
as follows:
Retained Earnings, Unappropriated xxx
Accumulated Depletion xxx
Capital distributed during the prior years (xxx)
Depletion in ending inventory (unrealized) (xxx)
Maximum dividend xxx
 The reason is that there is no point in retaining the funds because the amount
of “accumulated depletion” account can no longer be “reinvested” to obtain
more returns since the product of the company, that is natural resource, is
irreplaceable.