Derringdo (2.

5 6/03 part)

16 mins

Derringdo acquired an item of plant at a gross cost of $800,000 on 1 October 20X2. The plant has an estimated life of 10 years with a residual value equal to 15% of its gross cost. Derringdo uses straight-line depreciation on a time apportioned basis. The company received a government grant of 30% of its cost price at the time of its purchase. The terms of the grant are that if the company retains the asset for four years or more, then no repayment liability will be incurred. If the plant is sold within four years a repayment on a sliding scale would be applicable. The repayment is 75% if sold within the first year of purchase and this amount decreases by 25% per annum. Derringdo has no intention to sell the plant within the first four years. Derringdo's accounting policy for capital based government grants is to treat them as deferred credits and release them to income over the life of the asset to which they relate. Required (a) (b) Discuss whether the company's policy for the treatment of government grants meets the definition of a liability in the IASB's Conceptual Framework for Financial Reporting; and (3 marks) Prepare extracts of Derringdo's financial statements for the year to 31 March 20X3 in respect of the plant and the related grant: applying the company's policy; in compliance with the definition of a liability in the Conceptual Framework. Your answer should consider whether the sliding scale repayment should be used in determining the deferred credit for the grant. (6 marks) (Total = 9 marks)

Derringdo answer
Grant (a) Liability There are two issues here: 1 2 Should a capital grant be treated as deferred income in the financial statements? Should a liability be recognised for the potential repayment of the grant?

Derringdo has credited the $240,000 grant to a deferred income account which is shown as a liability in the statement of financial position. It is then released to the income statement over the ten year life of the related asset. However, the Conceptual Framework states that a liability should only be recognised if there is a probable outflow of economic benefits. This is not true for a grant; under normal circumstances the grant will not have to be repaid and so a liability does not exist. This example is complicated by the possibility of having to repay the grant if the asset is sold. At the end of the reporting period the asset has not been sold, and so there is no past event to give rise to a liability. Derringdo intends to keep the asset for its ten year useful life. Nor can it be classified as a contingent liability. Under IAS 37 the 'uncertain future event' that creates a contingent liability must be 'not wholly within the control of the entity'. In this case Derringdo will make the decision to keep or sell the asset. Following on from the above, the Conceptual Framework would not permit the grant to be shown as a liability. Instead the grant would be claimed as income in the year that it was received (provided that there was no intention to sell the asset within the four year claw-back period). However, the treatment of the grant as deferred income is in accordance with IAS 20 Accounting for Government Grants. (b) Extracts (Company policy complies with one of the two alternatives in IAS 20) STATEMENT OF PROFIT OR LOSS $ Operating expenses Depreciation charge (W1) Release of grant (W2) STATEMENT OF FINANCIAL POSITION $'000 Non-current assets Property, plant and equipment (W1) Non-current liabilities Deferred income (W2) Current liabilities Deferred income (W2) Workings 1 Property, plant, equipment Cost (gross, excluding grant) Depreciation (10 years straight line, 15% residual value for 6 months 800,000 85% 10% 6/12) Carrying value $'000 800,000 (34,000) 766,000 766,000 204,000 24,000 228,000 34,000 (12,000) 22,000

Deferred income Grant received ($800,000 30%) Release for this year ($240,000 10% 6/12) Total balance at year-end Presentation Current liability ($240,000 10%) Non-current liability (balance)

$ 240,000 (12,000) 228,000 24,000 204,000 228,000

Theoretical approach under the Conceptual Framework Because the 'deferred' element of the grant cannot be recognised as a liability, the grant will be claimed in full in the year that it is received. The repayment clause will not affect this policy because, at the end of the reporting period, Derringdo has not sold the asset and so no liability exists. STATEMENT OF PROFIT OR LOSS $ Operating expenses Depreciation charge (as before) Grant received and claimed STATEMENT OF FINANCIAL POSITION $'000 Non-current assets Property, plant and equipment 766,000 34,000 (240,000) (206,000)