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MODULE 12 PACKET
AE 15 and ELEC 1 – INTERMEDIATE ACCOUNTING
MODULE 12 ACCOUNTING FOR GOVERNMENT GRANTS AND BORROWING COSTS

Welcome to Module 12
In this module, we will understand the nature and accounting of a government grant and how they are
presented in the financial statements. The items included in borrowing costs will also be identified
considering its eligibility for capitalization.

CONSULTATION HOURS:
Virtual time: During your class schedule (either Monday or Tuesday)
Phone or Messenger: Every Thursday from 8am to 11am and 1pm to 4pm

MODULE 12 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:
1. Know the recognition and the proper accounting treatment of a government grant.
2. Know the accounting treatment of repayment of a government grant.
3. Know the concept of a qualifying asset for purposes of capitalization of borrowing costs.
4. Understand the proper accounting treatment of borrowing costs.

COURSE CONTENT FOR MODULE 12:

ACTIVITY DESCRIPTION TIME TO COMPLETE

Assigned Reading Government Grants 1 hour

Lecture discussion Borrowing Costs 1.5 hours

ACTIVITY 12 Problem Solving 2 hours

Summative quiz for module 12 (to be

Quiz 1.5 hours
announced)

Answers to ACTIVITY 12 will be due on NEO LMS

, 2020 thru Google Classroom or
Facebook Group. Correct answers will be posted thereafter for your reference.

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ASSIGNED READING

12.1 Government Grants

Government Grants (subsidies, subventions or premiums) are assistance received from the government
in the form of transfers of resources in exchange for compliance with certain conditions. Grants are
recognized only when the assistance meet the asset recognition criteria: entity compliance with conditions
attaching to the grant and receipt of the grant. The mere receipt of a grant is not conclusive evidence that
the condition will be satisfied.

If grants are monetary, it will be measured based on the amount of cash received or fair value of amount
receivable. If non-monetary, the fair value of the asset received or its nominal amount may be used.

A government grant is recognized as income on a systematic basis over the periods in which the entity
incurs related costs. If the related expense is not yet recognized, no income from government grant is
recognized. What accounting concept is this?

Types of Government Grants:

1. Grants related to assets – primary condition for the recipient entity is to acquire or construct long-term
assets. (buy equipment, construct building on land received from government)
2. Grants related to income – grants other than those related to assets.

Illustration 1:
An entity received a grant of P4.5M from the national Cash 4,500,000
government for the purpose of defraying safety and Deferred grant income 4,500,000
environmental expenses over 3 years
Safety and environmental expenses follow: Year 1
1st 500,000 (5/20 x 4.5M ) 1,125,000 Deferred grant income 1,125,000
2nd 700,000 (7/20 x 4.5M ) 1,575,000 Grant income 1,125,000
3rd 800,000 (8/20 x 4.5M ) 1,800,000 Environmental expense 500,000
2,000,000 4,500,000 Cash 500,000

Illustration 2:
An entity received a grant of P5M from the Korean Cash 5,000,000
government to acquire a research facility at P8M with Deferred grant income 5,000,000
useful life 8 years. Building 8,000,000
Cash 8,000,000
Depreciation Exp 1,000,000
Grants related to depreciable asset shall be Accum. Depreciation 1,000,000
recognized as income over the periods and in Deferred grant income 625,000
proportion to the depreciation of the related asset. Grant income 625,000

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Illustration 3:
An entity is granted a tract of land in San Dionisio by Land 3,000,000
the national government wherein a refinery shall be Deferred grant income 3,000,000
constructed. The fair value of the land is P3M. The Refinery 10,000,000
Cash 10,000,000
cost of the refinery is estimated at P10M with a
Depreciation Exp 1,000,000
useful life of 10 years. Accum. Depreciation 1,000,000
(10M/10 yrs)
Grants related to nondepreciable asset requiring Deferred grant income 300,000
fulfillment of certain conditions shall be Grant income 300,000
recognized as income over the periods which (3M/10yrs)
bear the cost of meeting the conditions

Illustration 4:
An entity received grant of P50,000,000 from the US Cash 50,000,000
government as aid to the pandemic. Grant income 50,000,000

A government grant that becomes a receivable as compensation for expenses or losses already incurred
or for giving immediate financial support to the entity with no further related costs shall be recognized
as income of the period it becomes receivable

PRESENTATION

Related to income

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Grants related to income (using Illustration 1)

Statement of Financial Position

Gross Presentation Net Presentation
Assets Assets
Liabilities Liabilities
Deferred Income (4.5M – 1.125M) 3,375,000 Deferred Income (4.5M – 1.125M) 3,375,000
Net effect on Equity 3,375,000 Net effect on Equity 3,375,000

Statement of Profit or Loss and Other Comprehensive Income

Gross Presentation Net Presentation – income from grant is recognized
as reduction of the related expenses incurred Environmental Exp
Other income 1,125,000 Other income 625,000
Environmental Expense -500,000 Environmental Expense 0 500,000 1,125,000
625,000
Net effect on profit or loss 625,000 Net effect on profit or loss 625,000 CREDIT

Grants related to assets (using Illustration 2) – answers to both methods are the same

Statement of Financial Position

Gross Presentation Net Presentation – grant deducted from CV of asset
Building 8,000,000 Building (8M – 5M) 3,000,000
Accumulated Depreciation -1,000,000 Accumulated Depreciation (3M/8yrs) -375,000
Carrying Amount 7,000,000 Carrying Amount 2,625,000
Liabilities Liabilities
Deferred Income (5M – 625,000) 4,375,000 Deferred Income (deducted fr building) 0
Net effect on Equity 2,625,000 Net effect on Equity 2,625,000

Statement of Profit or Loss and Other Comprehensive Income

Gross Presentation Net Presentation
Other income 625,000 Other income 0
Depreciation Expense -1,000,000 Depreciation Expense -375,000
Net effect on profit or loss (375,000) Net effect on profit or loss (375,000)

LEARN MORE:

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Repayment of Government Grant

A government grant that becomes repayable because of noncompliance with conditions shall be accounted
for as a change in accounting estimate.

Repayment of a grant related to income shall be applied first against any unamortized deferred income
and any excess shall be recognized immediately as an expense.

In 2020, an entity received a grant of Jan. 1 Cash 3,000,000

P3M for environmental expenses to be Deferred grant income 3,000,000
incurred over 3 years Dec. 31 Deferred grant income 1,000,000
Grant income (3M/3yrs) 1,000,000
In 2021, the amount became repayable Jan. 1 Deferred grant income 2,000,000
because the entity did not comply with Loss on repayment of grant 1,000,000
the condition attached to the grant Cash 3,000,000

Repayment of a grant related to asset is treated as a reduction in the deferred income balance or an
increase in the carrying amount of the asset. The loss on repayment of grant is also equal to deferred
grant income already earned. The cumulative additional depreciation that would have been recognized to
date in the absence of the grant shall be recognized immediately as an expense.

A forgivable loan from government is treated as a government grant when there is reasonable
assurance that the entity will meet the terms for forgiveness of the loan. PAS 20 provides that the benefit
of a government loan with a zero or below-market rate of interest is treated as a government grant. Such
benefit = face amount – present value of the loan. This is recognized as the discount on note payable and
grant income to be amortized over the term of the loan.

Government assistance is action by government designed to provide an economic benefit specific to an

entity or entities qualifying under certain criteria. No value can reasonably be placed upon it. Examples:
1. Free technical or marketing advice
2. Provision of guarantee
3. Government procurement policy that is responsible for a portion of the entity’s sales

Government assistance does not include those with indirect benefits to an entity:
1. Infrastructure in development areas such as improvement to the general transport and
communication network
2. Imposition of trading constraints on competitors
3. Improved facilities such as irrigation for the local community

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12.2 Borrowing Costs

These are defined as interest and other costs that an entity incurs in connection with borrowing of funds.
It includes interest expense derived using the effective interest method, finance charge from a finance
lease, and exchange difference arising from foreign currency borrowing to the extent that it is regarded as
an adjustment to interest cost.

A qualifying asset takes a substantial period of time to get ready for the intended use or sale such as
Intangible assets, Investment property, Manufacturing plant and Power generation facility.

On the other hand, borrowing costs are not capitalized if they relate to the following:
a. Assets measured at fair value, such as biological assets
b. Inventory manufactured or produced in large quantity on a repetitive basis, such as maturing
whiskey, even if it takes a substantial period of time to get ready for sale.
c. Assets that are ready for their intended use or sale when acquired.

Accounting for borrowing costs:

1. If the borrowing is directly attributable to the acquisition, construction or production of a qualifying

asset, the borrowing cost is required to be capitalized as cost of the asset.
The capitalization of borrowing cost is mandatory for qualifying asset. The borrowing costs that are
directly attributable to the acquisition, construction or production of a qualifying asset are borrowing
costs that would have been avoided if the expenditure on the qualifying asset had not been made.
2. All other borrowing costs shall be expensed as incurred. If the borrowing cost is not directly
attributable to a qualifying asset, it is expensed immediately.

Asset financed by specific borrowing

If the funds are borrowed specifically for the purpose of acquiring a qualifying asset, the amount of
capitalizable borrowing cost is the actual borrowing cost incurred during the period less any investment
income from the temporary investment of those borrowings.

An entity obtained a P10,000,000 loan with an interest of 10% specifically to finance the
construction of a new building. Availments from the loan were made quarterly in equal
amounts. Total borrowing cost during the year was P300,000. Prior to their disbursement,
the proceeds of the borrowing were temporarily invested and earned interest income of
P80,000. The building was completed at year-end.

Actual borrowing cost 300,000

Interest income from investment of proceeds (80,000)
Capitalizable borrowing cost 220,000

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Asset financed by general borrowing

If funds are borrowed generally and used for acquiring a qualifying asset, the amount of capitalizable
borrowing cost is equal to the average carrying amount of the asset during the period multiplied by a
capitalization rate or average interest rate.

However, the capitalizable borrowing cost shall not exceed the actual interest incurred. The capitalization
rate or average interest rate is equal to the total annual borrowing cost divided by the total general
borrowings outstanding during the period.

No specific guidance is provided for general borrowing with respect to investment income. Accordingly,
any investment income from general borrowing is not deducted from capitalizable borrowing cost.

Borrowings were made for general purposes and the proceeds were partly used to finance
the construction of a new building:
8% bank loan Principal: P3,000,000 Borrowing cost: P240,000
10% short-term note 1,500,000 150,000
6% long-term note 3,500,000 210,000
8,000,000 600,000

Capitalization rate = total annual borrowing cost / total general borrowings = 600,000/8,000,000 = 7.5%

The construction of the building was started on January 1 and was completed in 1 year.
Expenditures on the building were incurred all throughout the year resulting to an average
carrying amount of P2,000,000.

Capitalizable Borrowing Cost = Capitalization Rate x Average Carrying Amount = 7.5% x 2,000,000 =
150,000

The capitalizable borrowing cost shall not exceed the actual borrowing cost. In the above problem,
capitalizable borrowing cost is P150,000. Actual borrowing cost is P600,000. The difference of P450,000
is charged to interest expense.

Asset financed both by specific and general borrowing

An entity borrowed P3,000,000 at an interest of 10% specifically for the construction of a new
building. The actual borrowing cost is P300,000. The entity also had an outstanding 5-year
8% general borrowing of P14,000,000. The amount of average expenditures during the year
is P5,500,000.

Average expenditures 5,500,000 Specific borrowing (10% x 3M) 300,000

Specific borrowing (3,000,000) General borrowing (8% x 2.5M) 200,000
General borrowing 2,500,000 Total capitalizable borrowing cost 500,000

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Specific borrowing for asset used for general purposes

If the asset is financed by specific borrowing but a portion is used for working capital purposes, the
borrowing shall be treated as a general borrowing in determining capitalizable borrowing cost. Thus, the
capitalizable borrowing cost is equal to the average expenditures on the asset multiplied by the average
interest rate.

Commencement of capitalization

The capitalization of borrowing costs as part of the cost of a qualifying asset shall commence when the
following 3 conditions are present: incurs expenditures for the asset, incurs borrowing costs and
undertakes activities that are necessary to prepare the asset for the intended use or sale.

Activities necessary to prepare

The activities necessary to prepare the asset for the intended use or sale encompass more than the
physical construction of the asset. These include technical and administrative work prior to the
commencement of physical construction.

Merely holding assets for use or development without any associated development activity does not qualify
for capitalization.

Borrowing costs incurred while land is under development are capitalized during the period in which
development activities are being undertaken. But those incurred while land acquired for building purposes
is held without any associated development activity do not qualify for capitalization.

Suspension of capitalization

Capitalization of borrowing costs shall be suspended during extended periods in which active development
is interrupted. However, capitalization is not normally suspended during a period when substantial
technical and administrative work is being carried out.

Capitalization of borrowing costs is continued when a temporary delay is a necessary part of the process
of getting an asset ready for its intended use or sale: example, a period of high water levels delaying the
construction of a bridge, if such are common during the construction period in the region involved.

Cessation of capitalization

Capitalization of borrowing costs shall cease when substantially all the activities necessary to prepare the
qualifying asset for the intended use or sale are complete. An asset is ready for the intended use or sale
when the physical construction of the asset is complete even though some administrative work might still
continue.

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ACTIVITY 12 – Submit your handwritten answers through Google Classroom

Hala Company received a government grant of P2,000,000 related to a factory building that it bought in
January 2019. The entity’s policy treats grants as deferred income.

The entity acquired the building from an industrialist identified by the government for P12,000,000 with a
useful life of 10 years with no salvage value. If the entity did not purchase the building, it would have been
repossessed by the government agency.

On January 1, 2021, the entire amount of the government grant became repayable because of
noncompliance with the conditions.

1. What is the depreciation of the building for 2019?

2. What is the grant income for 2019?
3. What is the loss to be recognized resulting from the repayment of the grant in 2021?

Raider Corp borrowed P1,500,000 at 12% for general purposes an partly to finance the construction of a
warehouse on January 1, 2020. The loan is to be repaid a month after the completion of the warehouse.
Average expenditures of P500,000 during the year were incurred evenly. The entity earned interest of
P20,000 for the year on the unexpended portion of the loan.

4. What amount of interest is capitalized on December 31, 2020?

5. What is the interest expense for 2020?

An entity borrowed P4,000,000 on a 10% note payable to finance a new building. It has another
debt of P6,000,000, 12% mortgage payable. At the end of the year, average expenditures is
P4,750,000.

6. How much interest should be capitalized for the current year?

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