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Query No.

Subject:

Accounting treatment of government grant received from State Government for


repayment of term loans/bonds.1

A.

Facts of the Case

1.

A company (hereinafter referred to as the company), is incorporated under the

Companies Act, 1956. The authorised share capital of the company is Rs. 12,000 crore. The
subscribed and paid-up capital is Rs. 6,987.00 crore at 31.3.2012. The entire share capital is held
by the State Government and the State Financial Corporation.

2.

The querist has stated that the main objective of the company is execution of the

Multipurpose Irrigation Project (hereinafter referred to as the project) together with


rehabilitation and resettlement of the project affected people. The company was formed in the
year 1994 and commenced its business with effect from 14.1.1995. The assets of the project
which were then being implemented by the Water Resources Department of the State
Government along with selected liabilities were transferred to the company on 14.11.1995.
Further works were carried out by the company. The project is now substantially complete. The
expenditures incurred on the project have been capitalised in the books of account of the
company. The project cost has been partially funded by budgetary support from the State
Government and partially by borrowed funds, i.e., bonds from investors and term loans from
banks and financial institutions.

3.

The querist has also stated that the company does not have operational income from the

core assets. As such, as per the tripartite agreement entered into between the trustees to the
bondholders, the company and the State Government, having guaranteed the repayment, the
State Government has been funding the debt obligation through its budgetary support. The funds
1

Opinion finalised by the Committee on 21.5.2013 and 22.5.2013


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are released under the nomenclature for debt servicing as per the actual requirement furnished
to the Government with the break-up of principal and interest.

4.

The money released towards payment of interest component of the repayment is

recognised as income in the accounts and set off against the interest paid. Component of the
grants received towards principal repayment is being accounted under the head Reserves &
Surplus capital reserves, keeping in view the provisions of Accounting Standard (AS) 12,
Accounting for Government Grants.

5.

The accounting policy adopted by the company with regard to government grants as

related to debt servicing is reproduced below:

Government grants received for meeting specific debt obligation are bifurcated as
grants for principal and interest. The grants for meeting principal repayment are treated as
capital reserves. The grants for interest payments are accounted as income.

6.

While conducting audit of the accounts of the company for the year ended 31.3.2011, the

Comptroller Auditor and General (C&AG) had observed as follows:

The company has raised external borrowings from the market against the guarantee of
the State Government. Out of these borrowings, the company created assets and the same
had been capitalised in the books of account. However, in the absence of operational
income from its core assets, the State Government has been servicing both the installment
of principal and interest. While the repayment of interest installment is being recognised
as income in the accounts and set off against the finance charges paid, the principal
repayment is being treated as capital reserve. As a result, as on 31.3.2011, the company
had accumulated capital reserve of Rs. 3,334.75 crore. As the loan was borrowed for
creation of fixed assets, the amount should have been appropriated towards fixed assets
as per AS 12. However, in the absence of identification of the amount received towards
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specific asset, the company did not appropriate the grant amount. As the policy is in
contravention of AS 12, it is requested that the company should formulate a system to
identify the assets created out of each borrowing so as to enable appropriation of the
grant received from the State Government for servicing the loan against the assets created
out of that loan amount. The policy may also be modified suitably to appropriate such
unspecified capital grant/reserve in order to present a true and fair view of the accounts.

7.

The companys justification for adopting the accounting policy indicated in paragraph 5

above is as follows:

7.1. The State Government was releasing funds to the company for works bills payment,
debt servicing and other expenses till the year 2005-06 as contribution towards Share
Capital(emphasis supplied by the querist). The company had allotted equity shares to the
Government against the said releases. The company was preparing Expenditure During
Construction Period (pending capitalisation) Account up to the year 2006-07 as the
project had not been substantially completed.

7.2. The company had borrowed funds through bonds and loans for project expenditure
from the year 1995-96 onwards till the year 2006-07. From the year 2007-08, the
Government is releasing funds for capital works as grants while earlier to this period the
amount was being released as equity share capital and hence, accounted under advance
against equity.

7.3. In the observations of the Accountant General, it is suggested to identify the assets
created out of each borrowing and appropriate grant received from the Government for
repayment of debts against each asset by deducting the same from the value of assets
created. By doing so, the value of the fixed assets will become zero. There is also
difference between the time of creation of assets and the repayment of the principal of the
loan/Bonds. In view of the above, the company has accounted the funds received from
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Government for repayment of bonds and loans under capital reserve instead of advance
against equity considering it as shareholders funds. Further, it is not possible to identify
assets created against each borrowings as borrowed funds are pooled with other funds and
released to project offices for payment of bills for creation of various assets and as such,
the funds received from the Government for repayment of debts cannot be identified
against specific assets, while the grants received for capital expenditure have been netted
of against each asset.

7.4. Further, since the company is not earning any profits, the bonds/loans cannot be
repaid out of own cash flows. In this scenario, the owners of the company, i.e., the State
Government is replacing the debts from their own funds. Hence, the amount received from
the State Government, being the promoters of the company, for repayment of principal
loan amount is to be treated as contribution from the promoters. Therefore, it is rightly
accounted under capital reserves, and reckoned as a part of the shareholders funds. The
grant received from Government is in the nature of promoters contribution and treated as
a part of shareholders funds as per paragraph 16 of AS 12 which states as follows:

Government grants of the nature of promoters contribution should be credited to


capital reserve and treated as a part of shareholders funds.

B.

Query

8.

In the above context, the querist has sought the opinion of the Expert Advisory

Committee with regard to the following issues:

(i) Whether the money received from the Government for servicing the principal repayment
be treated at par with promoters contribution.
(ii) Whether the accounting policy adopted by the company, as stated in paragraph 5 above,
is in violation of the provisions of AS 12.
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(iii)If the above is so, what accounting policy should the company adopt for the financial
year 2012-13 for accounting for grants received from the Government for repayment of
principal debt?

C.

Points considered by the Committee

9.

The Committee notes that the basic issue raised in the query relates to accounting

treatment of grant received from the year 2007-08 onwards from the State Government, which
also holds majority shares in the company, for repayment of principal amount of term
loans/bonds that were taken for the creation of fixed assets or construction of the project. The
Committee has, therefore, considered only this issue and has not examined any other issue
arising from the Facts of the Case, such as, appropriateness of recognition of expenditure
incurred on the project as well as that incurred on rehabilitation and resettlement of the project
affected people as the cost of the project, appropriateness of preparation of Expenditure During
Construction Period (pending capitalisation) Account till the project had not been substantially
completed, accounting for grant received for repayment of interest on term loans/bonds,
recognition of borrowing costs, i.e., interest on term loans/bonds borrowed for the project, etc.

10.

As regards accounting for the grant/contribution received from the Government, the

Committee notes that although the amount received has been described as grant but the
Government holds majority of the shares of the company. Thus, the Committee is of the view
that its accounting would depend on whether the amount received is in nature of grant or
contribution as owner. In this context, the Committee notes paragraph 2 of Accounting Standard
(AS) 12, Accounting for Government Grants, which provides the scope of AS 12 as follows:

2.

This Standard does not deal with:


(i)

(ii)

government assistance other than in the form of government grants;

(iii)

government participation in the ownership of the enterprise.


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The Committee further notes clause 4.6 of the Tripartite Agreement between the company, the
State government and the Trustees of the bondholders (provided separately by the querist for the
perusal of the Committee), which provides as follows:

In the circumstances recited above, the company has requested the State Government to
enter into this agreement with a view to provide for various matters and contractual
obligations of the State Government to make available and to provide budgetary support
to the company as may be required for the purpose of facilitating and enabling, if
necessary, the company to make payments of principal, interest and other charges and
expenses in relation to the said Bonds. The State Government in its capacity as the
majority shareholder of the company, and being the principal sponsoring party in
relation to the Irrigation Projects executed, operated and maintained by the company,
has agreed to enter into and execute this Agreement and has permitted the company to
make certain representations in the Offer Documents.

From the above, it is clear that the Government while giving guarantee to the bond holders for
payment of interest and repayment of principal amount of the bond is acting in the capacity of
the majority shareholder and principal sponsoring party for the Irrigation Project. In other words,
the Government is providing financial support through budgetary allocation to the company for
repayment of debt/bonds. Since the company has no operational income, the Government is
contributing the money as the owner of the company. It is also evident from the Facts of the Case
that the company is receiving non-refundable funds from its owner, i.e., State Government,
without any consideration or reference to the total investment in the undertaking or towards total
capital outlay as it generally happens when Government provides grants in the nature of
promoters contribution under AS 12. Further, such funds provided are also not meant for the
acquisition/construction /creation of any specific fixed asset or infrastructure facility which is the
case of grants related to specific fixed assets under AS 12. Thus, the Government, in the extant
case, being owner, is coming to assist the company to avoid failure of repayment of its dues and
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obligations relating to loans. Accordingly, the Committee is of the view that though, the
Government may term the funds given to the company as grant, in substance, these are
owners contribution. Hence, the funds given should not be recognised in accordance with AS
12. In this regard, the Committee notes that paragraph 17 of Accounting Standard (AS) 1,
Disclosure of Accounting Policies recognises substance over form as one of the major
considerations governing the selection and application of accounting policies. The Standard
describes substance over form as follows:

The accounting treatment and presentation in financial statements of transactions and


events should be governed by their substance and not merely by the legal form.

From the above, the Committee is of the view that the accounting treatment should be governed
by the substance of the transactions and events and not by their legal form. Accordingly, in the
extant case, the funds provided by the Government should be accounted for as contribution from
owners and not as government grant.

11. For accounting treatment of contribution in the capacity of owners, the Committee notes
paragraph 69(a) of the Framework for the Preparation and Presentation of Financial Statements
(hereinafter referred to as the Framework, issued by the Institute of Chartered Accountants of
India (ICAI) states as follows:

(a)

Income is increase in economic benefits during the accounting period in the form
of inflows or enhancements of assets or decreases of liabilities that result in
increases in equity, other than those relating to contributions from equity
participants.

From the above, the Committee is of the view that funds provided by the Government, in the
capacity of owners, is a contribution from an equity participant and accordingly it should not be
accounted for as income in the financial statements of the company. It should be accounted as
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equity only. However, the Committee notes from the Facts of the Case that against the funds
provided by the Government, no shares have been issued to the Government and accordingly,
these cannot be classified as Share Capital of the company. The Committee also notes that
these funds are receipts of the company which are to be utilised by the management as per the
directions of the Government for a specific purpose, viz., repayment of debts. The Committee
further notes the definitions of the terms, reserve and capital reserve as per the Guidance Note
on Terms Used in Financial Statements as follows:

Guidance Note
14.04 Reserve
The portion of earnings, receipts or other surplus of an enterprise (whether capital
or revenue) appropriated by the management for a general or a specific purpose other
than a provision for depreciation or diminution in the value of assets or for a known
liability. The reserves are primarily of two types: capital reserves and revenue
reserves.

3.10 Capital Reserve


A reserve of a corporate enterprise which is not available for distribution as
dividend.

On the basis of the above and considering the Facts of the Case, the Committee is of the view
that such funds are of the nature of reserve. Since these receipts are used only for a specific
purpose and are not available for distribution as dividend. Accordingly, these should be credited
to capital reserve.

D. Opinion

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12. On the basis of the above, the Committee is of the opinion on the issues raised in paragraph
8 above as under:
(i) & (ii) The contribution made by the State Government is not a government grant as
discussed in paragraph 10 above and accordingly, the provisions of AS 12 would not
be applicable.
(iii) The funds provided by the Government are of the nature of owners contribution and
accordingly, these should be credited to capital reserve, as discussed in paragraph 11
above.

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