FAC3703 – GOVERNMENT GRANT

CLASS EXAMPLE
Question 1
(50 marks/60 minutes)

The directors of Comet Limited, a company involved in astrophysics, was successful in

tendering for the South African Large Telescope project. As part of their obligation, the
company has to erect an observatory outside Sutherland. One of the requirements of the
tender was that the successful bidder had to invest in the local community by supplying
low cost housing to locals.

Consequently, as part of its commitment to the local community, Comet Ltd entered into
an agreement to purchase low cost housing units for R2 000 000 during September
2011. On 1 January 2012 the housing units were ready for use, the risks and rewards of
ownership transferred to Comet Ltd, and the transaction was settled in cash. The
housing units have a useful life of 10 years and a residual value for accounting purposes
of R100 000.

Since it is important for National Government to provide housing to all citizens Comet Ltd
received a government grant of R250 000 on 1 January 2012. The South African
Revenue Service will grant a tax allowance on the straight-line method over ten years on
the total cost of the housing units.

Comet Limited will only receive income after the observatory becomes operational. In
order to finance the development costs of this project, the directors decided to sell all the
company’s equipment with a cost price of R500 000, a net carrying amount of R300 000
and a tax value of R281 250 to Courage Bank Ltd for R400 000. The fair value of the
equipment at the date of the sale was R460 000.

Comet Ltd will lease the equipment back from Courage Bank Ltd over a three year
period. The sale and commencement of the lease took place on 1 January 2012. The
lease is payable in quarterly instalments of R45 449 in arrears, at an effective interest
rate of 22,13% per annum and a nominal interest rate of 20,5% per annum.

The first instalment is payable on 31 March 2012. Comet Ltd paid R9 000 commission to
enter into the sale and leaseback agreement.

The company depreciates its assets on the straight-line method over the expected useful
lives of the assets. The expected useful life of this equipment at the date of original
purchase of the assets was 5 years with no residual value.

A tax allowance is calculated on the reducing balance method on the useful life of the
equipment of four years.

The profit before tax and the taxable income of the company for the year ended 31
December 2012, before the above transactions and depreciation, amount to R2.5 mil.

1
The company provides for deferred tax on all temporary differences, using the statement
of financial position approach. The SA Normal tax rate is 28%. The company had a
deferred tax liability at 31 December 2011 of R5 625.

It is estimated that the company will realise taxable income in future. Ignore capital gains
tax for purposes of this question.

REQUIRED:
1. Prepare the journals (including cash transactions) for the year ended 31
December 2012 in the accounting records of Comet Ltd in respect of the
government grant if it is assumed that the government grant is presented in the
statement of financial position as deferred income. You may ignore the
implications of current tax and deferred tax. Journal narrations are not required.
(7)

2. Explain how your answer in (1) would be different if Comet Ltd had accounted for
the government grant by deducting it from the carrying amount of the asset.
(4)

3. Show how the above transactions should be disclosed in the notes to the annual
financial statements of Comet Ltd for the year ended 31 December 2012. No
accounting policy notes are required. Notes relating to the deferred tax balance in
the statement of financial position are not required. Comparative figures are not
required.
(39)

Your answer must comply with the requirements of International Financial Reporting
Standards.

All calculations should be done to the nearest Rand.