Comments on Opinion of EAC of ICAI published in March 2020 issue of The CA Journal

1.      The facts of the case in brief is that a Government company has been entrusted with the task to execute the 2600 km long gas pipeline project connecting the eastern states of the country to the National Gas Grid. The Cabinet Committee on Economic Affairs (CCEA), Government of India (GoI) has approved a capital grant of ?5176 crore. The first instalment of ?450 crore was disbursed by the GoI to the company before the end of the reporting period. The company has presented the amount of ?450 crore in Balance Sheet as Other Non-current Liability. Further, the company has classified the amount of capital grant under Cash Flows from Financing Activities in Statement of Cash Flows. The Comptroller & Auditor General (CAG) Auditor has opined that the classification of the amount received as capital grant in Statement of Cash Flows would be Cash Flows from Investing Activities. Therefore, an opinion was sought from Expert Advisory Committee (EAC) of The Institute of Chartered Accountants of India (ICAI) on the following:

a.      Whether the classification of grant received under Cash Flows from Financing Activities is correct; and

b.      If the classification as Cash Flow from Financing Activities is not correct, what is the correct classification.

2.      The EAC has opined that:

a.      The classification of ?450 crore received as grant related to assets from GoI under Cash Flows from Financing Activities by the company is incorrect; and

b.      The same should be classified as Cash Flows from Investing Activities.

3.      The EAC provides the following as the basis for its opinion:

a.      It is assumed that the approval by the CCEA is a government grant as defined in Ind AS 20, Accounting for Government Grants and Disclosure of Government Assistance.

b.      For classification as financing activity, the receipt of the grant should result in change in the size and composition of contributed equity and borrowings. The receipt of the grant neither represents equity nor borrowing from the GoI. Therefore, the classification under Cash Flows from Financing Activities is not proper.

c.      At first sight, it may appear that the receipt of the grant does not meet the definition of investing activity, since the resulting cash inflow does not arise from disposal of any asset. However, in substance, to the extent of the grant, cost of the pipeline project is borne by the GoI. In effect, the cash outflow on the long-term asset, i.e. pipeline, is reduced by the amount of the grant. Therefore, the receipt of the grant is an investing activity.

d.      The view that the receipt of the grant is an investing activity is strengthened by paragraph 28 of Ind AS 20 which states as follows:

“The purchase of assets and the receipt of related grants can cause major movements in the cash flow of an entity. For this reason and in order to show the gross investment in assets, such movements are disclosed as separate items in the Statement of Cash Flows.”

4.      We neither agree with the opinion of the EAC of ICAI nor its basis. In our view, the receipt of grant related to long-term asset is Cash Flow from Financing Activity. Below are given our arguments in favour of our opinion:

a.      In case of a company controlled by GoI, any receipt from GoI must be analysed as whether the amount received is equity contribution by shareholder or satisfies the definition of Government Grant as defined in Ind AS 20. Ind AS 20 defines “Government Grant” as under:

“Government grants are assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. They exclude those forms of Government assistance which cannot have a value placed upon them and transactions with Government which cannot be distinguished from the normal trading transactions of the entity.”

Therefore, compliance with conditions is central to the definition of Government grant. Normally, if conditions are not satisfied, the grant received becomes refundable. If the amount received is not to be refunded regardless of completion of the task for which the CCEA approved the grant, the amount received is akin to equity contribution by the shareholder. In absence of information, it is assumed that if the task is not completed, the grant will be refunded. Therefore, till the conditions are not satisfied, the grant is a liability akin to borrowing. The company has presented the amount received as Other non-current liability in Balance Sheet. Therefore, we do not agree with the view of EAC that the grant received is not a borrowing, though presented as liability in Balance Sheet. As the grant received is a borrowing, the cash inflow shall be classified as Cash Flows from Financing Activities.

b.      A staff paper on examples illustrating the classification of cash flows was presented in IFRS Interpretations Committee meeting of July 2012 wherein example 5 considered the issue of presentation of government grant received to compensate for the cost of purchasing new equipment in statement of cash flows. The staff paper can be accessed from the link https://cdn.ifrs.org/-/media/feature/meetings/2012/july/interpretations-committee/031207ap03ias7examplesillustratingclassificationcashflows.pdf.

The staff paper evaluates two presentation principles:

                                                  i.     As financing activity

This determines that a grant represents a source of financing for the entity and the government is acting as a capital provider.

                                                ii.     As investing activity

This looks at the transaction financed by the grant instead of the grant itself. In addition, proponents of this view may observe that paragraph 28 of Ind AS 20 implies that the government grant may be deducted from the related item for presentation purposes.

The staff have expressed their support for first principle because the grant is providing a source of financing to the entity; and consequently, cash received should be part of the entity’s financing activities. The staff have disagreed with the second principle because it would mean focusing on the nature of the transaction that is financed by the grant instead of the nature of the grant itself.

Therefore, in concurrence with the view of the staff, we are of the view that the grant received by the company for executing 2600 km long gas pipeline project must be classified as Cash Flows from Financing Activities.

c.      The EAC has considered the definition of Financing Activity and Investing Activity as defined in Ind AS 7, Statement of Cash Flows. The EAC has rejected the applicability of definition of Financing Activity without providing any basis for the liability not to represent borrowings. The EAC has acknowledges that the definition of Investing Activity also does not apply as any inflow to be investing activity has to be from disposal of long-term assets which is not the case here. However, the EAC has gone beyond the definition of Investing Activity without also going beyond the definition of Financing Activity arguing that the cash outflows on the long-term asset is reduced by the amount of the grant. This particular argument could hold true when the grant was related to rebate on duties and taxes. In the given case, the company is required to pay full cost of construction of the pipeline to the vendors, labourers etc. The vendors, labourers etc. do not provide a discount because the GoI has approved a grant for the project. The grant received from GoI is used to part finance the cost of constructing 2600 km pipeline. Therefore, we do not agree with the argument that cash outflow on the long-term asset is reduced by the amount of the grant. In fact, the substance, is that the cash outflows on the long-term asset is partly financed by cash inflows of grant. Therefore, the cash inflow from grant must be classified as Cash Flows from Financing Activities.

d.      An increase in liability related to investing activities reduces the cash outflow during the reporting period. In the given case, the liability has increased because of cash inflow and not because of reduction of cash outflow. An increase in liability by cash inflow is either related to operating activities such as advance from customers or related to financing activities such as borrowings. Where the grant is related to income, the liability is related to operating activities and where the grant is related to assets, the liability is related to financing the acquisition or construction of long-term assets and therefore, related to financing activity. Therefore, we do not agree with the opinion of the EAC of ICAI that increase in liability represented by cash inflow is related to investing activity.

e.      Paragraph 28 of Ind AS 20 states as under:

“The purchase of assets and the receipt of related grants can cause major movements in the cash flow of an entity. For this reason and in order to show the gross investment in assets, such movements are often disclosed as separate items in the Statement of Cash Flows regardless of whether or not the grant is deducted from the related asset for presentation purposes in the balance sheet.”

Paragraph 28 of Ind AS 20 acknowledges the fact that there could be huge cash outflows due to purchase of assets and huge cash inflows from related grants which in Balance Sheet may be presented on net basis. However, in Statement of Cash Flows, the cash outflows on purchase of assets is shown separately and cash inflows from grants is shown separately on gross basis. Paragraph 28 of Ind AS 20 does not state whether cash inflows from Government grants is cash flow from investing activity whereas EAC opinion states the argument that the cash inflows of grant are cash flows from investing activities is strengthened by paragraph 28 of Ind AS 20. Therefore, we do not agree with the argument that paragraph 28 of Ind AS 20 advocates cash inflows from grants to be classified as Cash Flows from Investing Activities. In fact, in our view, paragraph 28 of Ind AS 20 requires separate presentation of cash outflows and cash inflows on gross basis and therefore, strengthens the view that cash inflow from grant related to long-term asset shall be classified as Cash Flows from Financing Activities.

f.       Paragraph 9 of Ind AS 1, Presentation of Financial Statements, states that the objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. By presenting the cash flows from Government grants as investing activities in accordance with the opinion by EAC of ICAI, the company will provide information to the users that it is financing the pipeline project fully from its operating activities which is not the case. The pipeline project is partly financed through Government grant and partly through cash flows from operating activities. Thus, the presentation of cash inflows from grants as cash flows from investing activities will provide information about cash flows of the company that might result in users making improper economic decisions. Therefore, the policy of presentation of grants related to assets in Statement of Cash Flows developed by EAC of ICAI does not satisfy the objective of financial statements as enunciated in Ind AS 1.

g.      Paragraph 44A of Ind AS 7, Statement of Cash Flows, requires an entity to provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities including both changes arising from cash flows and non-cash changes. Paragraph 44C clarifies that liabilities arising from financing activities are liabilities for which cash flows were or future cash flows will be classified in the Statement of Cash Flows as Cash Flows from Financing Activities. Therefore, for the purpose of the disclosure, it is important to understand classification of cash flows from financing activities. If the cash flows from the grant are classified as cash flows from investing activities, the users will be deprived of the information provided by paragraph 44A of Ind AS 7.