Topic 302 - Government grants

IAS 20 Accounting for Government Grants and Disclosure of Government Assistance

SIC 10 Government Assistance—No Specific Relation to Operating Activities

• 302.1.1.1

• IFRIC Agenda Decision - Accounting for repayable cash receipts

• 302.2.1.1

• IFRIC Agenda Decision - TLTRO III Transactions

302.1.1.1

IFRIC Agenda Decision - Accounting for repayable cash receipts

May 2016 - The Interpretations Committee received a request to clarify the accounting for cash received from a government to help an entity finance a research and development project. More specifically, the request asked whether the entity must recognise the cash received as a liability (on the basis that the entity has received a forgivable loan as defined in IAS 20 Accounting for Government Grants and Disclosure of Government Assistance) or in profit or loss (on the basis that the entity has received a government grant as defined in IAS 20). The cash received from the government is repayable in cash only if the entity decides to exploit and commercialise the results of the research phase of the project. The terms of that repayment can result in the government receiving as much as twice the amount of the original cash proceeds if the project is successful. If the entity decides not to exploit and commercialise the results of the research phase, the cash received is not repayable in cash, but instead the entity must transfer to the government the rights to the research.

The Interpretations Committee noted that, in this arrangement, the entity has obtained financing for its research and development project. The Interpretations Committee observed that the cash receipt described in the submission gives rise to a financial liability (applying paragraph 20(a) of IAS 32 Financial Instruments: Presentation) because the entity can avoid a transfer of cash only by settling a non-financial obligation (ie by transferring the rights to the research to the government). The entity accounts for that financial liability applying IFRS 9 Financial Instruments (IAS 39 Financial Instruments: Recognition and Measurement).

The Interpretations Committee noted that, in the arrangement described in the submission, the cash received from the government does not meet the definition of a forgivable loan in IAS 20. This is because, in this arrangement, the government does not undertake to waive repayment of the loan, but rather to require settlement in cash or by transfer of the rights to the research.

The Interpretations Committee noted that, applying paragraph B5.1.1 of IFRS 9 (paragraph AG64 of IAS 39), the entity assesses at initial recognition whether part of the cash received from the government is for something other than the financial instrument. For example, in the fact pattern described in the submission, part of the cash received (the difference between the cash received and the fair value of the financial liability) may represent a government grant. If this is the case, the entity accounts for the government grant applying IAS 20.

The Interpretations Committee noted that the requirements in IFRS Standards provide an adequate basis to enable an entity to account for the cash received from the government.

In the light of the existing requirements in IFRS Standards, the Interpretations Committee determined that neither an Interpretation nor an amendment to a Standard was necessary. Consequently, the Interpretations Committee decided not to add this issue to its agenda.

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IFRIC Agenda Decision – TLTRO III Transactions

March 2022 - The Committee received a request about how to account for the third programme of the targeted longer-term refinancing operations (TLTROs) of the European Central Bank (ECB). The TLTROs link the amount a participating bank can borrow and the interest rate the bank pays on each tranche of the operation to the volume and amount of loans it makes to non-financial corporations and households.

The request asks:

a. whether TLTRO III tranches represent loans with a below-market interest rate and, if so, whether the borrowing bank is required to apply IFRS 9 or IAS 20 to account for the benefit of the below-market interest rate;

i. if the bank applies IAS 20 to account for the benefit of the below-market interest rate:

ii. how it assesses in which period(s) it recognises that benefit; and

b. whether, for the purpose of presentation, the bank adds the benefit to the carrying amount of the TLTRO III liability;

c. how the bank calculates the applicable effective interest rate;

d. whether the bank applies paragraph B5.4.6 of IFRS 9 to account for changes in estimated cash flows resulting from the revised assessment of whether the conditions attached to the liability have been met; and

e. how the bank accounts for changes in cash flows related to the prior period that result from the bank’s lending behaviour or from changes the ECB makes to the TLTRO III conditions. 

Applying the requirements in IFRS Accounting Standards

The Committee observed that IFRS 9 is the starting point for the borrowing bank to decide how to account for TLTRO III transactions because each financial liability arising from the bank’s participation in a TLTRO III tranche is within the scope of IFRS 9. The bank:

a. assesses whether it would separate any embedded derivatives from the host contract as required by paragraph 4.3.3 of IFRS 9;

b. initially recognises and measures the financial liability, which includes determining the fair value of the financial liability, accounting for any difference between the fair value and the transaction price and calculating the effective interest rate; and

c. subsequently measures the financial liability, which includes accounting for changes in the estimates of expected cash flows.

The Committee noted that the request did not ask about the existence of an embedded derivative and, therefore, this agenda decision does not discuss the requirements in IFRS 9 regarding the separation of embedded derivatives.  

Initial recognition and measurement of the financial liability  

Applying paragraph 5.1.1 of IFRS 9, at initial recognition a bank measures each TLTRO III tranche at fair value plus or minus transaction costs, if the financial liability is not measured at fair value through profit or loss. A bank therefore measures the fair value of the liability using the assumptions that market participants would use when pricing the financial liability as required by IFRS 13 Fair Value  Measurement. The fair value of a financial liability at initial recognition is normally the transaction price—that is, the fair value of the consideration received (paragraphs B5.1.1 and B5.1.2A of IFRS 9). If the fair  value at initial recognition differs from the transaction price, paragraph B5.1.1 requires a bank to determine whether a part of the consideration received is for something other than the financial liability.

The Committee observed that determining whether an interest rate is a below-market rate requires judgement based on the specific facts and circumstances of the relevant financial liability. A difference between the fair value of a financial liability at initial recognition and the transaction price might indicate that the interest rate on the financial liability is a below-market rate.

If a bank determines that the fair value of a TLTRO III tranche at initial recognition differs from the transaction price and that the consideration received is for only the financial liability, the bank applies paragraph B5.1.2A of IFRS 9 to account for that difference.

If a bank determines that the fair value of a TLTRO III tranche at initial recognition differs from the transaction price and that the consideration received is for more than just the financial liability, the bank assesses whether that difference represents the benefit of a government loan at a below-market rate of interest (treated as a government grant in IAS 20). An entity assesses this difference only at initial recognition of the TLTRO III tranche. The Committee noted that if the difference is treated as a government grant, paragraph 10A of IAS 20 applies only to that difference. The bank applies IFRS 9 to account for the financial liability, both on initial recognition and subsequently.

Should a portion of a TLTRO III tranche be treated as a government grant in IAS 20? 

IAS 20 defines:

a. government as referring to ‘government, government agencies and similar bodies whether local, national or international’;

b. government grants as ‘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…’; and

c. forgivable loans as ‘loans which the lender undertakes to waive repayment of under certain prescribed conditions’.

Paragraph 10A of IAS 20 requires an entity to treat as a government grant the benefit of a government loan at a below-market rate of interest. The benefit of the below-market rate of interest is measured as the difference between the initial carrying amount of the loan determined by applying IFRS 9 and the proceeds received. Paragraphs 12 and 20 of IAS 20 specify requirements for an entity to recognise government grants in profit or loss.

The Committee observed that a TLTRO III tranche would contain a portion that is treated as a government grant in IAS 20 if the bank assesses that the ECB meets the definition of government in paragraph 3 of IAS 20 and:

a. the interest rate charged on the TLTRO III tranche is a below-market interest rate as referred to in paragraph 10A of IAS 20; or

b. the loan is a forgivable loan (as defined in paragraph 3 of IAS 20) to which paragraph 10 of IAS 20 applies.

The Committee observed that making these assessments require judgement based on the specific facts and circumstances. The Committee therefore noted that it is not in a position to conclude on whether the TLTRO III tranches contain a benefit of a government loan at a below-market rate of interest or a forgivable loan in the scope of IAS 20

The Committee acknowledged that judgement may also be required to identify the related costs for which the portion of the TLTRO III tranche that is treated as a government grant is intended to compensate. The Committee nonetheless concluded that IAS 20 provides an adequate basis for the bank to assess whetherthe TLTRO III tranches contain a portion that is treated as a government grant in IAS 20 and, if so, how to account for that portion.

Calculating the effective interest rate at initial recognition of the financial liability 

Appendix A to IFRS 9 defines both the amortised cost of a financial liability and the effective interest rate. Calculating the effective interest rate requires an entity to estimate the expected cash flows through the expected life of the financial liability by considering all the contractual terms of the financial instrument.

In calculating the effective interest rate for a TLTRO III tranche at initial recognition, the question arises as to what to consider in estimating the expected future cash flows and, specifically, how to reflect uncertainty that arises from conditionality related to the contractual interest rate. The Committee noted that the question of what to consider in estimating the expected future cash flows to calculate the effective interest rate is also relevant for fact patterns other than that described in the request. The Committee therefore concluded that considering how to reflect conditionality in the contractual interest rate when calculating the effective interest rate is a broader matter, which it should not analyse solely in the context of TLTRO III tranches. Such an analysis could have unintended consequences for other financial instruments, the measurement of which involves similar questions about applying IFRS Accounting Standards. The Committee is therefore of the view that the IASB should consider this matter as part of the post-implementation review of the classification and measurement requirements in IFRS 9, together with similar matters already identified in the first phase of that review.

Subsequent measurement of the financial liability at amortised cost 

The original effective interest rate is calculated based on estimated future cash flows at initial recognition as required by IFRS 9. The Committee noted that whether a bank alters the effective interest rate over the life of a TLTRO III tranche depends on the contractual terms of the financial liability and the applicable requirements in IFRS 9.

The contractual terms of TLTRO III tranches require interest to be settled in arrears on maturity or on early repayment of each tranche. There is therefore only one cash outflow over the life of the tranche.

Paragraphs B5.4.5 and B5.4.6 of IFRS 9 specify requirements for how an entity accounts for changes in estimated contractual cash flows.  

For floating-rate financial instruments, paragraph B5.4.5 of IFRS 9 specifies that the periodic re-estimation of cash flows to reflect the movements in the market rates of interest alters the effective interest rate. IFRS 9 does not define what a floating rate is.  

Paragraph B5.4.6 of IFRS 9 applies to changes in estimated contractual cash flows of financial liabilities other than those addressed in paragraph B5.4.5, irrespective of whether the change arises from revisions of estimated contractual cash flows or from a modification of the contractual terms of the liability. However, when changes in contractual cash flows arise from a modification of the contractual terms, an entity assesses whether those changes result in the derecognition of the original financial liability and the recognition of a new financial liability by applying paragraphs 3.3.2 and B3.3.6 of IFRS 9.

The Committee also noted that the application of paragraph B5.4.6 of IFRS 9 depends on a bank’s estimates of expected future cash flows in calculating the effective interest rate at initial recognition of the financial liability because paragraph B5.4.6 requires the use of the original effective interest rate to discount the revised cash flows.

The Committee observed that the question of how conditionality related to the contractual interest rate is reflected in the estimates of expected future cash flows when applying the effective interest method affects both initial and subsequent measurement. As this question is part of a broader matter, the Committee considered that it should not be analysed solely in the context of TLTRO III tranches. The Committee is therefore of the view that the IASB should consider this matter as part of the post-implementation review of the classification and measurement requirements in IFRS 9, together with similar matters already identified in the first phase of that review.

Disclosure 

If a bank assesses that the ECB meets the definition of government in IAS 20 and that it has received government assistance from the ECB, the bank needs to provide the information required by paragraph 39 of IAS 20 regarding government grants and government assistance.

Given the judgements required and the risks arising from the TLTRO III tranches, a bank also needs to consider the requirements in paragraphs 117, 122 and 125 of IAS 1 Presentation of Financial Statements, as well as paragraphs 7, 21 and 31 of IFRS 7 Financial Instruments: Disclosures. These paragraphs require a bank to disclose information that includes its significant accounting policies and management’s assumptions and judgements in applying its accounting policies that have the most significant effect on the amounts recognised in the financial statements.

Conclusion 

The Committee concluded that IAS 20 provides an adequate basis for the bank to assess whether TLTRO III tranches contain a portion that is treated as a government grant in IAS 20 and, if so, how to account for that portion.

Regarding the question of how conditionality related to the contractual interest rate is reflected in the estimates of expected future cash flows when calculating the effective interest rate at initial recognition or in the revisions of estimated future cash flows on subsequent measurement of the financial liability, the Committee concluded that the matters described in the request are part of a broader matter that, in isolation, are not possible to address in a cost-effective manner and should be reported to the IASB. The IASB should consider this matter as part of the post-implementation review of the classification and measurement requirements in IFRS 9.

For these reasons, the Committee decided not to add a standard-setting project to the work plan.

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