Advanced Accounting · AS 12 Accounting for Government Grants

AS 12 Accounting Treatment: Capital and Revenue Approach

Updated 4 October 2026 · Fact-checked

AS 12 says a government grant is not taken to profit or loss merely because it is received. A grant is recognised only when there is reasonable assurance that the entity will comply with its conditions and that the grant will be received. It is then recognised over the periods that bear the related costs. Grants for expenses or losses already incurred, or for immediate support, are recognised when receivable. Promoters' contribution goes to capital reserve.

Understand Accounting Treatment: Capital and Revenue Approach

A government grant is assistance by government in cash or kind to an entity, in return for past or future compliance with conditions. AS 12 asks one question: how do you show this grant in the books? There are two approaches.

Under the capital approach, the grant is treated as part of shareholders' funds. It is credited directly to capital reserve and never passes through profit or loss. Under the income approach, the grant is taken to profit or loss over one or more periods. AS 12 supports the income approach. Its reasoning: grants come from the government, not from shareholders, and they are given for specific purposes. So they should match the costs they are meant to offset. This is why a grant for a depreciable asset is not simply credited to capital reserve. It is taken to income in step with depreciation.

The treatment depends on what the grant relates to.

Depreciable fixed assets: the grant is allocated to profit or loss over the periods and in the proportion in which depreciation on that asset is charged. Presentation can be by deducting the grant from the asset's gross value (depreciation then runs on the reduced amount), or by showing it as deferred income in the balance sheet and crediting a part to profit or loss each year.
Non-depreciable assets (such as land): a grant is credited to capital reserve. If the grant requires fulfilling certain obligations, for example constructing a building on the land, the grant is credited to income over the same period and in the same proportion as the cost of meeting those obligations.
Revenue items: a grant for expenses is shown in profit or loss, either as a separate credit or under a general head such as other income, or deducted from the related expense. A grant receivable as compensation for expenses or losses already incurred, or for immediate financial support with no future related costs, is recognised in profit or loss in the period it becomes receivable.
Promoters' contribution: a grant in the nature of a promoters' contribution is given with reference to the total investment in an undertaking, or as a contribution towards its total capital outlay, and no repayment is ordinarily expected. It is credited to capital reserve and treated as part of shareholders' funds.

The key idea is matching. Income from a grant follows the cost it is meant to support. That is why a grant for a machine is spread over the life of the machine, and why a grant for land with no obligation goes to capital reserve.

Key rules to remember

Grant on depreciable asset: deduction method: Net cost of asset = Gross cost − Grant; Depreciation = on Net cost; Use when the question says the grant is deducted from the asset. Depreciation is charged on the reduced amount, so the grant flows to profit or loss automatically.
Grant on depreciable asset: deferred income method: Annual credit to P&L = Grant × (Depreciation of the year ÷ Total depreciation over the life); With straight-line depreciation and no residual value this is Grant ÷ useful life. Depreciation is charged on the full cost.
Grant for non-depreciable asset, no obligation: Credit Capital Reserve with the full grant; Not taken to profit or loss.
Grant for non-depreciable asset with obligation: Credit to income each year = Grant × (Cost of obligation met in the year ÷ Total cost of obligation); If the obligation is, for example, to build a factory on the land, spread the grant over the building's life in proportion to its cost charge.
Revenue grant: Recognise in P&L in the period of the related expense; Show as other income, or deduct from the related expense. If it compensates for expenses or losses already incurred, or gives immediate support, recognise it in the period it becomes receivable.
Promoters' contribution: Credit Capital Reserve; treat as shareholders' funds; Applies to grants given with reference to total investment or total capital outlay, with no repayment ordinarily expected.

How to solve Accounting Treatment: Capital and Revenue Approach questions

Use the same sequence for any AS 12 treatment question. Decide the nature of the grant first, because everything else follows from it.

1Read what the grant is for: a depreciable asset, a non-depreciable asset, a revenue expense, or general support to the entity.
2Check for conditions or obligations attached to the grant, such as constructing a building or running operations for some years.
3If it relates to a depreciable asset, see which presentation the question asks for: deduct from asset cost, or deferred income. If it is silent, show both or state the method you choose.
4For the deduction method, compute net cost, then depreciation on net cost for each year, and the book value at the required date.
5For the deferred income method, compute depreciation on full cost and credit the grant to profit or loss in the same proportion as depreciation. Show the unamortised balance as deferred income.
6For non-depreciable assets, credit capital reserve if there is no obligation. If there is an obligation, spread the grant over the obligation period.
7For revenue grants, credit profit or loss in the period in which the related expense is incurred. If the grant covers expenses already incurred or gives immediate support, credit it in the period it becomes receivable. For promoters' contribution, credit capital reserve.
8Write the journal entries and the extract of the balance sheet and profit and loss statement, and state the AS 12 reason in one line.

Quickest way: Classify, then match to the cost

When to use it: Use this in the exam hall for both MCQs and written answers.

Underline the purpose of the grant in the question. That one phrase decides the treatment.
Land with no condition, or promoters' contribution: capital reserve. Do not touch profit or loss.
Machine or building: choose between deduction from cost and deferred income. With straight-line depreciation and no residual value, the net P&L charge is the same each year under both methods, because the grant is credited in proportion to depreciation.
For MCQs, check the profit figure: under deduction, depreciation is lower. Under deferred income, depreciation is higher but grant income offsets it. With straight-line depreciation and no residual value, the net charge is the same.
In written answers, give the journal entry first, then a small table of year, depreciation, grant credit and closing balance. Step marks come from the working, so show each year clearly.
End with a one-line AS 12 reason, such as 'grant is recognised over the periods that bear the cost of the related asset'.

Common mistakes in Accounting Treatment: Capital and Revenue Approach

Crediting the whole grant to profit or loss in the year of receipt.
Students treat any government receipt as income.
Fix: Receipt alone is not recognition. Credit the grant to profit or loss over the periods that bear the related cost, unless it compensates for costs already incurred or gives immediate support.
Charging depreciation on the full cost when the grant is deducted from the asset.
Students forget that the deduction method reduces the depreciable base.
Fix: Under deduction, compute depreciation only on cost less grant. Under deferred income, use full cost and show the grant credit separately.
Taking a grant for land to profit or loss.
Students apply the depreciable asset logic to all assets.
Fix: Land is not depreciated, so a grant with no obligation goes to capital reserve. Spread it only if an obligation is attached.
Treating promoters' contribution like a revenue grant.
The word 'grant' makes students look for a matching expense.
Fix: If the grant is given with reference to total investment or total capital outlay, with no repayment ordinarily expected, credit capital reserve and treat it as shareholders' funds.
Showing deferred income as part of reserves or ignoring the unamortised balance.
Students stop after finding the annual credit.
Fix: Carry the unamortised balance forward as deferred income in the balance sheet and reduce it each year by the amount credited to profit or loss.

Worked examples

Example 1

A company bought a machine on 1 April for ₹50,00,000 and received a government grant of ₹10,00,000 for it. The machine has a useful life of 5 years with nil residual value. Depreciation is on the straight-line method. Show the accounting for the first two years (a) by deducting the grant from the cost of the asset and (b) by treating the grant as deferred income.

Show the solution

(a) Deduction method: net cost = ₹50,00,000 − ₹10,00,000 = ₹40,00,000.
Annual depreciation = ₹40,00,000 ÷ 5 = ₹8,00,000.
Book value at end of year 1 = ₹32,00,000. At end of year 2 = ₹24,00,000.
(b) Deferred income method: depreciation on full cost = ₹50,00,000 ÷ 5 = ₹10,00,000 per year.
Annual grant credit to profit or loss = ₹10,00,000 ÷ 5 = ₹2,00,000.
Deferred income balance: end of year 1 = ₹8,00,000; end of year 2 = ₹6,00,000.
Asset book value: end of year 1 = ₹40,00,000; end of year 2 = ₹30,00,000.
Net charge to profit or loss each year = ₹10,00,000 − ₹2,00,000 = ₹8,00,000, the same as under (a).

Answer: Deduction method: depreciation ₹8,00,000 a year; asset ₹32,00,000 and ₹24,00,000 at the end of years 1 and 2. Deferred income method: depreciation ₹10,00,000, grant credit ₹2,00,000, deferred income ₹8,00,000 and ₹6,00,000, asset ₹40,00,000 and ₹30,00,000. The net profit effect is ₹8,00,000 a year in both.

Example 2

A company received two separate grants. Grant A of ₹30,00,000 was given for acquiring a plot of land in a backward area, with no obligation attached. Grant B of ₹24,00,000 was given under a different scheme for a second plot of land, on the condition that the company constructs a factory building on that plot. The building costs ₹1,20,00,000, has a useful life of 20 years and is depreciated on a straight-line basis with nil residual value. The building is completed and put to use at the start of the year. Show the treatment of both grants and the amount credited to profit or loss in the first year of use of the building.

Show the solution

Grant A of ₹30,00,000: land is non-depreciable and no obligation is attached, so credit capital reserve with ₹30,00,000. Nothing goes to profit or loss.
Grant B of ₹24,00,000: it relates to non-depreciable land but carries an obligation, namely constructing the building. So it is credited to income over the period and in the proportion in which the cost of meeting the obligation is charged. The cost of the obligation is charged through depreciation on the building, so the grant is spread over the building's life.
Annual depreciation on the building = ₹1,20,00,000 ÷ 20 = ₹6,00,000.
Total depreciation over life = ₹1,20,00,000. Share of year 1 = ₹6,00,000 ÷ ₹1,20,00,000 = 1/20.
Grant B credited to profit or loss in year 1 = ₹24,00,000 × 1/20 = ₹1,20,000.
Deferred income at the end of year 1 = ₹24,00,000 − ₹1,20,000 = ₹22,80,000.

Answer: Grant A of ₹30,00,000 goes to capital reserve. Grant B of ₹24,00,000, which carries the obligation to construct the building, is credited to profit or loss at ₹1,20,000 a year, leaving deferred income of ₹22,80,000 at the end of year 1.

Exam tips

Always state the nature of the grant in your first line. Examiners award marks for correct classification before any calculation.
When the question does not specify a method for a depreciable asset, show both presentations if time permits, and point out that with straight-line depreciation and no residual value the net P&L charge is the same, because the grant is credited in proportion to depreciation.
Give journal entries for receipt of the grant, annual depreciation and the annual transfer of deferred income. Each entry is a separate step mark.
In MCQs, look for the trap options: the full grant in profit or loss, depreciation on gross cost with the deduction method, or land grant spread over years.
Quote the principle in one line: grants are recognised over the periods that bear the cost they are meant to offset.

Practice questions from AS 12 Accounting for Government Grants

Accounting Treatment: Capital and Revenue Approach in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Accounting Treatment: Capital and Revenue Approach: frequently asked questions

What is the difference between the capital approach and the income approach in AS 12?

Under the capital approach, the grant is credited directly to shareholders' funds, such as capital reserve. Under the income approach, it is taken to profit or loss over the periods that bear the related cost. AS 12 favours the income approach for most grants.

Should a grant for a depreciable asset be deducted from cost or shown as deferred income?

AS 12 allows both. Under deduction, depreciation is charged on the reduced cost. Under deferred income, depreciation is on full cost and the grant is credited to profit or loss in proportion to depreciation. With straight-line depreciation and no residual value, the net effect on profit is the same each year.

How do you treat a grant related to non-depreciable assets like land?

If there is no obligation attached, credit it to capital reserve. If the grant requires you to meet an obligation, such as building a factory on the land, credit it to income over the period and in the proportion in which the cost of that obligation is charged.

Where does promoters' contribution go under AS 12?

A grant in the nature of promoters' contribution is given with reference to the total investment or total capital outlay of the undertaking, and no repayment is ordinarily expected. It is credited to capital reserve and treated as part of shareholders' funds.