Introduction
In an increasingly interconnected world, businesses occasionally receive assets at no cost. These “free” assets can come from various sources, such as government grants, donations, or promotional campaigns. However, even though the assets are received at no cost, their accounting treatment still needs to follow the requirements of International Financial Reporting Standards (IFRS).
In this tutorial, we’ll explore how to account for free assets received under IFRS. We’ll cover the key principles of asset recognition, measurement, and journal entries, as well as provide illustrative examples with financial statement impacts. By the end of this tutorial, you’ll have a comprehensive understanding of how free assets are handled in financial reporting.
Key IFRS Standards Involved
Before diving into the details, let’s identify the relevant IFRS standards that guide the accounting for free assets:
- IAS 16 – Property, Plant, and Equipment (PPE): This standard provides guidance on the recognition, measurement, and depreciation of tangible fixed assets.
- IAS 20 – Accounting for Government Grants and Disclosure of Government Assistance: This standard covers the accounting treatment of government grants, which can include assets received for free from the government.
- IAS 38 – Intangible Assets: This standard addresses the accounting for intangible assets received for free, such as patents or software.
- IAS 8 – Accounting Policies, Changes in Accounting Estimates, and Errors: When no specific standard applies, IAS 8 helps determine appropriate accounting policies.
Core Principles
The general principles for accounting for free assets are similar to those of purchased assets, with key differences due to their nature (i.e., they are received at no cost). The key steps are:
- Recognition: Determine whether the asset meets the recognition criteria.
- Measurement: Measure the asset at its fair value upon initial recognition.
- Disclosure: Disclose information about the receipt of the free asset and how it has been accounted for.
Recognition of Free Assets
Under IFRS, an asset should be recognized in the financial statements when it meets the following criteria:
- Control: The entity has control over the asset.
- Future Economic Benefits: The asset is expected to bring future economic benefits.
- Reliable Measurement: The fair value of the asset can be reliably measured.
Free assets, if they meet these criteria, must be recognized despite no outflow of resources. Control refers to the entity’s ability to direct the use of the asset and obtain benefits from it, while reliable measurement typically involves estimating the asset’s fair value.
Initial Measurement of Free Assets
When an asset is received for free, its cost on initial recognition is its fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
To determine fair value, entities may use observable market prices, recent transactions for similar assets, or a valuation model.
Example 1: Free Equipment Received
Let’s say a company, GreenTech Ltd., receives a piece of machinery for free from a government agency to promote sustainable energy production. The fair value of the machinery is determined to be $100,000. GreenTech must record the machinery in its financial statements even though it did not pay for it.
Journal Entries
When the machinery is received, the following journal entry will be recorded:
Date | Account | Debit | Credit
------------|-----------------------------|-----------|---------
2024-01-15 | Machinery (PPE) | 100,000 |
| Government Grant Income | | 100,000Explanation:
- Debit: The “Machinery” account is debited to reflect the recognition of the asset.
- Credit: The “Government Grant Income” account is credited to recognize the income related to receiving the machinery.
Under IAS 20, entities can choose to recognize the grant either as deferred income or deduct it from the carrying amount of the asset. Let’s assume GreenTech opts to treat the government grant as deferred income.
Date | Account | Debit | Credit
------------|-----------------------------|-----------|---------
2024-01-15 | Machinery (PPE) | 100,000 |
| Deferred Income (Liability) | | 100,000Now, let’s say the useful life of the machinery is 10 years, and GreenTech uses straight-line depreciation.
Depreciation Journal Entry (End of Year)
At the end of each year, GreenTech will depreciate the machinery and recognize income from the deferred government grant.
Date | Account | Debit | Credit
------------|-----------------------------|-----------|---------
2024-12-31 | Depreciation Expense | 10,000 |
| Accumulated Depreciation | | 10,000Date | Account | Debit | Credit
------------|-----------------------------|-----------|---------
2024-12-31 | Deferred Income (Liability) | 10,000 |
| Government Grant Income | | 10,000Financial Statement Impact
The initial recognition of the machinery and the government grant will be reflected in the financial statements as follows:
- Balance Sheet (2024-01-15):
- Machinery: $100,000
- Deferred Income (Liability): $100,000
- Income Statement (2024-12-31):
- Depreciation Expense: $10,000
- Government Grant Income: $10,000
- Balance Sheet (2024-12-31):
- Machinery (Net of Accumulated Depreciation): $90,000
- Deferred Income (Liability): $90,000
As the asset is depreciated over its useful life, both the deferred income and the machinery account will decrease by equal amounts, creating a neutral effect on the income statement from a profit and loss perspective.
Example 2: Free Intangible Asset Received
Now, let’s consider a different scenario. BlueTech Ltd., a software company, receives free proprietary software from a university as part of a research collaboration. The fair value of the software is $50,000.
Journal Entries
Date | Account | Debit | Credit
------------|-----------------------------|-----------|---------
2024-02-01 | Intangible Assets (Software) | 50,000 |
| Donation Income | | 50,000Depreciation (Amortization)
BlueTech determines that the software has a useful life of 5 years. It uses straight-line amortization.
Date | Account | Debit | Credit
------------|-----------------------------|-----------|---------
2024-12-31 | Amortization Expense | 10,000 |
| Accumulated Amortization | | 10,000Financial Statement Impact
- Balance Sheet (2024-02-01):
- Intangible Assets: $50,000
- Donation Income: $50,000
- Income Statement (2024-12-31):
- Amortization Expense: $10,000
- Donation Income: $50,000 (one-time entry on the date of receipt)
- Balance Sheet (2024-12-31):
- Intangible Assets (Net of Accumulated Amortization): $40,000
Unlike government grants, donations often have no deferral, so they are recognized as income upfront, impacting the income statement immediately. The asset is then amortized over its useful life, reducing net income in subsequent periods.
Example 3: Free Land Received for Development
A real estate company, UrbanDevelopers Ltd., receives a plot of land valued at $1,000,000 from a city government to promote economic development in the area.
Journal Entries
Upon receiving the land, the journal entry is:
Date | Account | Debit | Credit
------------|-----------------------------|-----------|---------
2024-03-01 | Land (PPE) | 1,000,000 |
| Government Grant Income | | 1,000,000If UrbanDevelopers decides to treat this as a deferred government grant, the deferred income would be recognized gradually as the land is developed.
If the land is held indefinitely and not depreciated (as is often the case with land), UrbanDevelopers may recognize the grant income once the land is put to use or based on milestones achieved during the development project.
Financial Statement Impact
- Balance Sheet (2024-03-01):
- Land: $1,000,000
- Government Grant Income: $1,000,000 (if recognized upfront)
- or
- Deferred Income: $1,000,000 (if deferred)
Conclusion
Accounting for free assets received under IFRS involves several key principles:
- Recognition: The asset must meet the definition and recognition criteria.
- Initial Measurement: Free assets are measured at their fair value on the date of receipt.
- Income Recognition: Grants or donations may be recognized as income immediately or deferred and recognized over time as the asset is used.
By applying these principles and complying with relevant IFRS standards (IAS 16, IAS 38, IAS 20, etc.), entities ensure transparent and accurate financial reporting.
The examples provided highlight how free assets impact both the balance sheet and income statement, demonstrating the importance of fair value measurement and appropriate recognition of income or deferred liabilities.
This knowledge helps companies recognize and disclose free assets properly, ensuring compliance
with IFRS and enhancing the quality of financial statements for stakeholders.