Income Recognition Principle: Do You Think The Fair Value Of The Land Is Income To The Company? The fair value of the land should be a direct credit to equity.
Income Recognition Principle: Fair Value Of Land
- Under the Framework, income is defined as follows:
Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
- Arguments for direct credit to equity
- Those who would argue that the government’s contribution of land to the company is not income say that the government is not an equity participant in the business – that is, the government does not own shares of stock and is not entitled to dividends or other return on its contribution of the land.
- They also argue that the grant is not earned in the same way as income from the sales of goods and services is earned. Rather, it is simply an incentive provided by the government without any related costs.
- Therefore the land should be recognized as a direct credit to equity. It would be reported in the statement of financial position as a capital contribution from government. Sometimes this is described as “donated capital”.
- Arguments for income recognition:
- On the other hand, some accountants argue that it is income because the land is owned by the company, that it increases the assets attributable to the shareholders of the company, and that after the company meets its obligations to employ the specified number of people for the specified period of time, the company can sell the land and distribute the proceeds to shareholders.
- Also, while the land is held, it helps to generate profits (benefits) for the company, and those profits benefit the shareholders in the form of increased dividends and/or share value.
- Additionally, grants come with “strings attached” – in this case the company must employ a certain number of people for a specified time. This involves a cost. The grant is income to be matched against that cost.
- Also, government grants are like a “reverse income tax” – where the government gives something to the taxpayer rather than the taxpayer giving something to the government. Grants, like taxes, are determined based on a country’s fiscal and social policies. When a company pays taxes, it recognizes tax expense. When a company receives a grant, it should recognize grant income.