Accounting for Production Linked Incentive (PLI) Scheme

Accounting for Production Linked Incentive (PLI) Scheme

The Production Linked Incentive (PLI) scheme was originally introduced by the Government of India in March 2020 covering three sectors1, viz.,
(i) mobile manufacturing and electric components,
(ii) pharmaceutical (critical key starting materials active pharmaceutical ingredients), and
(iii) medical device manufacturing. Since then, the coverage of PLI has been expanded, with schemes being rolled out for multiple sectors to boost India's manufacturing capabilities and encourage export-oriented production. Presently, PLI Schemes cover various sectors including auto components, automobile, aviation, chemicals, electronic systems, food processing, medical devices, metal and mining, pharmaceuticals, renewable energy, telecom, textiles and apparels and white goods. The PLI scheme aims at incentivizing companies to boost domestic manufacturing and attract large investments which ultimately help India in increasing export, reducing impact and generating employment.

There are peculiarities and differences in the PLI scheme applicable to each industry. For e.g., as per the scheme applicable for white goods, PLI incentive and eligibility criteria for air conditioners (ACs); AC components (large investments) are as below

For availing PLI benefit, a company may make an investment in greenfield or brownfield projects. The company should also make incremental investment in purchase/ production of plant and machinery, technical transfer fee, research, and development expenses, etc.

We understand that whilst conditions related to incremental investment and incremental sales have been prescribed for most sectors, the exact quantum, incentives, and certain conditions vary, depending upon the underlying sector, type of product and fulfillment of criteria. Each eligible entity desirous of availing an incentive under the PLI scheme needs to evaluate its compliance based on specific notification, guidelines and other requirements prescribed by the government.

From an accounting perspective, PLI incentive meets the definition of a government grant under Indian Accounting Standard (Ind AS 20) Accounting for Government Grants and Disclosure of Government Assistance and, therefore, is treated as such.

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 reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the entity.

Recognition criteria

As per paragraph 8 of Ind AS 20, government grants, including non-monetary grants at fair value, shall not be recognized until there is reasonable assurance that the entity will comply with the conditions attaching to them, and the grant will be received.

The evaluation of whether and when an entity meets the recognition criteria under Ind AS 20 requires exercise of judgment based on the requirements of the scheme and entity specific facts, including but not limited to progress on the application made by the entity, its ability to meet prescribed criteria as well as additional requirements, if any, laid by the approving authority, interpretation issues involved and others. The entity should start applying government grant accounting only if it can demonstrate its ability to meet prescribed requirements for receiving incentive under the PLI scheme.

If the recognition criteria is met, certain peculiar issues might arise in applying the principles under Ind AS 20. This article looks at those issues and possible views. In preparing this article, whilst PLI Scheme applicable to white goods has been referred to, we believe that similar consideration would apply in other cases also.

1. Gazette Notification No.CG-DL-E-01042020-218990 dated April 01, 2020 Gazette Notification No. CG-DL-E-21072020-220617 dated July 21, 2020

Asset related grant vs. income related grant

As per paragraph 3 of Ind AS 20, grants related to assets are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term assets, and grants which are not the asset related grant are considered as income related grants.

Considering the nature of the grant and the fact that the PLI scheme contains conditions both related to incremental investment and incremental sales, one may argue the following views on this matter.

View 1: PLI scheme is an asset related grant

One may argue that incremental investment/ acquisition of asset is the primary eligibility condition because without making incremental investment, the grant would not be received. Therefore, the condition relating to the acquisition of asset is a primary condition. Incremental sales are the result of the investment made by an entity and hence, consequent incremental sales is only an incidental condition. Thus, PLI is an asset related grant.

View 2: PLI is a grant related to income

The PLI scheme specifies two conditions for entities to become eligible for such grant, i.e., incremental investment and incremental sales. One may argue that whilst it is true that without acquisition of the assets, the eligible criteria will not commence, however, it can only be completed after the entity is able to achieve incremental sales. Thus, incremental sale is a primary condition, and hence it is an income related grant. This view can be supported by the following further arguments:

• The amount of grant is determined as a percentage of incremental sales, thereby suggesting that incremental sale
is a very important condition.
• The PLI scheme is aimed at helping companies achieve better performance. It is intended to ensure level playing field for Indian companies by compensating them for challenges faced resulting from higher operating costs and thereby, enabling companies to price their product in a more competitive manner.
• Even without the PLI scheme, entities can make investments; however, without appropriate support for their operating margin, practically it is not economically viable for entities to make such investments.
• PLI grant is treated as deferred income to be presented as a liability in the balance sheet. Such deferred income is recognized in profit or loss on a systematic basis over the useful life of the asset. Under this option, there are below two options with regard to presentation of grant amortization in profit or loss:
  • As reduction from depreciation expense on the relevant asset, or
  • Under general heading such as ‘Other income’
• If an entity opts to include the grant amortization under ‘Other income’, a related questing arises whether such amortization should be presented as ‘Other income’ only or it can also be presented as ‘Other operating revenue.’ This issue is not specifically addressed in authoritative guidance. We believe that one may make below key arguments to support ‘Other operating revenue’ presentation:
• Ind AS 20 has in-built flexibility with regard to presentation of government grant and presentation as ‘Other income’ is only an example. The overarching principle is that such a grant cannot be clubbed with the revenue from contracts with customers. The entity considers this aspect and other factors such as nature of grant, cost the grant is intending to compensate, linkage with operating activities, and decides an appropriate heading under which grant is presented. Since grant is closely related to operating activities and intends to compensate for higher operating costs / lower revenue, it can be argued that the grant arises from the company’s operating activities and should be presented as ‘Other operating revenue.’
• Recognition of grant under Ind AS 20 is based on the key principle that it is matched with related activity/ income/ expense. It may be argued that the said principle is also maintained regarding the presentation of grants.
• The Guidance Note on Ind AS Schedule III provides the following guidance with regard to ‘Other operating revenue’. “9.1.8. The term ‘other operating revenue’ is not defined. This would include revenue arising from a company’s operating activities, i.e., either its principal or ancillary revenue-generating activities, but which is not revenue arising from sale of products or rendering of services. Whether a particular income constitutes ‘other operating revenue’ or ‘other income’ is to be decided based on the facts of each case and detailed understanding of the company’s activities.”

PLI as an income related grant — subsequent accounting treatment

Attention is drawn to paragraphs 12 and 29 of Ind AS 20, income related grants should be recognized in profit or loss on a systematic basis over the periods in which the entity recognizes the related expenses and it could be presented either separately or under a general heading such as ‘Other income’ in the profit and loss. Alternatively, income related grants can be deducted from the related expense presented in the profit and loss.

In the context of PLI, it may be difficult to identify any specific expense which the grant is intended to compensate. In the absence of any other criteria, one may argue that the entity is incurring overall expenses in terms of higher production cost and the same are being compensated through PLI incentive. Hence, PLI grant income is recognized in the profit or loss based on actual/ estimated sales during the year.

Regarding presentation in profit or loss, attention is drawn to guidance under the previous issue relating to subsequent accounting treatment of a PLI incentive considered as an asset related grant. Considering similar arguments, one may take a view that the amount can be presented under the head ‘Other operating revenue/ Other income’.

Accounting in the quarterly financial results

Ind AS 34 Interim Financial Reporting provides as below:

“37. Revenues that are received seasonally, cyclically, or occasionally within a financial year shall not be anticipated or deferred as of an interim date if anticipation or deferral would not be appropriate at the end of the entity’s financial year.

38. Examples include dividend revenue, royalties, and government grants. Additionally, some entities consistently earn more revenues in certain interim periods of a financial year than in other interim periods, for example, seasonal revenues of retailers. Such revenues are recognized when they occur.”

Based on the above, at each reporting date including at the end of each quarter, an entity will need to assess and exercise judgement whether grant conditions are expected to be met. If the assessment indicates that there is a reasonable assurance that the condition will be met and the company will become eligible for the grant, recognition will be made on the same basis as that used for year-end financial statements in the quarterly results as well.