How to explain grant income

This article outlines how to explain a grant payment received into your business bank account in FreeAgent.

Once the relevant bank transaction has been imported into your FreeAgent account via a bank feed or uploaded from a bank statement, you will need to explain it using the appropriate ‘Type’ and ‘Category’ as detailed below.

You’ll need to have level 6 access or above to your FreeAgent account to explain bank transactions.

For information on how to explain a grant received under the Coronavirus Job Retention Scheme or Self-Employment Income Support Scheme, please see this article.

Explaining grant income paid into your business bank account

Begin by navigating to the ‘Banking’ tab at the top of the screen and selecting ‘Bank Accounts’ from the drop-down menu.

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Choose the relevant bank account from the list.

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Select the transaction that you’d like to explain.

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The way you explain the grant income in FreeAgent depends on the type of costs that the grant is intended to cover. The three types are day-to-day running costs, non-trading activity and capital costs. If you’re unsure which you should use, please speak to your accountant to keep yourself right.

Running costs

If the grant is intended to cover day-to-day running costs that would normally be recorded on your profit & loss report, then the grant would be recorded as taxable income. This also applies to grants that aren’t for a specific purpose but will cover general trading costs.

To explain this type of grant income, select ‘Other Money In’ from the transaction ‘Type’ drop-down menu and ‘Grant Income’ from the ‘Category’ drop-down menu.

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Select ‘Explain Transaction’ to complete the process.

A record of the bank transaction being explained will appear in your Audit Trail report.

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Running costs over several years

If the grant covers running costs that’ll last for a number of years, the income should be recognised over the same time span. In this scenario, you’ll need to create journal entries to spread the income by means of accruals. If you’re unsure which journal entries are required, please speak to your accountant.

Non-trading activity

If the grant is intended to cover non-trading activity, then the grant shouldn’t be recorded as taxable income. In this scenario, you can either explain the grant to a dummy bank account, dummy user or as grant income. If you’re unsure which option you should use, please speak to your accountant.

Dummy bank account

One option to explain a grant intended to cover non-trading activity is to add a dummy bank account to FreeAgent to represent the grant. To do this, you will first need to add a new bank account.

Then, when explaining the bank transaction, select ‘Transfer from Another Account’ from the transaction ‘Type’ drop-down menu and choose the dummy bank account that you added from the ‘Bank Account’ drop-down menu.

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Select ‘Explain Transaction’ to complete the process.

The bank account will then show as a liability in the balance sheet.

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Dummy user

Alternatively, you can create a dummy user to represent a grant intended to cover non-trading activity. To do this, you will first need to add a new user to your FreeAgent account.

Then, when explaining the bank transaction, select ‘Money Received from User’ from the transaction ‘Type’ drop-down menu and the dummy user that you added from the ‘Received from’ drop-down menu.

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If your business is a limited company, select ‘Payment to Director Loan Account’ from the ‘Category’ drop-down menu.

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If your business is a sole trader, partnership or LLP, select ‘Capital Introduced’ from the ‘Category’ drop-down menu.

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Select ‘Explain Transaction’ to complete the process.

The ‘user’ will then show as a liability in the balance sheet.

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Grant income

A final option to explain a grant intended to cover non-trading activity is to use FreeAgent’s default ‘Grant Income’ category. Please note that using this method will record the grant as taxable income in your accounts. Therefore, you’d need to create journal entries to adjust the tax calculation in your accounts. If you’re unsure which journal entries are required, please ask your accountant.

To do this, when explaining the bank transaction, select ‘Other Money In’ from the transaction ‘Type’ drop-down menu and ‘Grant Income’ from the ‘Category’ drop-down menu.

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Select ‘Explain Transaction’ to complete the process.

Regardless of which way you choose to explain the grant income, a record of the bank transaction being explained will appear in your Audit Trail report.

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Capital costs

If the grant is intended to cover capital costs, such as buying a new asset, then it will normally be used to reduce the value of the asset in the balance sheet. The way to explain this type of grant depends on whether you received the grant before or soon after the asset was bought, or a long time after the asset was bought.

Explaining grant income received before or soon after the asset was bought

If you received the grant before or soon after the asset was bought, select ‘Other Money In’ from the transaction ‘Type’ drop-down menu and ‘Receipt into Contra Account’ from the ‘Category’ drop-down menu when explaining the bank transaction.

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Select ‘Explain Transaction’ to complete the process.

A record of the bank transaction being explained will appear in your Audit Trail report.

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Explaining the capital asset purchase

In this scenario, once the payment for the purchase of the capital asset has been imported into FreeAgent, you’ll need to split the bank transaction between the amount covered by the grant and the remaining value.

For the amount of the purchase that is covered by the grant, select 'Other Money Out’ from the transaction ‘Type’ drop-down menu and ‘Payment from Contra Account’ from the ‘Category’ drop-down menu.

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For the remaining value of the purchase, select ‘Purchase of Capital Asset’ from the transaction ‘Type’ drop-down menu, the useful life from the ‘Asset Life’ drop-down menu and the relevant type from the ‘Asset Type’ drop-down menu. If you’re VAT-registered and you’re unsure what the rate of VAT should be, please ask your accountant.

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Explaining grant income received a long time after the asset was bought

If the capital asset purchase has already been explained in a previous accounting year, a year’s worth of depreciation will already have been accounted for.

In this scenario, when explaining the transaction, select ‘Other Money In’ from the transaction ‘Type’ drop-down menu and ‘Receipt into Contra Account’ from the ‘Category’ drop-down menu.

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Select ‘Explain Transaction’ to complete the process.

A record of the bank transaction being explained will appear in your Audit Trail report.

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Creating journal entries

You’ll then need to create journal entries to reduce the asset’s net book value, its subsequent depreciation and to clear the balance in the contra account.

To do this, you’ll need to create the following journals dated the day that the grant was received:

  • Debit code ‘998 - Contra Account’ for the value of the grant
  • Credit code ‘604-4 - Other Capital Asset Disposal’ for the value of the grant
  • Debit code ‘606-4 - Other Capital Asset Depreciation In Year’ for the difference between one year’s depreciation of the asset at its full cost and one year’s depreciation of the asset at the cost not covered by the grant
  • Credit code ‘460 - Depreciation Charge’ for the difference between one year’s depreciation of the asset at its full cost and one year’s depreciation of the asset at the cost not covered by the grant

The following journals would need to be created, dated the end of your accounting year each year:

  • Debit code ‘606-4 - Other Capital Asset Depreciation In Year’ for the difference between one year’s depreciation of the asset at its full cost and one year’s depreciation of the asset at the cost not covered by the grant
  • Credit code ‘460 - Depreciation Charge’ for the difference between one year’s depreciation of the asset at its full cost and one year’s depreciation of the asset at the cost not covered by the grant

If you have a limited company account, you’ll also need to adjust your Corporation Tax liability figures as FreeAgent will calculate capital allowances on the full cost of the asset, not the amount excluding the value of the grant. If you’re unsure which journal entries to create, please ask your accountant.

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