Accounting for government grants: help for Innovate UK recipients

Winning an Innovate UK grant is a big achievement. But once the celebrations are over, someone has to work out how the funding and project costs should appear in your accounts. Accounting for government grants is not always as simple as it sounds.

The main thing to understand is that grant income does not automatically belong in your accounts when the cash reaches your bank. Your accounting records can also run to a different timetable from your Innovate UK claims.

Get the treatment wrong and your figures could be misleading – showing a large loss in one period and an artificial profit in another. Poor records can also cause problems when a claim needs to be independently checked.

This guide keeps things practical. It is intended for UK companies applying FRS 102, the accounting standard used by many small and medium-sized businesses. If your business uses FRS 105, IFRS or another framework, ask your accountant which rules apply.

Start with your grant offer letter

Before accounting for anything, find the documents that establish what you are entitled to claim. These will normally include:

• Your signed grant offer letter
• The project start and end dates
• Your approved budget
• The funding percentage
• The eligible cost categories
• Your claim and reporting deadlines

Make sure whoever looks after your finances can access this information.

Costs incurred before Innovate UK authorises the project will not normally be eligible. UKRI explains what happens after you receive a funding offer.

How accounting for government grants works

Under FRS 102, recognising grant income is not simply a matter of recording the cash when it arrives.

Before recognising a grant, the business must have reasonable assurance that it will comply with the grant conditions and that the funding will be received.

FRS 102 then permits two approaches: the performance model and the accrual model. The accounting policy must be chosen and applied consistently on a class-by-class basis.

The performance model

Under the performance model, a grant containing specified future performance conditions is recognised as income only when those conditions are met.

A grant without specified future performance conditions is generally recognised when it becomes receivable. Funding received before the recognition conditions are met is recorded as a liability.

The accrual model

Under the accrual model, a revenue grant is recognised systematically over the periods in which the business records the costs the grant is intended to compensate.

A grant relating to an asset is normally recognised over that asset’s expected useful life. Funding received before the recognition criteria are met is recorded as a liability, usually described as deferred income.

For accounting periods beginning on or after 1 January 2026, the September 2024 edition of FRS 102 continues to permit both models. You can read the current FRS 102 standard on the Financial Reporting Council website.

Your accountant can help determine which model applies to each class of grant and ensure that the policy is used consistently.

Grant income and grant payments are not the same thing

This is where many businesses get tripped up.

Suppose your grant covers 50% of eligible project costs. During an accounting period, you spend £60,000 on qualifying work. Therefore, your next claim will be for £30,000 – but you may not submit the claim or receive payment until after your year-end.

Assuming the accrual model applies and the recognition conditions have been met, your accounts for that period could show:

• £60,000 of project costs
• £30,000 of grant income
• A £30,000 grant receivable

When Innovate UK subsequently pays the £30,000, the payment clears the amount owed to you. It does not create another £30,000 of income.

The lesson is simple: do not post every grant payment directly to income. If you do, your accounts may not reflect what actually happened during the period.

Keep your books tidy

A little structure at the beginning of the project can save a great deal of work later.

Set up separate accounts so you can identify:

• Grant income recognised
• Grant funding receivable
• Any grant funding received in advance
• Deferred grant income

Give the project its own code or reference and tag every related cost to it. Continue to use normal expense categories such as wages, subcontractors, materials and travel rather than putting everything into a single “grant costs” account.

This allows you to answer two important questions:

1. What was the cost?
2. Which project did it relate to?

Your grant claims, management reports and any subsequent independent examination will all be easier to prepare.

Your accounts and your claim may not match exactly

Statutory accounts follow accounting standards. Your Innovate UK claim follows Innovate UK’s eligibility rules. The two are connected, but they serve different purposes, so their totals may legitimately differ.

Do not try to force them to match. Instead, maintain a straightforward reconciliation explaining the differences.

For example, an expense may be valid in your accounts but ineligible for reimbursement under the grant. That is not necessarily a problem, provided it is identified and excluded from the claim.

Keep invoices, timesheets, payroll records, proof of payment and other supporting evidence together. Your records should show clearly how every claimed cost relates to the project. You can check the current terms and conditions of an Innovate UK grant award for more information.

Check the project every month

Do not leave everything until the next claim deadline.

Each month, check that:

• Costs have been coded to the correct project
• No costs have slipped in from outside the approved project dates
• Grant income has been recognised under the appropriate accounting policy
• Receivables and deferred income are properly up to date
• Actual spending is being compared with your approved budget
• Supporting documents are complete

Regular checks help prevent artificial swings between losses and profits. They also make it much easier to produce the spending forecasts and financial information Innovate UK may request.

What about VAT?

Innovate UK grant funding will normally be outside the scope of VAT, as the funding is not generally payment for a supply made to Innovate UK. You therefore do not add VAT to the grant income.

If your business is VAT-registered and can recover the VAT on a project cost, your grant claim should normally use the cost excluding recoverable VAT.

If your business is not VAT-registered, or the VAT genuinely cannot be recovered, it may be possible to include that VAT in the eligible cost. Continue recording purchase VAT through your usual accounting system.

The Innovate UK costs guidance for non-academic organisations explains the relevant rules in more detail.

Is an Innovate UK grant taxable?

It can be, but the answer depends on the purpose and nature of the funding.

Grants covering day-to-day costs such as wages and materials will often be treated as trading income and can therefore affect your taxable profit.

The treatment of grants relating to capital expenditure can be different. The funding may affect the expenditure qualifying for capital allowances rather than being taxed in the same way as ordinary trading income.

Grant funding can also affect an R&D tax relief claim, sometimes significantly. It is worth getting specialist R&D tax advice rather than making assumptions.

HMRC’s guidance on grants and subsidies provides more information about the distinction between revenue and capital grants.

If the numbers do not reconcile

A difference between your accounts and your grant claim is not automatically a problem. It may simply be caused by timing or differences in eligibility.

Common causes include:

• Costs coded to the wrong project
• Costs included outside the approved project period
• Invoices claimed before the relevant payment conditions were met
• Recoverable VAT included in the claim
• Missing or incomplete timesheets
• Grant income recorded twice
• Payments posted directly to income when a receivable had already been recognised

Do not post a journal merely to make the figures balance. Find the underlying cause and record the correct treatment.

Our Innovate UK cost guidance and audit checklist explains the common claim errors in more detail.

Tidy books make an independent review easier

Depending on the size and terms of your award, Innovate UK may require an Independent Accountant’s Report to support a claim.

If your accounting records are clean, complete and reconciled, tracing the claimed costs back to the evidence should be straightforward. Good records also reduce the risk of last-minute queries holding up your claim.

The best time to organise your grant accounting is at the beginning of the project. The second-best time is before your next claim – not the night before the final report is due.

Talk to THP

If your Innovate UK project is underway, THP can help you prepare for an Independent Accountant’s Report and provide a quote for our Grant Audit service.

To get started, you should send us:

• Your grant offer letter
• The project start and end dates
• Your next claim or reporting deadline
• The total value of the grant
• Your latest project-cost summary

Get in touch with THP and our friendly and experienced Grant Audit team will help you take the next step.